Structural Stability of Okun’s Law in Pakistan: An Econometric Analysis

Abstract

This research study reveals about the structural stability and application of the Okun’s law in Pakistan. The law postulates a negative relationship between unemployment rate and GDP growth. It has been originally presented empirically by Arthur Okun in early 1960s. Various studies have been conducted in the past as well on the applicability of the Okun’s law in Pakistan and also around the world. This particular analysis is based on the difference version of the Okun’s law. For this purpose time series data has been taken from 1985 to 2015. ARDL model has been used to find the long-run relationship between the unemployment and real national income. The stability of the model has been checked by applying the dummy variable approach. For this purpose the data period has been segregated into two sections i.e., 1985-2001 and 2002-2015. The dummy results confirm the structural instability in the Okun’s coefficient in Pakistan during the study period. This research also uses the Chow test for the investigation of structural stability of the Okun’s Law in Pakistan. The Chow test also confirmed that there is structural instability. The ARDL results verify the negative long-run relationship between the unemployment rate and GDP growth rate. This research concludes that there is a negative correlation between the two variables but structurally unstable.

Keywords GDP, Unemployment, Okun’s Law, Structural stability, Dummy variable approach, Chow test.