Disinflation and Equilbrium Participation Rates Across the OECD

Abstract

Larry Ball's recent work shows that OECD countries with large and long lasting disinflations during the 1980s had the largest rises in their equilibrium unemployment rates. While supply side factors did not initiate the rises in equilibrium unemployment, Ball finds evidence for an interactive relationship between disinflation and open ended unemployment duration. He concludes that the results support the theory that disinflation has a permanent impact on unemployment (hysteresis) over the theory that there is a unique equilibrium rate of unemployment that is invariant to disinflation (the natural rate hypothesis). A hysteresis theory also implies, in addition to trend unemployment 1ates, that trend labour force participation should be changed by disinflation. The study examines changes in trend participation across twenty OECD countries between 1980 and 1990 and finds confirmation for the prediction of the hysteresis hypothesis. Countries with high disinflation have the smallest rises in trend labour force participation. Some evidence was found in support of an interactive relationship between disinflation and benefit duration. For a given disinflation, the greater the duration of unemployment benefit payments, the smaller the rise in trend labour force participation. The results of both this study and that of Ball raise important issues regarding the current operating structures of monetary policy in New Zealand, based as these are on the natural rate hypothesis.