Memoranda The relation between unemployment and interest rate : Some empirical evidence

In Bierens (1987) a Granger causal relation was found between unemployment and the interest rate for the Netherlands. This phenomenon could be explained by the revenue maximization theory of Baumol (1959) augmented with a flexïble labour effort rate. This implies that fixed costs are important in determining the employment decisions of firms. In the present paper we will investigate whether there exists a similar Granger causal relation between unemployment and interest rate for a number of other countries. It appears that, with our ARMAX modeling approach, this relationship is not confined to the Netherlands, but also holds for the USA, Canada, Japan, Germany, the UK and France. For these countries the interest rate is the main explanatory variable, together with industrial production (the latter with one exception), whereas for most countries the wage rate is of minor or no importance as a determinant of unemployment.