Productivity and unemployment over the business cycle

The low correlation between cyclical unemployment and productivity over the post-war period hides a large sign switch in the mid-1980s: from significantly negative the correlation became significantly positive. Using a search model of unemployment with nominal rigidities and variable labor effort, I show that technology shocks can generate a positive unemployment-productivity correlation whereas non-technology shocks (i.e. aggregate demand shocks) tend to do the opposite. In this context, I identify two events that can quantitatively explain the increase in the correlation: (i) a sharp drop in the volatility of non-technology shocks in the mid-1980s, and (ii) a decline in the response of productivity to non-technology shocks, which from procyclical became acyclical in the last 25 years.

Research highlights► Correlation between labor productivity and unemployment switched sign in the mid-1980s ► Similar pattern for other labor input and productivity measures ► Search model with nominal rigidities and variable labor effort gives an explanation ► Decline in volatility of non-technology shocks and in cyclicality of productivity ► Perhaps the result of more flexible labor market