Okun’S Law

Published Oct 25, 2023

Definition of Okun’s Law

Okun’s Law is an empirical relationship between the change in unemployment and the change in gross domestic product (GDP) of an economy. It states that for every 1% increase in the unemployment rate, there will be a corresponding 2% decrease in the GDP growth rate. Conversely, for every 1% decrease in the unemployment rate, there will be a corresponding 2% increase in the GDP growth rate.

Example

To illustrate Okun’s Law, let’s consider a hypothetical economy where the current unemployment rate is 5%. If there is a recession or a contraction in the economy, causing the unemployment rate to increase to 7%, according to Okun’s Law, there would be a corresponding 2% decrease in the GDP growth rate.

On the other hand, if the economy starts to recover and the unemployment rate decreases to 3%, Okun’s Law predicts a corresponding 2% increase in the GDP growth rate.

It is important to note that Okun’s Law is a general relationship and may vary across countries and time periods. Other factors such as productivity, labor force participation, and structural changes in the economy can also influence the relationship between unemployment and GDP growth.

Why Okun’s Law Matters

Okun’s Law is used by economists, policymakers, and analysts to understand the relationship between unemployment and economic growth. It provides insights into the potential effects of changes in employment on the overall economy.

By understanding Okun’s Law, policymakers can design appropriate fiscal and monetary policies to stimulate economic growth and reduce unemployment. For example, during an economic downturn, policymakers can implement measures such as fiscal stimulus packages or monetary easing to boost economic activity and reduce unemployment.

Okun’s Law also highlights the importance of maintaining a low and stable unemployment rate for sustainable economic growth. High levels of unemployment not only indicate inefficient allocation of resources but can also have negative social and economic consequences, such as reduced consumer spending and increased income inequality.