Monday, January 3, 2011

Okun’s Law and Current Unemployment

Here’s a short snippet from my unfolding macro text:
It is possible that this relationship has been changing over time. If you plotted only the years 1990-2009 (not shown), the corresponding trend line would be

change in unemployment rate = 2/3 (2.7 - GDP growth)

The only difference is that unemployment remains constant at a somewhat lower rate of economic growth; above or below this point the impact of growth on unemployment is the same. What is the significance of Okun’s Law today? At the time this is being written, the unemployment rate in the US is too high at 9.8%. Suppose we would like it to fall to 5%. If the more recent relationship continues to hold, it is telling us we need 7.2% of extra growth (4.8%, the desired reduction in unemployment, divided by 2/3, which means multiplied by 3/2) above the 2.7 level. We could accomplish this in a single year if we could get to 9.9% growth, but this is almost certainly out of reach. To get to 5% in three years would mean averaging 5.1% over that period. (Divide 7.2 by three and add to 2.7.) This is highly unlikely as well unless the government undertakes a much more aggressive adjustment program than we have yet seen. In fact, current growth hovers close to the break-even level itself, suggesting that high unemployment is likely to remain a fact of life for a long time.

1 comment:

ajsutter said...

Your account assumes that the causality runs from growth -> employment. How does Okun's law establish this causality? Isn't it more plausible that higher employment leads to higher growth -- if Okun's law is indeed causal at all?