General equilibrium macroeconomic models of unemployment: Can they explain the unemployment path in the OECD?

Several theories which seek to explain the high and apparently persistent unemployment in the OECD countries over the past two decades have arisen within the framework of imperfections in the goods and labour markets. Probably the most prominent theories within this class of models are the general equilibrium models of Phelps (1994), Layard and Nickell (1986) and Layard, et al. (1991), labelled structuralist theories of unemployment by Phelps (1994). Common to the structuralist theories is that the low frequency movements in unemployment, or the NAIRU, are determined by structural variables such as unemployment benefits, taxes, real interest rates, etc. However, the high frequency movements in unemployment are determined by wage and price surprises, and, in the Layard and Nickell (1986) model also by cyclical mark-ups. Employment is entirely determined by the firms' willingness to supply and the firms are never sales constrained. By contrast the general equilibrium model of Sarantis (1993) which is in Post Keynesian spirit, suggests that unemployment on all frequencies is mainly an outcome of demand side factors. In this model imperfections in the goods and labour markets are less important determinants of unemployment. This paper estimates the extent to which the models of Phelps (1994), Layard and Nickell (1986) (henceforth L and N), and Sarantis (1993), are able to explain the unemployment path of the OECD countries using annual data over the period 1960 to 1993. The theoretical set-up of the models is presented in section 1 and the empirical estimates are set out in section 2.