DT 30/21 - What's behind Okun's law? A multiple equation approach to the Uruguayan labour market

The objective of this research is to overcome the limitations of conventional Okun's coefficient estimations, highlighting the indirect nature of the effect of the GDP over the unemployment rate. To do so, we estimate a multiple equation model composed by a labour demand, a labour supply and a real wages equation. Our results shed light on the determinants of the demand, the supply and wages. We found that both labour demand and supply react positively to GDP and negatively to wages, but the supply side with lower intensity than demand with respect to both variables. Based on simulations of shocks, we analysed how the variations of the GDP impact on unemployment and found that the effect is not as large as previous research have presented. This result suggests that the estimation of Okun's coefficient arising from a single equation model with only unemployment and GDP as variables suffers from the omitted variables bias, as it captures part of the effects of other variables that affect labour demand and/or labour
supply.