Deriving natural rates of unemployment for sub-national regions: the case of Canadian provinces

In order to pursue informed stabilization policies, it is vital for policy-markers to have estimates of how much of the total unemployment rate can be classified as cyclical rather than natural unemployment. This paper describes a method for generating regional natural-rate estimates and applies this method to the case of Canadian provinces. Results indicate that unemployment insurance generosity and relative minimum wages play an important role in determining natural unemployment rates in Canadian provinces. One of the enduring characteristics of the Canadian labour market has been substantial and peresistent unemployment rate disparities across provinces. The results of this study indicate that these disparities are primarily explained by differences in provincial values of structural variables such as unemployment generosity and by differences in provincial sensitivities to these structural variables. A furher result is that variation in cyclical unemployment rates is substantially less in the traditionally high unemployment region of Atlantic Canada than it is in the traditionally low unemployment province of Ontario. This result implies that the most appropriate policies to reduce unemployment in Atlantic Canada are not regionally-applied expenditure policies but rather policies designed to reduce structural distortions in the provincial labour markets.