Analyzing State Equilibrium Unemployment Rates

Persistence of unemployment rates Unemployment rates among states tend to stay low or stay high year after year.

Comparing unemployment rates among states Comparing unemployment rates among states is difficult as the rate in a particular year may be heavily influenced by the state’s sensitivity to the national business cycle. Unemployment due to the business cycle is thought to be a disequilibrium event.

Comparing unemployment rates among states One approach to overcome this is to determine a state’s equilibrium unemployment rate, then use this equilibrium rate to compare states. The point is to determine and explain what differences remain among states after business cycle effects are ruled out.

Determining the equilibrium unemployment rate An equilibrium unemployment rate implies that the unemployment rate is constant from year to year. This means that U t = U t-1 = U* where U* is the equilibrium unemployment rate, t is the current year, and t-1 is the previous year.

Determining the equilibrium unemployment rate We can determine the relationship between U t and U t-1. This will allow us to calculate the equilibrium unemployment rate. Consider the equation U t = α + βU t-1 The task is to: Estimate the equation, Substitute U* for U t and U t-1 : U* = α + βU* Solve for U* to obtain the equilibrium unemployment rate: U* = α / (1- β)

Determining the equilibrium unemployment rate

The relationship for Tennessee is shown in the previous slide: U t = U t-1 Setting U t = U t-1 = U* : U* = U*. Solving: U* = /( ) = 7.18%. Since the equation is estimated using data from , we can call this the long-run equilibrium unemployment rate.

Determining the equilibrium unemployment rate For the United States: U t = U t-1 Setting U t = U t-1 = U* : U* = U*. Solving: U* = /( ) = 6.53%. The U.S. equilibrium unemployment rate is lower than that of Tennessee. Why?

Explaining differences in equilibrium unemployment rates Reasons for differences in the equilibrium unemployment rate among states: – Compensating variations, – Structural characteristics, and – Wage rates.

Explaining differences in equilibrium unemployment rates Compensating variations : favorable climate, local amenities, low crime rates, and recreational opportunities cause residents to accept a higher unemployment rate than otherwise would occur. Unemployed residents are less willing to move to other states for jobs and give up local advantages.

Explaining differences in equilibrium unemployment rates Structural characteristics: workers who are highly educated are more able to move to other states for employment since demand for these workers is strong. Less educated workers with smaller incomes will have more difficulty paying all the costs of moving a household. These workers may also have more difficulty obtaining information about job opportunities.

Explaining differences in equilibrium unemployment rates Wage rates: states that offer higher wages by industry also have higher equilibrium unemployment rates. Higher than average government transfer payments may also have an impact.

Explaining differences in equilibrium unemployment rates Structural characteristics: research also shows that workers who are home owners and those who have resided in a state for at least 5 years are less likely to move on.

A Model of Equilibrium Unemployment Rates

Selected Indicators for Tennessee

Equilibrium Unemployment Rates and Bachelor’s Degree

Equilibrium Unemployment Rates and No High School Diploma

Model Results

Results The equilibrium unemployment rate clearly is: – Inversely related to the percent of the population with a least a Bachelor’s degree, and – Directly related to the percent of the population without a high school diploma. – The other variables, home owner cost, heating degree days, and cloudy days, are significant but ambiguous, since the signs are the opposite

Model Results A 1 percentage point rise in Bachelor’s degrees will reduce the equilibrium unemployment rate by 0.14 percentage points. A 1 percentage point reduction in the percent without a high school diploma will reduce the equilibrium unemployment rate by 0.44 percentage points.

Model Results Clearly, a 1 point rise in high school diplomas is much more effective than the same increase in Bachelor’s degrees for the purpose of reducing the equilibrium unemployment rate.