Revisiting Okun’s law: testing for asymmetric adjustment in Chile

Okun’s law establishes how much of a country’s output is ‘lost’ when unemployment exceeds its natural or trend rate. Most studies assume a linear unemployment–output trade-off towards long-run equilibrium, which implies that economic expansions and recessions have a symmetric effect on unemployment. Nevertheless, this negative relationship may take a nonlinear form, in the sense that changes in output may cause asymmetric changes in unemployment. This paper therefore aims to test the linear assumption of Okun's law by deploying an asymmetric error correction model using seasonally adjusted quarterly data from Chile for the period 1996–2019 disaggregated by sex. The findings of the study confirm that unemployment in Chile adjusts asymmetrically across business cycles; to be precise, unemployment adjusts as expected during downturns in the business cycle but does not respond in the same way during upturns. Furthermore, the effect of economic growth on unemployment is almost twice as large for women as for men, but again only during recessions. The relevance of this research lies in the policy implications of misinterpreting the effects of business cycles on unemployment if asymmetry is ignored. For instance, the effectiveness and required ‘size’ of stabilisation policy on the real economy will depend on the ‘regime’ in which the Okun relationship is found. Similarly, economic growth policies should be accompanied by measures that address the gender gap, since the supply side tends to have incentives to penalise female employment.