Research Discussion Papers, Bank of Finland
No 10/1999:
Unemployment in a Small Open Economy: Finland and New Zealand
David Mayes ()
and Jouko Vilmunen ()
Abstract: Unemployment is now the key issue for economic policy in
the OECD and Europe in particular. By examining data from the period
1962–1996 for two highly different small open OECD economies, Finland and
New Zealand, in a VEC model this paper seeks to cast light on three
questions: the degree to which unemployment has been the result of slow
adjustment to large external shocks; the degree to which differences in
labour market structures can lead to different responses to shocks; the
importance of the exchange rate and the external sector in resolving the
problem. The approach uses a fairly general model of the labour market that
includes wages, unemployment, the capital stock and the terms of trade. It
uses cointegration analysis to establish long-run relationships among the
four variables. In the case of Finland we find that the short-run response
of unemployment to shocks (to the long-run relationship) is large relative
to the response of real wage and the terms of trade. In New Zealand on the
other hand both real wages and the terms of trade, in particular, adjust
more rapidly. As a result the burden of short-run adjustment in the New
Zealand economy appears to fall more heavily on (relative) prices. Since
the unemployment rate in both countries displays hysteresis, these results
suggest that relative price adjustment in the New Zealand economy is more
effective in preventing adverse aggregate shocks from becoming adverse
unemployment shock.
Keywords: unemployment; open economy; structural change; labour market; (follow links to similar papers)
40 pages, July 28, 1999
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