Econometric modelling of slack and tight labour markets

Empirical and theoretical studies suggest that employment behaviour varies with the state of the labour market since hiring and firing costs depend on the availability of labour. Extending earlier empirical work on this subject, we test for state dependence in employment adjustment and in the effects of forcing variables such as indicators of aggregate demand. We also test whether anticipated labour shortages lead to multiple equilibria in (un)employment. We develop both a linear equilibrium correction model (ECM) and a two-state Markov switching version of the ECM. The models are based on quarterly data for Norwegian industry employment and aggregate unemployment in the period 1974-1996. We find clear evidence of state-dependent adjustment and responses to changes in forcing variables. Yet equilibrium solutions for employment and unemployment appear invariant to cyclical and structural changes in the sample.