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I'm wondering how to interpret Okun’s coefficient. Say you have $y^c = -1*u^c$. This means that a 1% increase in the cyclical unemployment gap will produce a 1% decrease in the cyclical output gap. And if we had $y^c = -2*u^c$, this means that a 1% increase in the cyclical unemployment gap will produce a 2% decrease in the cyclical output gap. The “-2” regime therefore looks more contractionary.

However if we renormalize the equations we have respectively,

$u^c = -1*y^c$ [renormalized -1 case]

And

$u^c = -0.5*y^c$ [renormalized -2 case]

Here the -2 case looks the least contractionary, since a 1% fall in the cyclical output gap will only produce a rise of 0.5% in unemployment.

In one case a scenario is most contractionary and in the other least contractionary.

Can anyone lift my confusion?

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  • $\begingroup$ With a constant of 2, a 0.5% increase in cyclical unemployment corresponds to a 1% decrease in output, and a 1% decrease in output corresponds to a 0.5% increase in cyclical unemployment. I don't see the issue. What do you mean by contractionary? $\endgroup$ – Kent Shikama Oct 11 '19 at 13:44

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