Okun’s Law

The Fed of San Francisco just published a note on Okun’s Law and the Unemployment Surprise of 2009.

In the paper they conclude that strong productivity was the main reason employment growth was weaker than the traditional relationship that Okun’s law implied.

Of course, we at Angry Bear have long known this. I have published this chart that shows that roughly before 1974 that a one percentage point growth in real GDP generated a 0.3 percentage point growth in employment. This is what Okun’s law is based on. But during the era of low productivity growth, 1974 to 1995 a percentage point growth in real GDP generated almost a 0.5 percentage growth in employment.

But since productivity growth rebounded in 1995, every percent increase in real GPD was accompanied by almost a 0.9% gain in productivity so that employment barely rose 0.1% — a significantly lower rate than Okun thought.

The data in the chart is the long term trend and ignores the cyclical pattern in productivity where productivity growth peaks in a recession or early recovery period and slows as the expansion continues. That is why productivity growth has long been widely considered a leading indicator. It is also why you get patterns such as the San Francisco Fed found for 2009, and why we now seem to have jobless recoveries.