Estimating Okun’s Law for Malta

The results presented point to a number of interesting observations on the relationship between real economic activity and the labour market in Malta. First, developments in the real economy affect the domestic labour market with a lag. Second, the relationship between output and unemployment is relatively weak in Malta compared with other EU economies, although the link has become more pronounced in recent years perhaps due to the changing structure of employment and the labour market. Empirical estimates suggest that the rate of output growth consistent with a stable unemployment rate is around 1.5% to 2.0%, with an Okun’s coefficient of around 0.2. This implies that GDP growth in excess of 1.5%-2.0% lowers the unemployment rate. More specifically, a 1 percentage point increase in GDP above this threshold lowers the unemployment rate by around 0.2 percentage point. Finally, the relationship appears to be more pronounced during economic recessions. This finding would strengthen the call for prudent fiscal policy during the business cycle to create fiscal space in good times, thereby allowing room for manoeuvre in times of subdued demand to stimulate economic activity and avoid job losses. In addition, the asymmetric relationship between unemployment and output implies that the pace of job creation following a recession may be insufficient to absorb the newly unemployed. Hence, a more proactive approach should be pursued to provide appropriate training and incentives to the unemployed to upgrade their skills to meet the changing requirements of the new industries, thereby facilitating their re-employment.