Okun's Law: Output and Unemployment

The relationship between economic growth and unemployment first observed by Arthur Okun, and why it is a rule of thumb rather than a law.

When the economy grows quickly, unemployment usually falls. When growth slows or turns negative, unemployment rises. In 1962, the economist Arthur Okun described this relationship in numbers. It became known as Okun’s law.

The relationship

Okun observed in U.S. data that when output grew faster than its normal trend, unemployment fell, and when output grew slower, unemployment rose. A common version of the rule says that for every 2 percentage points that output falls below its potential, unemployment rises by about 1 percentage point above its normal level.

Another way to put it: the economy must grow at roughly its trend rate just to keep unemployment stable, because the labour force and productivity are growing.

Why it happens

When demand for goods and services falls, firms need fewer workers, so they cut hiring or lay people off. When demand rises, they hire. But the relationship is not one for one, because firms also adjust hours, productivity changes, and some people leave or enter the labour force.

A rule of thumb

Despite its name, Okun’s law is an empirical rule of thumb, not a fixed law. The relationship varies across countries and time periods. In countries with strong job protection, unemployment may respond less to output changes. In some recoveries, output grew but unemployment fell slowly, sometimes called “jobless recoveries”.

Using Okun's rule

Suppose an economy's output falls 4 percent below its potential in a recession. Using the rule of thumb, unemployment might rise by about 2 percentage points, for example from 5 percent to 7 percent. Policymakers use rough estimates like this to judge how deep a recession is and how much support may be needed.

Why it matters

Okun’s law links two headline figures, GDP and unemployment, helping forecasters and policymakers translate growth forecasts into employment forecasts. Central banks use such relationships when judging how much slack there is in the economy.

Treating Okun's law as exact

The relationship between output and unemployment changes over time and differs between countries. It is a useful rough guide, not a precise formula.

Key takeaways

Okun's law links output growth to changes in unemployment.
A common version says output 2 points below potential means unemployment about 1 point higher.
The economy must grow at its trend rate to keep unemployment stable.
It is a rule of thumb that varies across countries and time.