State Level Tests of Okun's Coefficient

Brian Kennedy

Major Professor: Carlos Ramirez

Committee Members: Philip R. Wiest, Gerald A. Hanweck

Enterprise Hall, Room 318
July 07, 2009, 08:00 PM to 07:00 PM

Abstract:

Okun's Coefficient states that there is a three to one relationship between output and unemployment, a relationship that policy makers can exploit.  Numerous studies conducted at the national level have confirmed the overall validity of this empirical proposition, even while calling into question some of the details.  Using U.S. State level data, this paper tests for Okun’s coefficient over the period of 1977- 1997, and 1997 – 2007.  This paper finds that Okun’s coefficient does exist at the state level, though it is generally lower than national U.S. measures, averaging about 1.5 to 1, a result that is in line with other recent regional studies, but which differs from previous U.S. studies.  Pooled data also strongly suggests that Okun’s coefficient in the U.S. is asymmetrical, negative output changes are associated with larger changes in employment than positive ones, though this result is sensitive to how one defines downturns.  No strong evidence of a structural break was found.

Additionally, this paper tests the resulting coefficients against a variety of supply and demand variables, to see which ones influence the existence and size of the relationship.  These results support the generally accepted notion that Okun’s coefficient is higher for, and more stable in, states with a larger industrial sector, but not for states with large mineral extraction industries.  Various labor market rigidities also have an impact on Okun’s coefficient, but usually only for larger states.  Political issues did not seem to have much effect, though government policies did.  Evidence is presented of interstate migration as an explanation of dynamics in Okun’s coefficient, though no statistically significant results were found.

Finally, an extended form of Okun’s coefficient, that accounted for variance in capital stock, and capital and labor utilization rates, was tested for the ten most populous U.S. states.  These tests gave a significantly lower estimate for Okun’s coefficient – as most macro theories with diminishing marginal returns to labor, would predict.   

 

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