Staff Working Paper No. 1,182
Marta Garcia-Rodriguez and Clemente Pinilla-Torremocha
We show that the joint behaviour of confidence measures and unemployment in a panel of European countries favours a view of labour market fluctuations driven largely by a shock that does not affect unemployment contemporaneously but affects it persistently over business‑cycle horizons and explains the major share of the forecast error variance of confidence measures. This shock is captured in firm and household surveys and is almost perfectly correlated (-0.95) with non-technological disturbances driving the long-run behaviour of unemployment, but only modestly correlated with shocks affecting long-run productivity. One structural interpretation is that it represents news about future non-technological fundamentals, which is first captured in confidence measures. This shock accounts for 50% of unemployment variance at business-cycle frequency. It behaves as a mildly inflationary transitory demand shock – raising investment, wages, interest rates, fiscal surplus, and vacancies – is orthogonal to identified monetary policy shocks, and induces professional forecasters to revise unemployment expectations downward.
The role of confidence measures in European unemployment dynamics
