Okun's law: economic growth and unemployment (2023)

When it comes to studying the economy, growth and employment are the two most important factors that economists should consider. There is a clear connection between the two, and many economists have shaped the debate in an attempt to examine the relationship between economic growth and unemployment levels.

The economist Arthur Okun began to address this debate in the 1960s, and since then his research on the subject has been known asOkun's law. Below is a more detailed description of Okun's Law, why it is important and how it has stood the test of time since its first publication.

main learning points

  • Okun's law was postulated in the early 1960s by Yale economist and professor Arthur Okun.
  • Okun's law analyzes the statistical relationship between a country's unemployment rate and the rate of economic growth.
  • Okun's law states that a country's gross domestic product (GDP) must grow at about 4% per year to achieve a 1% drop in unemployment.

How does Okun's law describe unemployment?

Okun's law: basic concepts

In its most basic form, Okun's law studies the statistical relationship between a country's populationunemployment rateand the growth rate of its economy. The Department of Economic Research of the Federal Reserve Bank of St. Louis explains that Okun's Law "is designed to tell us how much of a country's wealth amounts togross domestic product (GDP)could be lost if the unemployment rate exceeds this amountnatural cup.”

He goes on to explain that “the logic behind Okun's law is simple. Production depends on the amount of labor used in the production process. So there is a positive relationship between production and employment. Total employment is equal to the labor force minus the unemployed, so there is a negative relationship between output and unemployment (depending on labour).'

Arthur Okun, a Yale professor and economist, was born in November 1928 and died in March 1980 at age 51. He first published his findings on this subject in the early 1960s, and they have been known as his "law" ever since. Okun's law is basically a general principle that explains and analyzes the relationship between employment and growth. Speech by the former chairman of the Federal ReserveBena BernkePerhaps it summarizes the basics of Okun's law more succinctly.

“This rule of thumb describes the observed relationship between changes in the unemployment rate and the rate of growthreal gross domestic product (GDP).Okun pointed out that due to the continued increase in the labor force and productivity levels, real GDP growth close to the potential growth rate is usually necessary to keep the unemployment rate stable. To reduce unemployment, the economy must therefore grow above its potential.
More precisely, according to currently accepted versions of Okun's Law, to achieve a one percentage point fall in unemployment in one year, real GDP must grow about two percentage points faster than the growth rate of potential GDP over that year. period of time. . . So, for example, if potential GDP growth is 2%, Okun's law says that GDP needs to grow at about 4% for a year to achieve a one percentage point drop in the unemployment rate.

a closer look

It is very important to remember that Okun's law is a statistical relationship based onregressionunemployment and economic growth. Therefore, performing a regression can lead to different coefficients being used to calculate the change in unemployment depending on economic growth. It all depends on the periods used and the inputs, which are historical GDP and employment data. Here is an example of Okun's law regression:

Okun's law: economic growth and unemployment (1)

In fact, the law has evolved over time to adapt to the current economic climate and employment trends. One version of Okun's law states very simply that when unemployment falls by 1%,gross national product (GNP)increases by 3%. Another version of Okun's law focuses on the relationship between unemployment and GDP, according to which a percentage increase in unemployment causes a 2% decrease in GDP.

Bloomberg article integrating data from highly volatile sectorsGreat RecessionDuring this period, it was noted that “a general rule of thumb is that for every percentage point of annual growth that exceeds the trend rate (which the Federal Reserve has set at 2.3% to 2.6%), unemployment will rise by 2.3% drops to 2.6%. half a percentage point." Look at the different applications of economic growth, such as GNP and GDP, and what is considered a measure of potential economic growth.

Okun's law has proven itself several times, but failed during the 2008 financial crisis.

Does it hold up over time?

As with any law in economics, science, or any discipline, it is important to determine whether it is true under different circumstances and over time. As for Okun's law, it seems to work quite well under some circumstances, and not under others.

For example, an examination of Okun's law by the Federal Reserve Bank of Kansas City found that one of Okun's early reports looked at quarterly changes in unemployment versus quarterly real output growth, and all seemed to be holding up well.

There are also different ways to map unemployment, and of course the US is the main testing ground for Okun's law. Okun also analyzed the gap between potential economic output and the actual level of production in the economy.

The Kansas City study detailed several versions of Okun's law, starting with his original quarterly statement, a "gap version" that accounted for differences in actual and potential output even if the law were to hold.full employmentor even high unemployment. A more dynamic version was chosen, leaving the possibility to exclude or add variables depending on the current and historical level of economic growth.

How useful is Okun's law?

While there are in fact many moving elements in the relationship between unemployment and economic growth, this law seems to have empirical support. A Kansas City Federal Reserve study found that "Okun's law is not closely related," but "predicts that slowing growth often coincides with rising unemployment." Regarding the fact that things didn't work out so well during the financial crisis, Bernanke speculated that "the apparent failure of Okun's law may, in part, reflect statistical noise."

Other studies have provided more support for Okun's law. Federal Reserve Bank of St. Louis stated that "Okun's law can be a useful guidemonetary policy, but only if the natural rate of unemployment is measured correctly.

What is Okun's Law of Economics?

Okun's law of economics focuses on the relationship between unemployment and a country's productivity. It is argued that a 1% rise in unemployment causes the country's GDP to fall by a larger percentage, usually twice as much.

What are the Phillips curve and Okun's law?

Both the Phillips curve and Okun's law are designed to establish the relationship between unemployment and another economic factor. In the case of the Phillips curve, that factor is inflation; for Okun's law, this factor is productivity (GDP). The Phillips curve states that there is an inverse relationship between unemployment and inflation, while Okun's law states that there is an inverse relationship between unemployment and GDP.

What is the difference between the sacrifice factor and Okun's law?

The sacrifice factor measures the sacrifice an economy must make to reduce inflation. Analyze the amount of lost production to reduce inflation. It measures the percentage of GDP that must be returned to reduce inflation by 1%. Okun's law analyzes the loss of GDP due to an increase in unemployment.

the most important

Overall, there is little debate about whether Okun's law is one of the simplest and most convenient methods for studying the relationship between economic growth and employment. One of the main benefits of Okun's law is the simplicity of stating that unemployment will fall by 1% if the economy grows about 2% faster than expected.

However, relying on making specific unemployment forecasts given economic growth trends also fails. For example, since research has been known to change over time and be influenced by more unusual economic climates, inclrecovery of the unemployedand the 2008 financial crisis

Due to the complexity of the input data, the different time periods that can be used, and the underlying uncertainty associated with running economic regressions, the analysis can become quite complex. Okun's law may not be fully predictive, but it can help shape the debate about economic growth, the impact of employment on it, and vice versa.


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