School of Economics and Finance

No. 585: The Macroeconomics of the Labor Market: Three Fundamental Views

Marika Karanassou , Queen Mary, University of London and IZA
Hector Sala , Universitat Autònoma de Barcelona and IZA
Dennis J. Snower , Institute for World Economics, University of Kiel, CEPR and IZA

February 1, 2007

Download full paper


We distinguish and assess three fundamental views of the labor market regarding the movements in unempoyment: (i) the frictionless equilibrium view; (ii) the chain reaction theory, or prolonged adjustment view; and (iii) the hysteresis view. While the frictionless view implies a clear compartmentalization between the short- and long-run, the hysteresis view implies that all the shortrun fluctuations automatically turn into long-run changes in the unemployment rate. We assert the problems faced by these conceptions in explaining the diversity of labor market experiences across the OECD labor markets. We argue that the prolonged adjustment view can overcome these problems since it implies that the short, medium, and long runs are interrelated, merging with one another along an intertemporal continuum.

J.E.L classification codes: E22, E24, J21, J30

Keywords:Unemployment, Interactive labor market dynamics, Interplay of lags and shocks, Frictional growth, Growth drivers