Do Financial Market Variables Predict Unemployment Rate Fluctuations

This paper examines empirically the Granger-causal relationship between financial market variables and real economic activity as measured by the unemployment rate. We find in our paper that the in-sample measures of fit are largely affected by one particular influential observation: 1974:12. This observation accounts for superior performance of the paper-bill spread in explaining the unemployment rate. We then show that none of the commonly employed measures of monetary policy contain incremental information useful in forecasting the unemployment rate. A simple pure autoregressive model performs better than three-variable models that contain the paper-bill spread, the federal funds rate or M2 in out-of-sample forecasting. The different data vintage matters in evaluating a model. The fact that the results are sensitive to the different data vintage make us suspect the robustness of the Granger Causality between financial market variables and the unemployment rate concluded in the earlier studies.