Economic and Business Forecasting: Analyzing and Interpreting Econometric Results

CHAPTER 4

Characterizing a Time Series

In decision making, many rules of thumb are employed in economics and finance—for example, the relationship between gross domestic product (GDP) and the unemployment rate (Okun's law), the unemployment rate and the job vacancy rate (Beveridge curve), and the inflation rate and money supply (money neutrality).¹ In practice, however, these relationships need to be tested with the help of econometric techniques using real-world data. Why? Typically, economic theory suggests the direction of a relationship; for example, Okun's law suggests that a rise in GDP is associated with a decline in the unemployment rate. But how much? As a country's economy evolves, so do economic relationships. Furthermore, it is important to know the estimated magnitude of these economic relationships and how these relationships change over the business cycle and over time.

Knowledge of the magnitude of the relationship between GDP growth and the unemployment rate will help decision makers assess how jobs, income and thereby personal consumption follow the pace of GDP growth. For instance, during 2008 to 2010 of the Great Recession and early phase of the recovery, the Federal Reserve Board (monetary) and Presidents Bush and Obama (fiscal) introduced stimuli to boost the U.S. economy. U.S. GDP growth turned positive during 2009:Q3,² and real GDP surpassed its prerecession peak in 2011:Q4. But as of August 2012, the unemployment rate remained well above its prerecession ...