Testing for the Robustness of Okun’s Law With Breakpoint Analysis: Evidence From Korea

Abstract

This study re-evaluated Okun’s law by applying breakpoint analysis; concerning this, the study analyzed six models including the first differenced, modified, and gap models. Empirical evidence reveals that models without breakpoints support the proposition of the conventional Okun’s law, even though the estimated Okun’s coefficients do not match up to the expected values. A few models with breakpoints also support Okun’s law at all the breakpoints. Apparently, the robustness of Okun’s law has been demonstrated in the Korean economy. However, the signs of Okun’s coefficients have been mixed in the gap model since the 2000s. Such changes provide robust evidence that Okun’s law has been weak since the 2000s. Therefore, Okun’s law may not hold if it discusses the potential real GDP and full employment. Taken together, it can be said that the effectiveness of an employment policy based on the manipulation of the national income level may be questionable in the Korean economy. Particularly, when the policy, potential real GDP, and full employment are interrelated, it has to be elaborately established to maximize the effectiveness of the policy.