An Unobserved Components Model Approach to the Relationship between Real GDP and Unemployment for Cyprus

Abstract

This empirical study employs a bivariate unobserved components model to estimate the permanent and transitory movements in real GDP and the unemployment rate and the relationships between them, using information from observable aggregates for the economy of Cyprus. The main motivation for quantifying this relationship is the absence of any measure for the Okun’s law that can be used to evaluate the effects of macroeconomic policy. The results suggest that both the transitory movements in Cypriot output and unemployment rate are critical for explaining overall fluctuations. The estimated Okun’s coefficient for transitory movements implies that a 1% change in transitory unemployment causes 1.73% change in transitory real GDP in the opposite direction.