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Asymmetry in Okun’s Law Revisited: New evidence on cyclical unemployment–cyclical output trade-off in the Free State Province using NARDL model.

Omoshoro-Jones, Oyeyinka Sunday (2021): Asymmetry in Okun’s Law Revisited: New evidence on cyclical unemployment–cyclical output trade-off in the Free State Province using NARDL model.

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Abstract

Since 1994, the ineffectiveness of adopted pro-growth policies to reduce the persistently high unemployment rate in the Free State (FS) province has become a conundrum for policymakers, begging the questions: Is Okun’s law that predicts an inverse unemployment-output relationship exists in the FS province? If so, what is the nature of Okun’s relationship? This paper re-examines the asymmetric unemployment–output tradeoff employing the nonlinear autoregressive distributed lag (NARDL) modelling framework. Cyclical components of unemployment and output are generated from annual data covering the period 1994-2019, using Hodrick-Prescott and Corbae-Ouliaris filters. We controlled for structural breaks and performed a sensitivity analysis on the models estimated. Irrespective of the filtering method, our results confirm asymmetric Okun’s relationship among variables in both the long-and-short run. The negative and statistically significant coefficient on changes of the positive cyclical output reveals that a 1% rise in cyclical output could lower cyclical unemployment between –0.87 to –0.70 percentage points, reliant on a sustained economic expansion. Estimated long-run coefficients of changes in the positive cyclical output show that an economic upswing between 1.88% and 2.03% would lower unemployment by 1%, in the FS province, consistent with the accepted 2:1 ratio for Okun’s law in the empirical literature. We also find significant contemporaneous effects of changes in cyclical output on cyclical unemployment, where a 1% increase (decrease) in one-period lagged positive (negative) cyclical output reduces (increases) cyclical unemployment between –0.52 and –0.41 (+0.99 and +0.56) percentages points. The detection of these asymmetries explains the failure of the enacted policies to successfully reduce the prevalent high unemployment rate in the FS province. Based on these findings, some apt remedial actions are suggested to policymakers.

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