A year ago, we revisited our prediction of the rate of unemployment in Italy made in 2008 and found that it was excellent. The model worked well. As it has an 11-year horizon, we can check our old prediction for 2012 and 2013 (preliminary). A new estimate of unemployment rate in 2012 is 10.6%. For 2013, the rate is 11.5 in March. There is no doubt, these values fully validate our model of unemployment as a function of the change in labour force.
We introduced the 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 2013-2014.
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 standard – we seek for the best overall fit between observed and predicted curves by the LSQR 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 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 2013 was predicted almost exactly. (If anybody knows a better prediction in 2008 of 2013 unemployment rate please give us the link.) 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. Four years ago, we expected the peak in the rate of unemployment in 2013-2014 at the level of 11% (+5% from the level in 2008) and it has come!
The evolution of the rate of unemployment in Italy is completely defined ten year ahead. Since the linear coefficient in (1) is positive one needs to reduce the growth in labour force (see Figure 3) in order to reduce unemployment in the 2020s. For the 2010s everything is predefined already and the rate of unemployment will be high, i.e. above 9%.
Figure 1. Observed and predicted rate of unemployment in Italy.
Figure 2. The rate of growth in labour force.