https://macropaperwarehouse.com/jel_codes/e29/E29Hugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/the-role-of-shocks-and-institutions-in-the-rise-of-european-unemployment-the-aggregate-evidence/https://macropaperwarehouse.com/papers/the-role-of-shocks-and-institutions-in-the-rise-of-european-unemployment-the-aggregate-evidence/<p>Blanchard and Wolfers argue that neither adverse macroeconomic shocks alone nor adverse labor market institutions alone can account for the two central facts about European unemployment: its rise from 1.7 percent in the early 1960s to 11.0 percent in the mid-1990s, and the wide and persistent dispersion of unemployment rates across European countries (from 4 percent in Switzerland to over 20 percent in Spain by the mid-1990s). Shocks can explain the common upward trend but, the authors show, do not differ enough across countries to explain the cross-country dispersion; institutions can explain the cross-country differences but mostly predate the rise in unemployment and in many cases moved toward being more employment-friendly after the 1970s, the opposite direction from what a pure institutions story would require. Using a panel of 20 OECD countries since 1960, with two separate empirical approaches &ndash; one treating shocks as common but unobserved across countries (captured by interacted time and institution effects) and one constructing observable country-specific shock series &ndash; they find consistent evidence that the interaction between shocks and institutions is what matters: a given adverse shock produces a substantially larger and more persistent rise in unemployment in countries with poorer labor market institutions (such as high benefit replacement rates and long benefit duration, strong employment protection, and a high tax wedge) than in countries with better institutions. They interpret this as institutions determining how relevant the unemployed remain to wage-setting after a shock hits, which in turn governs whether equilibrium unemployment returns to its earlier level or stays persistently elevated.</p>