ROLLING REGRESSION VERSUS TIME-VARYING COEFFICIENT MODELLING: AN EMPIRICAL INVESTIGATION OF THE OKUN'S LAW IN SOME EURO AREA COUNTRIES

Authors


Luca Zanin, Prometeia, via G. Marconi 43, 40122 Bologna, Italy. Tel: +39 051 64 80 451; Fax: +39 051 22 07 53; Email: luca.zanin@studio.unibo.it. The authors thank Rosalba Radice for many detailed suggestions on the earlier draft of this paper, and the Associate Editor and two anonymous reviewers for many helpful comments that have improved the presentation and quality of the article.

ABSTRACT

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.

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