In the literature, the unemployment rate has been explained by two hypotheses: the natural rate hypothesis vs. the hysteresis hypothesis. The former hypothesis refers to the rate of unemployment towards which the economy naturally gravitates in the long run. The latter hypothesis refers to the long-lasting effects of shocks on the unemployment rate. We test these two competing hypotheses using conventional unit root tests on the US unemployment rate at the state level and provide empirical evidence for both the hysteresis and the natural rate hypotheses. We then explain why reconciliation of opposite views regarding the unemployment rate is unlikely.
JEL Classification: C22, C23, E24, J64