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 Ut = Ut-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 Ut and Ut-1 . This will allow us to calculate the equilibrium unemployment rate.

• Consider the equation Ut = α + βUt-1 • The task is to:• Estimate the equation,• Substitute U* for Ut and Ut-1: U* = α + βU*• Solve for U* to obtain the equilibrium

unemployment rate:• U* = α / (1- β)

Determining the equilibrium unemployment rate

Determining the equilibrium unemployment rate

• The relationship for Tennessee is shown in the previous slide: Ut = 0.9886 + 0.8623 Ut-1

• Setting Ut= Ut-1= U* :• U* = 0.9886 + 0.8623 U*.• Solving: U* = 0.9886/(1-0.8623) = 7.18%.

• Since the equation is estimated using data from 1976-2011, we can call this the long-run equilibrium unemployment rate.

Determining the equilibrium unemployment rate

• For the United States: Ut= 1.728+ 0.8204 Ut-1

• Setting Ut= Ut-1= U* :• U* = 1.728 + 0.8204 U*.• Solving: U* = 1.728 /(1-0.8204) = 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 RatesCorrelations with Equilibrium Unemployment Rate

Bachelor's degree -0.503 *

No High School Diploma 0.636 *

Wind speed -0.408 *

Homeownership -0.069

Home owner cost -0.140

Homeowner vacancy rate 0.398 *

Renter vacancy rate 0.315 *

Medicaid per capita -0.282 *

Aggravated Assault 0.382 *

Heating degree days -0.272

Cloudy days 0.028

Selected Indicators for Tennessee

Tennessee United StatesBachelor's Degree or better (%) 23.60 28.50No high school diploma (%) 9.70 8.10

Aggravated assault (per 100,000) 473 269Medicaid per recipient (thousands) 4.91 5.14Heating degree days 3,041 4,967 Cloudy days (%) 67.7 71.8Homeowner vacancy rate 2.6 2.6Rental vacancy rate 12.5 10.2

Equilibrium Unemployment Rates and Bachelor’s Degree

Equilibrium Unemployment Rates and No High School Diploma

Model ResultsModel ResultsDependent variable: equilibrium unemployment rate

Variable Coefficient p-value

Bachelor's degree -0.1407 0.0078 ***

No High School Diploma 0.4409 0.0004 ***

Home owner cost 0.0017 0.0205 **

Heating degree days 0.0002 0.0324 **

Cloudy days 0.0362 0.0466 **

Adjusted R-squared 0.5956

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.