Okun loops and anelastic relaxation in the EU15

Abstract

We show that Okun loops – loop deviations from Okun’s law – exist in all EU15 countries and that these loops can be explained by the anelastic form of Okun’s law. We also find, for what appears to the first time, that Okun loops can undergo counterclockwise rotation. We show that these counterclockwise rotations can be explained using an anelastic extension of Okun’s law, that this theory implies that in these cases the unemployment gap is driving changes in the output gap, and that this directionality is consistent with macroeconomic policy in these countries when the counterclockwise rotation was observed. We find that the anelastic form of Okun’s law provides a statistically significant and operationally parsimonious representation of output–unemployment dynamics in general and Okun loops in particular in all EU15 countries.