Cyclical Unemployment, Natural Rate of Unemployment

This paper develops a bivariate correlated unobserved components model to investigate the interaction between output and unemployment. The model separates these two key macroeconomic variables into permanent and transitory components and provides estimates of the correlations among these components. The results for the US indicate that fluctuations in both output and unemployment are largely permanent and there exists a negative relationship between these permanent components similar to the Okun’s Law relationship between the transitory components. These results call into question macroeconomic theories that imply zero correlation between the different components, as well as theories that consider recessions as purely transitory movements in either output or unemployment