Editor's note: This is a brief excerpt from today's Morning Newsletter written by Hedgeye U.S. macro analyst Christian Drake. For more information on how you can subscribe click here.
Okun’s Law: Okun’s Law – named for Kennedy economic advisor Arthur Okun - links the growth rate of output to changes in the unemployment rate and says that short-run output needs to grow ~2.25% above trend to reduce unemployment by 1%. Historically, the relationship has been strong with ~70% of the annual change in unemployment explained by the change in GDP growth. In the Chart of the Day below we show Okun’s Law on an annual basis over the 1948-2014 period. We’ve highlighted the large dispersion/break from trend in the peri and post-crises period with unemployment spiking higher than predicted by the model in 2009/10 and subsequently falling faster than predicted over the 2011-14 period.
Secular and structural changes in the economy and labor market have certainly shifted the relationship over the last 65 years and the Great Recession served to bring those changes further into focus. But that’s also largely the point. If the forecast error in a workhouse macro model such as Okun’s Law rises to such an extent that its practical utility is lost when it’s needed most, the conventionalist forecaster’s tackle box gets increasingly bare.