Asymmetric Co-fluctuations of U.S. Output and Unemployment: Friedman’s Plucking Model and Okun’s Law

Abstract

We integrate Friedman’s plucking model and the gap version of Okun’s law by embedding output and the unemployment rate in a bivariate unobserved components model with Markov-switching to examine their asymmetric co-fluctuations in the U.S. economy. The results establish that output and unemployment are synchronously and proportionally characterized by the plucking property. Given that the labour market has been identified as the source of the plucking property, we suggest that the plucking property, through stable Okun’s law, transmits from unemployment to output. Our proposed asymmetric bivariate model provides two additional results regarding two specification aspects of trend-cycle decomposition: First, we identify an unprecedented deceleration in U.S. potential output in the aftermath of the 2007−09 global financial crisis. Second, our model yields a robust estimation of parameters and components with insignificant correlations between shocks.

Keywords: Business Cycle Asymmetries, Friedman’s Plucking Model, Okun’s Law, Structural Break, Trend-Cycle Decomposition.

JEL Classification: C32, E32, F44, O47.