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okuns law description where components are described
Typology: Lecture notes
Uploaded on 04/07/2019
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OVERVIEW
We characterize the economy by three relations:
Okun’s Law : a relation between output growth and the change in unemployment Phillips Curve : a relation between unemployment, inflation, and expected inflation Aggregate Demand : a relation between output growth, money growth, and inflation.
OKUN’S LAW
Given productivity, output moved with employment:
ut − ut− 1 = −gyt
The change in the unemployment rate should be equal to the negative of the growth rate of output. For example : If output growth is 4% then the unemployment rate should decline by 4%.
Extending our analysis of employment and output
ut − ut− 1 = −β(gyt − gy)
OKUN’S LAW (^) ut − ut− 1 = −β(gyt − g y)
The actual relation between output growth and the change in the unemployment rate is known as Okun’s law
ut − ut− 1 = − 0. 4 (gyt − 3%)
Using 30 years of data, the line that best fits the data!
OKUN’S LAW
ut − ut− 1 = − 0. 4 (gyt − 3%)
Suppose the economy is growing at 4 % What would be the reduction in unemployment rate?
Why is it less than one-for-one?
OKUN’S LAW
ut − ut− 1 = −β(gyt − gy)
Output growth above (below) normal leads to a decrease (increase) in the unemployment rate.
This is Okun’s law:
gyt > gy ⇒ ut < ut− 1
gyt < gy ⇒ ut > ut− 1
Regression equation: Δ u t = α+β g t + εt
where
Predicted Δ u t = 0.57 - 0.21 g t ᡄ⡰^ = 0.
To work out the predicted percentage change in the unemployment rate for Germany in 2009, plug in the value of GDP growth for Germany in 2009 and solve the equation:
Predicted Δ u t in 2009 = 0.57 - 0.21 x (-5.1) = 1.
So Okun’s law predicts that the fall in GDP of 5.1% in 2009 should have been associated with an increase in the unemployment rate of 1.641%. In fact Germany managed to protect jobs…