Threshold effects in Okun's Law: a panel data analysis

Our approach involves the use of switching regime models, to take account of the structural asymmetry and time instability of Okun's coefficient. More precisely, we apply the non-dynamic panel transition regression model introduced by Hansen (1999) to a panel of 20 OECD countries over the last three decades. With all specifications applied, the tests lead to the rejection of the null hypothesis of a linear relationship between cyclical output and cyclical unemployment. The asymmetry implies the existence of four regimes. For lower or higher values of cyclical unemployment, it follows that there is a relatively strong negative correlation between unemployment rate and output. However, when unemployment stands at intermediate levels, this relationship tends to weaken.