A gauge known as Okun’s Law that’s historically used to predict the U.S. unemployment rate based on the economic growth outlook is “broken,” according to Goldman Sachs Inc.
Okun’s law indicated the unemployment rate should have remained steady when the rate unexpectedly dropped 1.7 percentage points from a recent peak, Andrew Tilton, a senior economist in New York at the firm, said in an interview today on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt.
“For a long time, we and most other economists used Okun’s Law as a rule of thumb for deciding what kind of unemployment rate we should expect given a GDP outlook,” Tilton said, calling the recent loss of correlation “really quite striking.”
Okun’s law is named for the late Arthur Okun, a Yale University professor who was chairman of the White House Council of Economic Advisers in the late 1960s. The law holds that year-on-year growth of 2 percentage points above the trend rate -- widely considered 2.5 percent -- is needed to lower unemployment by one point.
“We’ve actually had growth almost exactly in line with that over the last couple of years, just below 2½percent,” Tilton said. “That would historically have suggested unemployment would be relatively steady. But, instead, it’s down almost 2 points from the peak in late 2009, early 2010.”
The gauge reflects lower potential growth over that period, said Tilton.
The unemployment rate unexpectedly dropped in January to
8.3 percent, a three-year low, the Labor Department reported Feb. 3. The rate touched a high of 10 percent in October 2009, the highest since 1983. The same report showed the share of working-age people in the labor force had declined to the lowest level in 29 years.
“Labor force participation has dropped sharply over the last couple of years,” Tilton said. “That the labor market has been so bad has caused a number of people to stop looking actively for work.”
The U.S. economy needs GDP growth of about 3 percent for the next four years to catch up to potential, Tilton said, adding that the economy may take at least four to five years to reach its potential.