Bank of England staff working paper finds confidence measures capture shocks driving half of European unemployment fluctuations

The Bank of England has published Staff Working Paper No. 1,182, The role of confidence measures in European unemployment dynamics, which presents research indicating that firm and household confidence measures in European countries mainly pick up news about future non-technological conditions rather than technology. In the authors' analysis, this shock does not move unemployment immediately but affects it persistently over business-cycle horizons and explains about 50% of unemployment variance at business-cycle frequency. Using a panel of 22 European countries, the paper finds that the confidence shock is almost perfectly correlated at -0.95 with disturbances driving the long-run behaviour of unemployment, while only modestly correlated with shocks affecting long-run productivity. The shock is described as a mildly inflationary transitory demand shock that raises investment, wages, interest rates, fiscal surplus and vacancies, is orthogonal to identified monetary policy shocks, and leads professional forecasters to revise unemployment expectations downward. The paper is part of the Bank's staff working paper series, which is published to encourage comments and debate. The views expressed are those of the authors and do not represent Bank of England policy.