DP17369 Explaining Deviations from Okun's Law

Author(s): Claudia Foroni, Francesco Furlanetto
Publication Date: June 2022
Keyword(s): Bayesian VAR, Business cycle fluctuations, labor markets, Okun's law
JEL(s): C32, E24, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17369

Despite its stability over time, as for any statistical relationship, Okun's law is subject to deviations that can be large at times. In this paper, we provide a mapping between residuals in Okun's regressions and structural shocks identified using a SVAR model by inspecting how unemployment responds to the state of the economy. We show that deviations from Okun's law are a natural and expected outcome once one takes a multi-shock perspective, as long as shocks to automation, labor supply and structural factors in the labor market are taken into account. Our simple recipe for policy makers is that, if a positive deviation from Okun's law arises, it is likely to be generated by either positive labor supply or automation shocks or by negative structural factors shocks.