Here we introduce a new model of unemployment in New Zealand. It extends the set of models linking the rate of unemployment and the change in labour force. The agreement between the measured and predicted unemployment estimates in New Zealand validates our concept which states that there exists a long-term equilibrium (causal) linear and lagged link between unemployment, ut, and the rate of change of labour force, lt=dLF/LFdt. For this purpose, we use data borrowed from the OECD.
The estimation method is standard – we seek for the best overall fit between observed and predicted curves by trial-and-error method. All in all, the best-fit equation is as follows:
ut = -2.0lt-3 + 0.09 (1)
Therefore, the lead of lt is three years. The intercept of 0.09 implies the rate of unemployment at the level of 9% when the labour force does not change. Hence, New Zealand needs increasing labour force in order to reduce unemployment.
Figure 1 presents the observed unemployment curve and that predicted using the rate of labour force change 3 years before and equation (1). Since the estimates of labour force in New Zealand are very noisy we have smoothed both annual curves with MA(3). All in all, the predictive power of the model is excellent and timely fits major peaks and troughs after 1984.
Relationship (1) allows a relatively accurate prediction of the rate of unemployment at a three-year horizon. Figure 1 demonstrates that unemployment will likely grow to the level of 7% in 2012 from the current level of 6.5%. Hence, the drop in the rate of real economic growth will be accompanied by an elevated unemployment.
Figure 1. Observed and predicted rate of unemployment in New Zealand. The lower panel shows the cumulative curves for the annual curves in the upper panel.