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On the behavior of Okun's law across business cycles

Luiggi Donayre

Economic Modelling, 2022, vol. 112, issue C

Abstract: As useful barometers of the macroeconomy, output and unemployment dynamics are relevant for markets, policymakers and the average economic agent. This paper relaxes the two-regime assumption of existing models of their relationship (the so-called Okun's law) motivated by a literature that documents three phases of the business cycle. Using U.S. data for 1949–2020, a threshold regression of output and unemployment is estimated, which allows for a straightforward extension of previous linear and two-regime models. The results reveal a steepening of Okun's relationship across three endogenously-determined regimes that align closely with expansions, mild recessions and deep recessions. The steepening is robust to a battery of considerations. Meanwhile, the variation in Okun's coefficient correlates with changes in the average deviation of nominal wages from the median. These findings uncover the need for differentiated policy responses across recessions.

Keywords: Okun's law; Unemployment; Threshold autoregression; Business cycles (search for similar items in EconPapers)
JEL-codes: C22 E24 E52 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.econmod.2022.105858

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