Sectoral Okun's law and cross-country cyclical differences

Abstract

It is widely confirmed that Okun's law, the negative relationship between output and the unemployment rate, varies across countries. We take a new approach to investigate the cause of this variation: using new sectoral data, we estimate Okun's law at the sector level for the US, the UK, Switzerland, and Japan. We show that the sectoral Okun's coefficients follow patterns similar to the aggregate Okun's coefficients across countries. A novel decomposition allows us to determine that the standard deviation of unemployment is the main driver of the cross-country differences in the Okun's coefficients. Further, we show that the sectoral composition is not a driver and that the sectoral coefficients are proportional to the aggregate coefficients. These findings are consistent with labor market policies being crucial to explain the cross-country differences in the aggregate Okun's coefficients.