We introduced a model of unemployment in Italy in 2008 with data available only for 2006. The rate of unemployment was near its bottom at the level of 6%. The model predicted a long-term growth in the rate unemployment to the level of 11% in 2013. In this post we revisit the model. The agreement between the measured and predicted unemployment estimates in Italy validates our concept which states that there exists a long-term equilibrium link between unemployment, ut, and the rate of change of labour force, lt=dLF/LFdt. Italy is a unique economy to validate this link because the time lag of unemployment behind lt is eleven (!) years.
The estimation method is trivial – 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 = -5.0lt-11 + 0.07 (1)
As mentioned above, the lead of lt is eleven years. This defines the rate of unemployment many years ahead of the current change in labour force. Figure 1 presents two versions of unemployment as defined by the U.S. Bureau of Labor Statistics (BLS) and the OECD. We describe the estimates provided by the OECD (labour force estimates also obtained from the OECD) but have to emphasise that the divergence before 1994 makes it difficult to find a unique model for both agencies.
Figure 2 presents the observed unemployment curve and that predicted using the rate of labour force change 11 years ago and equation (1). Since the estimates of labour force in Italy are very noisy we have smoothed the annual predicted curve with MA(5). All in all, the predictive power of the model is excellent and timely fits major peaks and troughs after 1988. The period between 2006 and 2010 was predicted almost exactly. This is the best validation of the model – it has successfully described a major turn in the evolution of unemployment near its bottom. No other macroeconomic model is capable to describe such dramatic turns many years ahead. As four years ago, we expect the peak in the rate of unemployment in 2013-2014 at the level of 11%.
The evolution of the rate of unemployment in Italy is completely defined 10 year ahead. Since the linear coefficient in (1) is positive one needs to reduce the growth in labour force in order to reduce unemployment in the 2020s.
Figure 1. The rate of unemployment in Italy as measured by the BLS and OECD.
Figure 2. Observed and predicted rate of unemployment in Italy.