Okun's Law

4 Key excerpts on "Okun's Law"

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  Political Economy Perspectives on the Greek Crisis

  Debt, Austerity and Unemployment

  • Ioannis Bournakis, Christopher Tsoukis, Dimitris K. Christopoulos, Theodore Palivos, Ioannis Bournakis, Christopher Tsoukis, Dimitris K. Christopoulos, Theodore Palivos(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  12.1 Introduction Unemployment in Greece in the period of the severe recession, 2010– 2017, has tripled. Okun (1962)—in his seminal study—has correlated cyclical GDP movements and changes in unemployment to what has since been known as the “Okun’s Law”. The Okun’s Law integrates the demand with the supply side of the economy as it associates aggre- gate rate demand shocks with labour market outcomes. Accordingly, below-normal output growth leads to an increase in unemployment (job losses) while above-normal output decreases unemployment (job creation). The evolution of unemployment in the short-run determines the rate of inflation; this is the main relation of the Phillips curve. 12 Output and Unemployment: Estimating Okun’s Law for Greece Ioannis Bournakis and Dimitris K. Christopoulos © The Author(s) 2017 I. Bournakis et al. (eds.), Political Economy Perspectives on the Greek Crisis, DOI 10.1007/978-3-319-63706-8_12 273 I. Bournakis Department of Economics, Middlesex University, London, UK e-mail: [email protected] D.K. Christopoulos (*) Department of Economic and Regional Development Panteion University, Athens, Greece e-mail: [email protected] 274 I. Bournakis and D.K. Christopoulos Figure 12.1 illustrates the sequence of effects in the short-run followed from an adverse demand shock in the economy. The lower demand for output means that firms hire less labour, which decreases demand for labour and leads to lower wages and disinflation. The Greek economy has entered such a spiral since 2010 when the first bailout programme was offered to save the country from a disorderly bankruptcy. 1 The external financial assistance came at the cost of severe austerity necessary for the consolidation of public finances. As expected, austerity caused adverse demand shocks that impacted on unemployment.

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  Working in the Macro Economy

  A study of the US Labor Market

  • Martin F. J. Prachowny(Author)
  • 1997(Publication Date)
  • Taylor & Francis

    (Publisher)

  There is a long history to the debate about the real wage being procyclical or countercyclical; the most recent summary is provided by Abraham and Haltiwanger (1995). They report results (p. 1236), based on Granger causality tests, that indicate the real wage as exogenous and employment as endogenous, yet most empirical studies in this area take the real wage as the dependent variable. For the sake of comparison, the employment regression was “inverted” to produce the following:

  Not only is there now a positive relationship between w−p and n, but this regression also perversely predicts that the real wage will fall when the capital stock increases. As Abraham and Haltiwanger point out (p. 1262), employment has been found to be clearly procyclical, but “the cyclically of real wages is not likely to be stable over time.” However, the evidence here is that rising (falling) wages reduce (increase) employment ceteris paribus, over the entire 37-year period.

  1.6 Okun's Law

  One of the most enduring empirical relationships is Okun’s Law which specifies that a one-point reduction in the unemployment rate increases output by about 2–3%. Writing a production function in natural logs, with capital and labor as inputs and defining the supply of labor as n s= n−u, produces

  where 1 and 2 are output elasticities of the two inputs. For a reduction in u to lead to an increase in y that is two to three times as large would require either that 2 is of the same size or that other factors change pari passu with u. It was the latter argument that Okun used; he wrote:

  Clearly, the simple addition of 1 percent of a given labor force to the ranks of the employed would increase employment by slightly more than 1 percent…. If the workweek and productivity were unchanged, the increment to output would be only that 1+percent. [Note the assumed constant marginal product of labor, which is inconsistent with most production functions.] The 3 percent result implies that considerable output gains in a period of rising utilization rates stem from some or all the following: induced increases in the size of the labor force; longer average weekly hours; and greater productivity.

  (1970, p. 140)

  Of these factors, Okun believed that productivity gains were the most important. He was convinced that, “The record clearly shows that manhour productivity is depressed by low levels of utilization, and that periods of movement toward full employment yield considerably above-average productivity gains” (p.

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  Asymmetry and Aggregation in the EU

  • D. Mayes, Matti Virén(Authors)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  134 6 Output, Unemployment and the Labour Market: The Okun Curve After the Phillips curve, the Okun curve – the relationship between output and unemployment – is probably the most obviously nonlinear. In the growth phase of the economic cycle unemployment tends to fall steadily until the point when labour shortages are reached. In the downturn, even if it only represents slow growth, unemployment tends to rise disproportionately but with a lag. This inter-relationship, which is reflected in fluctuations in labour (and total factor) product- ivity, lies at the heart of the real business cycle literature and it has proved difficult to provide a totally convincing explanation that covers the whole cycle, the shocks that are experienced and the leads and lags that affect behaviour. Hiring and firing have costs. Hence firms try to take a longer-term view of their labour needs. In periods of rapid expansion they prefer to get the workforce to work longer hours and seek means of increasing productivity, albeit temporarily, if they think that the growth may be exceptional. Similarly in a downturn, if the pause is expected to be relatively short-lived, they will attempt to hold onto their labour force and reduce costs by cutting back on hours worked and limiting pay increases. One of the characteristics of the present recession in Europe, unlike the United States, is that unemployment has risen by less than what might otherwise have been expected from previous, milder fluctuations. In part, this is probably due to the concentration of the problems in the financial sector but it no doubt also represents a general feeling that demand will bounce back, particularly in the investment goods sectors, as soon as the banking problems are sorted out.

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  Growth and Employment in Europe

  • M. Zagler(Author)
  • 2004(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  186 Evidence into Figure 10.2. The empirical analysis has revealed that the model presented in sections 10.2 and 10.3 is consistent with the facts. We do find a long-run relationship between unemployment and economic growth, or evidence for cointegration. In the short run, unemployment and economic growth are negatively related, which is consistent with the resource constraint. Together with the microeconometric evidence presented in chapter 7, this provides ample evidence in favor of an endogenous growth model with labor market frictions. 10.5 The scope for economic policy The previous sections have sketched a unifying framework for the dis- cussion of economic growth and unemployment, and presented some favorable evidence. We find that the relation between economic growth and unemployment can best be described as an innovation-driven endo- genous growth model with imperfect matching in the labor market. Both innovation-driven endogenous growth models and search models of unemployment contain an intrinsic externality, which implies that the economy will exhibit a suboptimally low rate of growth and a subop- timally high rate of unemployment, thus presenting great opportunities for welfare-improving economic policy interventions. The externality in the growth process is a knowledge externality. Knowledge – or at least its economically relevant parts – is very limited in the model economy described in the previous sections. Indeed, agents only know, and only need to know, the different types of consumption goods in the economy. In that respect, we may consider n t to be an index of knowledge in the economy. This knowledge is not totally worthless, as innovators can build on existing knowledge to create novel products. 2 The good news for innovators is that knowledge is non-appropriable, so they have access to this information for free.

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