Rolling Regression Versus Time-Varying Coefficient Modeling: An Empirical Investigation of the Okun's Law in Some Euro Area Countries
Bulletin of Economic Research, Vol. 64, No.1, pp. 91–108, 2012
Posted: 1 May 2011 Last revised: 13 Dec 2011
Date Written: April 30, 2011
During the last decade, economists have shown that the inverse relationship between economic growth and unemployment rate varies over time. Rolling regression has been the main tool used to quantify such a relationship. This methodology suffers from several well-known problems which lead to spurious non-linear patterns in the Okun's coefficient behaviour over time. Here, we take a penalized regression spline approach to estimate the Okun's time-varying effects. As a result, spurious non-linearities are suppressed and hence important time-varying coefficient features revealed. Our empirical results show that the inverse relationship in some Euro area countries is spatially heterogeneous and time-varying. The findings are complemented by the calculation of the rate of output growth needed for a stable unemployment rate, as proposed by Knotek.
Keywords: Okun's coefficient, penalized regression spline, rolling regression, time-varying coefficient model
JEL Classification: C14, C50, E24
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