A strong hysteretic model of Okun's Law: theory and a preliminary investigation

• Published in: International review of applied economics Vol. 23; no. 4; pp. 445 - 462
• Main Authors: Lang, Dany, de Peretti, Christian
• Format: Journal Article
• Language: English
• Published: New York Routledge 01.07.2009; Taylor and Francis Journals; Taylor & Francis Ltd; Taylor & Francis (Routledge)
• Series: International Review of Applied Economics
• Subjects: Algorithms; Comparative analysis; Economic conditions; Economic fluctuations; Economic growth; Economic models; Economic theory; Economics and Finance; Empirical research; Evolutionary economics; Growth rates; Historical analysis; Humanities and Social Sciences; hysteresis; Linear models; Okun's law; Studies; Unemployment; unemployment fluctuations; Okun’s law; unemployment fluctuations; hysteresis
• ISSN: 0269-2171; 1465-3486
• DOI: 10.1080/02692170902954775

This paper presents a 'strong hysteretic' version of Okun's Law, that is, a version of the law in which 'history matters.' In this version of the link between fluctuations in unemployment and growth, the most important past growth shock exerts an influence on the current unemployment rate. A theoretical framework is proposed in order to lay the foundations of this version of Okun's Law. In this framework, the hysteresis property arises because a large number of heterogeneous firms discontinuously adjust their activity levels in response to fluctuations in the rate of growth. The foundations having been laid, a method for empirically testing our hysteretic Okun's Law is presented. An algorithm permits construction of a hysteresis operator, which synthesizes, for every moment, the growth shocks that have remained in the memory bank of the unemployment rate. Empirical tests are conducted to assess the empirical relevance of this version of Okun's Law, as compared to the more familiar linear relationship. Empirical results consistent with hysteresis are found for several of the countries in our sample.