RESEARCH PAPER NO. 846

A SIMPLE MODEL OF UNEMPLOYMENT RATE DYNAMICS

BY

ROBERT DIXON

APRIL 2002

Department of Economics. University of Melbourne. Melbourne Victoria 3010 Australia

ABSTRACT

The paper seeks to 'explain' certain stylised facts in relation to flows into and out of Unemployment and especially to identify the 'proximate' determinants of the amplitude and the frequency of fluctuations in the Unemployment Rate over the course of the business cycle. Since the evolution of the Unemployment Rate must be seen as dependent on the relative size of the Inflow and Outflow Rates, a multiple equation model has to be employed. It is found that the transition probability is a determinant of the amplitude, and thus the mean value of, the Unemployment Rate but not the frequency of fluctuations in the Unemployment Rate. However, it is found that the Inflow Rate is a determinant of both the amplitude and the frequency of fluctuations in the Unemployment Rate. We are also to explain why it is that researchers find that the long-run effect of a change in the Inflow Rate upon the Outflow Rate is to change the Outflow Rate by exactly the same amount as the Inflow Rate has changed.