Okun's Law across the Business Cycle and during the Great Recession: A Markov Switching Analysis

Rui Pereira

No 139, Working Papers from Department of Economics, College of William and Mary

Abstract: The substantial increase in unemployment during the Great Recession, coupled with the possibility of a breakdown in Okun's law, gave rise to concerns of a structural increase in the natural rate of unemployment. We estimate asymmetries in Okun's law using quarterly data from 1948:01-2012:04 across the business cycle as defined by exogenous breaks for the period after the peak of the business cycle to the trough. We further allow for endogenous break points by estimating a markov switching model. The estimated asymmetries rely on adequate specification of the dynamics of the relationship. The non-linearities in Okun's law provide strong support for an understanding of deviations in Okun's law during the Great Recession as a natural by-product of a stronger relationship between GDP growth during contractions than recoveries, although this fails to explain the entirety of the weak labor market conditions during the tepid recovery in economic activity. This similarly contributes towards an understanding of the phenomena of jobless recoveries which are a product of weak economic growth in recent decades coupled with a weaker relationship between GDP growth and unemployment during expansions. In this respect, the Great Recession, despite the relatively larger contraction in economic activity, was no different from previous recessions.

Keywords: Okun's law; the Great Recession; Business Cycle; Auto-regressive distributed lag; Markov Switching. (search for similar items in EconPapers)
JEL-codes: C22 E32 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2013-06-01
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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