Business Cycles and Low-Frequency Fluctuations in the US Unemployment Rate

I show that business cycles can generate most of the low-frequency movements in the unemployment rate. First, I provide evidence that the unemployment rate is stationary, while its flows have unit roots. Then, I model the log unemployment rate as the error correction term of log labor flows in a vector error correction model (VECM) with intercepts that change over the business cycle. Feeding historical expansions and recessions into the VECM generates large low-frequency movements in the unemployment rate. Frequent recessions from the late 1960s to the early 1980s interrupt labor market recoveries and ratchet the unemployment rate upward. Long expansions in the 1980s and 1990s undo this upward ratcheting. Finally, the VECM predicts that the unemployment rate will be near 3.6 percent after a 10-year expansion and that lower unemployment rates are possible with longer expansions.