Empirical analysis of the elasticity of employment to output gap in the republic of croatia

This article deals with the impact of cyclical activity of GDP on employment in the Republic of Croatia in the period from 2000 to 2020. According to the prevailing economic paradigm, employment growth follows GDP growth in the long run, but cyclical changes in GDP are also an important factor in monitoring economic developments and require adjustments by economic policy makers in the short term. Okun’s law, based on the natural unemployment rate, is often used as a guide for the purpose of determining corrective economic policy measures. In practice, the unemployment rate is not a particularly reliable labour market variable, so this study sought to empirically examine how cyclical GDP activity affects a much more reliable labour market variable - the number of employed. Empirical studies of the impact of the income gap on employment are very rare compared to those dealing with the impact of GDP growth on employment, so this study on the example of the Republic of Croatia aimed to show that employment elasticity with respect to income gap can serve as a measure of the impact of cyclical economic activity on the number of employees. Empirical analysis of the impact of the income gap on employment was conducted using the vector error correction model (VEC). The results of the analysis indicate a statistically significant impact of the cyclical component of GDP on cyclical employment in the Croatian economy and therefore the authors suggest that this approach should be used as a complementary to Okun’s law.