GDP Growth, the Unemployment Rate, and Okun's Law

By Higgins, Patrick | EconSouth, Fall 2011 | Go to article overview

GDP Growth, the Unemployment Rate, and Okun's Law


Higgins, Patrick, EconSouth


Since June 2009, when the most recent recession ended, the unemployment rate has declined only 0.4 percentage point, from 9.5 percent to 9.1 percent. Over the same two-year period, real gross domestic product (GDP) has grown at an annual rate of 2.4 percent. This estimate is in line with many analysts' and policymakers' reckonings of the "potential" growth rate of the economy.

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Looking down the road

The Council of Economic Advisers, the people who advise the White House on economic matters, defines potential GDP growth as "the rate of growth of real GDP that could be sustained with the economy at full employment and steady inflation." The council projects average potential growth of 2.5 percent through the end of 2021. The Congressional Budget Office (CBO) projects a slightly lower potential growth rate: 2.3 percent over the same time period.

And the Federal Reserve Board of Governors' and Reserve Bank presidents' projections of longer-run real GDP growth range from 2.4 percent to 3 percent. (Longer-run real GDP growth is defined as the rate growth "would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy.") As Atlanta Fed President Dennis Lockhart discussed in a recent speech at Jackson Hole, Wyo., the Atlanta Fed's own estimate is that, the current long-run trend growth rate is 2.5 percent.

The long arm of Okun's law

Okun's law describes one of the most famous empirical relationships in macroeconomics. Proposed by economist Arthur Okun in 1962, it basically states that if GDP grows rapidly the unemployment rate declines, if growth is very low or negative the unemployment rate rises, and if growth equals potential the unemployment rate remains unchanged. Considerable debate and disagreement take place about how close and stable a relationship these factors have under Okun's law. However, over the past two years, Okun's law has held up reasonably well--growth has been close to many estimates of potential and the unemployment rate, on balance, has not declined much since the end of the last recession.

The August issue of Blue Chip Economic Indicators, which surveys leading business economists, had a consensus projection for average GDP growth of 2.6 percent in the second half of 2011 and 2012. The panel did not forecast beyond 2012 in the most recent issue, but in March it did, projecting just under 3 percent average growth in 2013-7. Are the Blue Chip growth forecasts high enough to bring the unemployment rate down to, say, 7 percent by the end of 2014? …

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