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

  • Rui M. Pereira

    ()

    (Department of Economics, The College of William and Mary)

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.

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File URL: http://economics.wm.edu/wp/cwm_wp139.pdf
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Paper provided by Department of Economics, College of William and Mary in its series Working Papers with number 139.

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Length: 22 pages
Date of creation: 01 Jun 2013
Date of revision:
Handle: RePEc:cwm:wpaper:139
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  1. Rothstein, Jesse, 2012. "The Labor Market Four Years Into the Crisis: Assessing Structural Explanations," Institute for Research on Labor and Employment, Working Paper Series qt2x576316, Institute of Industrial Relations, UC Berkeley.
  2. Juan Carlos Cuestas & Luis A. Gil-Alana, 2011. "Unemployment hysteresis, structural changes, non-linearities and fractional integration in European transition economies," Working Papers 2011005, The University of Sheffield, Department of Economics, revised Feb 2011.
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  5. Mark J. Holmes & Brian Silverstone, 2005. "Okun's Law, Asymmetries and Jobless Recoveries in the United States: A Markov-Switching Approach," Working Papers in Economics 05/06, University of Waikato, Department of Economics.
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  7. Moosa, Imad A., 1997. "A Cross-Country Comparison of Okun's Coefficient," Journal of Comparative Economics, Elsevier, vol. 24(3), pages 335-356, June.
  8. Laurence M. Ball & Daniel Leigh & Prakash Loungani, 2013. "Okun's Law: Fit at Fifty?," NBER Working Papers 18668, National Bureau of Economic Research, Inc.
  9. Edward S. Knotek & II, 2007. "How useful is Okun's law?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 73-103.
  10. Paramsothy Silvapulle & Imad Moosa & Mervyn Silvapulle, 2004. "Asymmetry in Okun's law," Canadian Journal of Economics, Canadian Economics Association, vol. 37(2), pages 353-374, May.
  11. Brian Silverstone & Richard Harris, 2001. "Testing for asymmetry in Okun's law: A cross-country comparison," Economics Bulletin, AccessEcon, vol. 5(2), pages 1-13.
  12. Weber, Christian E, 1995. "Cyclical Output, Cyclical Unemployment, and Okun's Coefficient: A New Approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 10(4), pages 433-45, Oct.-Dec..
  13. Owyang, Michael T. & Sekhposyan, Tatevik, 2012. "Okun’s law over the business cycle: was the great recession all that different?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 399-418.
  14. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
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