What is the 'Okun's Law'

Okun's law pertains to the relationship between the U.S. economy's unemployment rate and its gross national product (GNP). It states that when unemployment falls by 1%, GNP rises by 3%. However, the law only holds true for the U.S. economy and only applies when the unemployment rate falls between 3 and 7.5%.

BREAKING DOWN 'Okun's Law'

Other versions of Okun's law focus on a relationship between unemployment and GDP, whereby a percentage increase in unemployment causes a 2% fall in GDP.

Arthur Okun was a Yale professor and economist who studied the market relationship between unemployment and production. He first published his research on the topic in the 1960s, and his findings were established as Okun’s law. Okun’s law provides a general notion construing that when unemployment falls, the production of a country will increase. This measure can be used for estimating both GNP and GDP.

The percentage increase by which GNP changes when unemployment falls by 1% is the Okun coefficient.

The relationship between unemployment and GNP or GDP varies by country. In the United States, the Okun coefficient estimates that when unemployment falls by 1%, GNP will rise by 3% and GDP will rise by 2%. When unemployment rises by 1%, then GNP is expected to fall by 3% and GDP is expected to fall by 2%.

Industrialized nations with labor markets that are less flexible than those of the United States, such as France and Germany, tend to have higher Okun coefficients. In those countries, the same percentage change in GNP has a smaller effect on the unemployment rate than it does in the United States.

Highly Inaccurate

Economists broadly support Okun's law, but it is not considered to be highly accurate; numerous variables are involved with changes in GNP and GDP. Economists support an inverse relationship between unemployment and production. Most economists believe that when unemployment rises, GNP and GDP will simultaneously fall; when unemployment declines, GNP and GDP are expected to increase.

Further studies on the relationship of unemployment to production include a broader set of labor market variables to analyze the effects of the labor market on GNP and GDP. More detailed labor market variables include the level of the total labor market, hours worked by employed workers and productivity levels for workers. In further analysis, economists have found the change in production for every 1% change in unemployment to vary with more volatility than Okun's law sets forth.

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