Question

One of the most remarkable associations in macroeconomics relates GDP growth to unemployment (or the so-called Okun’s Law, see p.293-294 in Burda&Wyplosz textbook). This empirical regularity describes inverse relationship between the change in unemployment and the change in GDP growth. Resulting negative coefficient has been repeatedly confirmed for different countries and different periods. Your task is to:

a) Propose a different version about how the GDP is related to the labour market. Specifically, make a statement akin to the textbook (so read the relevant section) on how the employment rate is related to the output growth and write a formal/theoretical equation describing the link.

b) Check the relationship with some macroeconomic data! Firstly, you need to find time-series (for the employment rate choose people aged 15-74, and for the real GDP annualized growth rates) for one country of your own choice. Find online data from your home/preferred country’s statistical office or Eurostat (Links to an external site.)Links to an external site.).

c) Retrieve a set of 40 most recent quarterly observations for both variables, arrange the data and plot the relationship on a graph.

d) Figure out the correlation coefficient between the variables, add the trend-line relationship between the variables.

e) How the proposed model (expected coefficient) fits your analysis.

Answer 1

In 1960 economist Okun researched about the relation between economic growth and unemployment levels. In the most basic form of this theory the statistical relation of unemployment and growth of a country evaluated. Okun's law explained how much the GDP of an economy lost due to rise in unemployment rate. Output defined by the labour involved in the production process, which reflects the positive relation between output and employment. total employment = labour force - unemployment. Okun's theory noted the continuous increase in labour force size and in the productivity, real GDP growth close to the rate of it's potential growth. so to avoid unemployment situation economy must grow above it's potential.

To achieve one percent reduction in unemployment rate we need to gate 2 percent GDP growth rate over the period which is more than the potential GDP growth rate, so the GDP must grow above 4 percent to gain potential reduction in the unemployment rate.

Y=1.9133x + 3.3652

R² = 0.75013 this explains Okun's law of regression.