GDP Growth, Unemployment, and the G-spot

July 27th, 2012 at 1:21 pm

Today’s GDP report warrants a few more posts.  As I noted this AM, it revises some older data, showing the downturn to be a bit less deep in 2009 and growth a bit slower than we thought in 2010.  The important points re where we are today, however, are a) the average growth rate since the economy began to expand in 2009q2 is 2.2% (revised slightly from 2.3%), and b) the slowing I discussed in the above link.

The problem implied by both of those points shows up in the figure below, which plots the change in the unemployment rate against the change in real GDP, yr/yr, starting in 2008q1.   In this graph, which economists call Okun’s law, you very much want to avoid the northwest quadrant (GDP down, unemp up) and inhabit the southeast corner (GDP up, unemp down).



In fact, all the points in the NW are from 2008-09, the heart of the great recession.  And thus, all the points in the SE are from 2010-12, and in fact, there’s a nice little clump at the bottom there from when the jobless rate fell a point over the last year (though of course it’s been stuck north of 8% for the past few months).

If you run a simple regression of these variables going back to 2000, you get the Okun coefficient of -0.5, implying that for every percentage point that real GDP grows above trend, the jobless rate should fall by half a percentage point.

So what’s “trend GDP growth”?  According to my little regression, it’s 2.5%, though that’s a bit high given most other estimates around right now (CBO is closer to 2%).  You’ll notice we’ve actually gotten a favorable Okun bump lately, as recent points in the SW are below the line, suggesting a bit lower unemployment then you’d expect given GDP growth (maybe due to diminished labor force participation which tends to dampen the increase in the jobless rate as fewer folks are looking for work).

The basic takeaway, however, is this: as long as were slogging along at trend or, as in the most recent quarter, worse, don’t expect unemployment to come down. 

 But other takeaways are even more important:

 1)      the Okun rule is a pretty stable relationship that you can broadly count on to be your friend if you’re growing above trend and vice versa.

2)      GDP=C+I+G+(X-M); this morning’s report showed C, I, and X-M to have weakened somewhat, and G to be downright negative, as I showed in my earlier post.

3)      So until those other letters are reliably back to work, we need more G.  Not less G.  More G.

 I know this isn’t a fashionable conclusion but must we be so backwards in how we’re thinking about it?  From this AM’s WaPo:

For growth to take off, the analysts say, officials have to deal with the debt problems in Europe and U.S. policymakers must resolve the nation’s long-term debt problems without resorting to sharp tax increases and spending cuts. [my bold]

No, no, no!  Once we get out of this slog, we absolutely have to address long-term debt, but if doing so now implies more near-term austerity—shrinking G even faster!—as I believe it does, then it’s totally bass-akwards.

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