Hysteresis vs. natural rate of US unemployment

This paper investigates the stochastic nature of the unemployment rate allowing for cross-section dependence from a panel of US state-level data. We first employ the PANIC method to identify the common and idiosyncratic components. Powerful recursive mean adjustment (RMA) methods are used to test for unit roots. We find significant evidence of a nonstationary common component when the data from the most recent recession are included. Even when stationarity is empirically supported, the bias-corrected half-life of the common component appears very long, casting doubt on the usefulness of the natural rate hypothesis. ► We study US state unemployment rates allowing for cross-section dependence. ► The PANIC method is used to separate the common and idiosyncratic components. ► We implement a more powerful RMA-based unit root test for these components. ► Including the data from recent recession yields a nonstationary common component. ► Even when stationarity is supported, the bias-corrected half-life appears very long.