Unemployment dynamics and cyclical fluctuations in the Icelandic labour market

Abstract

This paper studies business cycle dynamics in the Icelandic labour market with the focus on two separate but related dimensions. First, which margin for adjustment of labour input, the extensive margin or the intensive margin, accounts for more variation in total working hours? It finds that both margins are important. Variation in employment accounts for 56% of the overall variation in total hours while variation in hours per worker contributes 44% to variation in total hours. Second, which of the two unemployment transition rates, the separation rate or the job-finding rate, drives the observed fluctuations in unemployment, and how do these transition rates move over the business cycle? The results show that fluctuations in the separation rate explain 70% of the total variation in the unemployment rate. Both transition rates are highly cyclical. The procyclical job finding rate moves roughly contemporaneously with the cycle, while the countercyclical separation rate is found to lead the cycle.