THE EQUILIBRIUM RATE OF UNEMPLOYMENT IN THE NETHERLANDS** BY D.P. BROER, D.A.G. DRAPER, AND F.H. HUIZINGA* Summary The rise in unemployment in the 1970s and its subsequent persistence have challenged the conven- tional wisdom embodied in the standard Phillips curve, namely that equilibrium unemployment is fairly constant over time. This paper attempts to explain the apparent non-constancy of equilibrium unemployment by developing and estimating a structural model in which equilibrium unemployment is endogenous and results from the interactions of wage bargaining and the price and employment determination of firms. We find that the three major determinants of equilibrium unemployment are tax rates, the replacement rate and the real interest rate. The rise in unemployment in the 1970s and early 1980s was mainly due to a rise in the first two factors. That equilibrium unemployment re- mained high when tax rates and the replacement rate were reduced in the 1980s and early 1990s is attributed to the rise in real interest rates during this period. Key words: equilibrium unemployment, labour demand, wage bargaining, price setting 1 INTRODUCTION The high level of unemployment in OECD Europe remains one of the puzzles of empirical macroeconomics. In recent years the unemployment rate shows a ten- dency to fall in some countries, but overall its level remains high OECD 1997. This is somewhat surprising in view of the considerable policy effort that has been made to redress the adverse supply conditions that are generally held re- sponsible for the high rate of unemployment. This raises the question whether these policy reforms were ineffective, or still have to yield their full benefit. Is the present high rate of unemployment in Western Europe a consequence of slow adjustment to structural reforms and are we heading towards an era of low un- employment, or are other factors at work, that prevent us to reap the benefits of the reforms? This paper considers these questions in a structural empirical model of wage and price setting and employment dynamics for the Netherlands. * CPB Netherlands Bureau of Economic Policy Analysis, P.O. Box 80510, 2508 GM The Hague, The Netherlands; e-mail: dpb@cpb.nl, dagd,@cpb.nl, fhh@cpb.nl; Phone 070 338 33 80; Fax 070 338 33 50. ** We are grateful for helpful comments by two anonymous referees, F. den Butter, R. Douven, A. Lammertsma, Th. van de Klundert, S. Kuipers, R. Okker, and E. Sterken and for the statistical assis- tance of P. de Jongh. DE ECONOMIST 148, NO. 3, 2000 De Economist 148, 345–371, 2000. © 2000 Kluwer Academic Publishers. Printed in the Netherlands.