Distance to Frontier and the Big Swings of the Unemployment Rate: What Room is Left for Monetary Policy?

Hian-teck Hoon and Kong Weng Ho

No 1347, Kiel Working Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: This paper builds upon Hoon and Phelps (1992, 1997) to ask how much of the evolution of the unemployment rate over several decades in country i can be explained by real factors in an equilibrium model of the natural rate where country i's productivity growth depends upon its distance from the world's technological leader. One motivating contemporary example includes the evolution of unemployment rates in Europe as it recovered from the second world war and caught up technologically to the US. Another example that may be less familiar to many people is Singapore (the second fastest growing economy from 1960 to 2000 in Barro's data set of 112 countries) that is best thought of as catching up to the world's technological leaders (the G5 countries with whom it trades extensively and from where it receives substantial foreign direct investments) and that saw its unemployment rate go down from double-digit levels in the early 1960's to the low 2 to 3 percent in the late 1990's. How much of the big movements in the unemployment rate can be explained by non-monetary factors in a model of an endogenous natural rate exhibiting both monetary neutrality and super-neutrality? What room is left for monetary policy in explaining the movements of the unemployment rate? The paper develops the theory and seeks to ask how much non-monetary factors can quantitatively account for the evolution of the unemployment rate.

Date: 2007
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