The Cause of Unemployment: Demand or Supply Shocks?

We study the Danish unemployment experience 1905-92 using a common trends model with cointegration constraints. To justify the identifying assumptions about the cointegration vectors and the common trends we present a simple macroeconomic model of the labor market. The model determines the long run behavior of labor productivity, employment, unemployment, real product and real consumer wages. The empirical results indicate that there are three cointegration relations and two common trends. Based on the economic model the trends are interpreted as representing productivity (technology) and labor supply. With unemployment being nonstationary, the common trends analysis indicates that labor supply shocks is the primary source for explaining the behavior of unemployment.