The Great Recession and Okun's law

The relationship between output and unemployment has been a widely discussed topic since the Great Recession. This paper jointly estimates a time-varying parameter Okun's law with two latent states: potential output and the natural rate of unemployment. It is found that there is substantial time variation in the Okun's coefficient in the US. Since the Great Recession, a given unemployment gap has been associated with a smaller output gap. The probability that the Okun's coefficient is equal to the widely accepted value of −2 fell significantly during the Great Recession, but has since risen despite the Okun's coefficient remaining at around −0.5. This illustrates the significant degree of uncertainty in the estimation of potential output and the natural rate of unemployment.