# Okuns law expresses a relationship between change in me sheet

elasticity vis-à-vis the GDP growth rate question the relevance of Okun's law. Second . relationship between economic growth and employment as well as labour productivity and work force. the observed unemployment rate (u) is expressed by: . represents the average change in GDP growth rate over the sa me period. of the relation between inflation and unemployment has been a focus of M. E. Taylor for typing, and to Andrea V. Mills for computational help. smaller than calculations such as Okun's law imply. the inflation of the last decade and the change in real living Tab'le 8 gives employment profiles of the. Of course, the views I express today are my own, not necessarily those Figure 5, which shows that the per cent change in real final sales was rule of thumb, called Okun's Law, to characterize the relationship Given the need for very rapid growth to get unemployment back to 5 per cent, let me pose an.

Some discouraged workers will be attracted to the labor market. Overall, the interaction of these factors will make interpreting the data complex. Using the line the students have drawn, show that GDP changes by less than unemployment. Give immediate feedback if necessary. A cluster of data points form around 5. This shows that 5.

Have the students discuss this cluster and what it means. Have them complete the table. It takes labor to produce output.

Explain that structural plus frictional unemployment equals the natural rate of unemployment. Why is some unemployment, 5. Structurally unemployed workers are out of a job because their work has become obsolete.

In other words, the economy is creating new jobs while destroying inefficient ones. Economists call this creative destruction. Paul Krugman explains that workers can be structurally unemployed when they receive higher than market clearing wages such as a minimum wage or efficiency wage. There is a link between GDP, unemployment, and inflation. When unemployment changes, GDP changes by less. The natural unemployment rate is 5. There are three reasons why output does not change with unemployment.

The students should understand that when the unemployment rate is not changing, the labor market is in equilibrium. Some frictional and structural unemployment is healthy for the economy. An alternative definition is a period when the level of output is below its normal level, even if the economy is growing. It is not over until output has grown enough to get back to normal.

## Okun’s Law

It is clear from the ups and downs of the series in Figure We often hear about economies going through a boom or a recession as growth swings from positive to negative, but there is no standard definition of these words.

So we have two definitions of recession: A recession is over once the economy begins to grow again. A recession is not over until output has grown enough to get back to normal. There is a practical problem with the second definition: The economy goes from boom to recession and back to boom.

The movement from boom, to recession, and back to boom is known as the business cycle. In the twentieth century, the big downward spikes coincided with the end of the First and Second World Wars, and with the economic crisis of the Great Depression. In the twenty-first century, the global financial crisis followed a period in which fluctuations were limited.

In the lower part of Figure During the Great Depression, unemployment in the UK was higher than it had ever been, and it was particularly low during the World Wars.

Look at this articleespecially Figures 5, 6, and 7, to find out more. Consider a country that has been producing a lot of oil and suppose that from one year to the next its oil wells run out. The country will be poorer than previously. According to the two definitions above, is it in a recession?

### The Economy: Unit 13 Economic fluctuations and unemployment

Does knowing whether a country is in recession make a difference to policymakers whose job it is to manage the economy? Based on this information, which of the following statements is correct? The slope of the best-fit straight line is the average annual growth rate. The graph shows that the average growth rate was lower in the decades after than in the decades before The graph of real GDP per capita plotted using a ratio scale would look very different to the graph above.

It was, in fact, e8. This is stated in Figure While the log of real GDP per capita was lower immediately after than beforethe slope of the log graph is steeper. This means that the growth rate was higher after than before The graph of real GDP per capita plotted using a ratio scale would look the same as the graph of the natural log of real GDP per capita plotted on a linear scale. Einstein Ratio scales and logarithms In Unit 1, we made frequent use of a ratio or log scale on the vertical axis to display long-run data.

For example, we used ratio scales with the units doubling in Figure 1. The ratio scale is also called a logarithmic or log scale. We can write a scale where the tick marks on the vertical axis double like this: Or a scale where they rise tenfold, like this: The first is called a logarithmic scale in base 2; the second is in base As we saw in the charts in Unit 1, if the data forms a straight line on a ratio logarithmic scale, then the growth rate is constant.

A different method of using this property of logarithms is to first convert the data into natural logs and then plot it on a scale that is linear in logs. We can use a calculator or a spreadsheet program to convert levels into natural logs. As you can see, when applied to this data, it converts the curved line in Figure Using the chart functions in Microsoft Excel helps illustrate the relationship between plotting the data with a ratio scale on the vertical axis Figure Note that the tick marks double from 4, to 8, to 16, in Figure The ratio scale and an exponential function.

The linear scale in natural logs and a linear function. In each chart, a line appears alongside the data series. Using Excel, we created Figure Excel finds the line or curve that best fits the data points: The equation of the line is given. Other spreadsheet or graphing software offers similar features. We can see that the exponential function uses what is called base e in contrast to base 2 doubling or base 10 increasing tenfold. The exponent on e tells us the compound annual growth rate of the series: This time, we see an equation for a straight line with intercept 8.

Now the slope of the line tells us the exponential, or equivalently, the compound annual growth rate of the series: When a data series is plotted, either using a ratio scale or by transforming the data into natural logs, and the outcome is approximately linear, it means that the growth rate of the series is approximately constant.

This constant growth rate is called an exponential growth rate. The exponential growth rate known also as the compound annual growth rate or CAGR is the slope of the line when the natural logarithm of the data series is plotted.

Notice the persistent deviation of the British economy from the trend line following the financial crisis. In each country chart, there is a downward-sloping line that best fits the points. Our Einstein at the end of this section shows how to derive the coefficient. The dot labeled in each graph in Figure We can see that inall four of the advanced economies experienced their worst output contraction in 50 years.

Germany looks very different: We will see why this occurred later in this unit. Brazil and Malaysia also experienced contractions in output and increases in unemployment in However, like most developing economies, they were hit less hard by the crisis than the advanced economies.

Also, Malaysia had recently experienced a much worse contraction during the East Asian crisis inwhen growth was —7. We can summarize the relationship between output, unemployment, and wellbeing like this: What explains the significant deviation from the historical experience during these two time periods? One hypothesis is that the two periods are interconnected: During the recent recovery, the unemployment rate decreased more than expected given the actual increase in GDP because during the recent recession the unemployment rate increased more than expected given the actual decrease in GDP.

This hypothesis implies that deviations from Okun's law were balanced out between the two periods and that the earlier historical data should be usable to perform forecasts going forward. Our analysis challenges that view. The second chart shows the relationship between the year-to-year percentage-point changes in the unemployment rate and in the employment-to-population ratio.

The open circles in both panels show the historical relationship between these two variables from January to the peak that occurred one month before the start of the Great Recession. The solid circles show the relationship between the data during the recession left panel and since the recovery started in July right panel. The blue lines represent the historical relationship, while the red lines represent that relationship estimated for the Great Recession left panel and recovery right panel.

The left panel of the second chart shows that the relationship between the increase in the unemployment rate and the decline in the employment-to-population ratio during the recent recession is in line with the historical pattern. Thus, while changes in GDP were not useful for predicting changes in unemployment during the recent recession, changes in the employment-to-population ratio were—unemployment during the Great Recession increased significantly because the ratio decreased proportionally.

The right panel of the second chart shows a different story for the recovery, however.