Unemployment and Input Prices: A Fractional Cointegration Approach

Abstract

This paper examines the relationship between unemployment, real oil price and real interest rates in Canada. Instead of following the classical approach based on I(0) stationarity or I(1) cointegrating relationships, we use fractional integration/cointegration techniques which allow for the possibility that unemployment is highly persistent. In line with other studies, we find that all three variables are I(1). But we only find cointegration in the presence of autocorrelated disturbances, which means that the relationship between these variables also has a dynamic component. Furthermore, there is evidence of fractional (as opposed to classical cointegration, which implies long memory and slow reversion to equilibrium. This suggests that an equilibrium model with highly persistent shocks might be adequate to account for the observed behaviour of unemployment.