From VoxEU:
Will recovery be jobless? A broad array of analysts, from Vox columnists to McKinsey, are arguing that Okun’s Law is broken. This column presents new research suggesting that, in fact, Okun is alive and well. When output recovers, the jobs will come back, although employment will differ across countries. There may be good reasons for the structural reforms that many propose as a way to boost job creation, but undertaking them in the belief that Okun’s Law has broken down should not be one of them.
Unemployment rates remain high in most advanced countries. Many scholars have drawn attention to an apparent decoupling of unemployment increases from output declines during the Great Recession (e.g. IMF 2010, Cazes et al. 2011).
Figure 1 shows peak-to-trough declines in output for a group of OECD countries during the Great Recession against the change in unemployment over the same period. The correlation is essentially zero. In the language of economics textbooks, Figure 1 suggests a breakdown of Okun’s Law, the short-run negative relationship between output and unemployment reported by Arthur Okun in 1962.
Figure 1. The Great Recession: Peak-to-trough output and unemployment changes (simple scatter plot)
We believe the casual impression that "Okun’s broken" is misleading (Ball, Leigh and Loungani 2013). Two adjustments are needed to restore Okun’s Law (as shown in Figure 2):
For the set of recessions shown in these charts, the period from peak to trough ranges from two quarters to seven quarters. As we show in our paper, Okun’s Law implies a relationship between the changes in unemployment and output only if we control for this factor.
- The first adjustment is to account for differences in the duration of the recessions;
Figure 2. The Great Recession: Peak-to-trough output and unemployment changes (with adjustments for duration of recessions and country-specific Okun coefficients)...MORE
- The second adjustment accounts for the fact that, historically, the coefficient in Okun’s Law varies across countries.
