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An Analysis of Okun’s Law

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  1. Introduction
  2. Explain Okun's law
  3. What influences the effect on unemployment of a given deviation of output growth from normal?
    1. Labour market participation
    2. Training costs
    3. Some workers are needed regardless of output level
    4. Employment protection legislation
    5. Politics
  4. What role does Okun's law play in determining the effect of a monetary contraction?
  5. Conclusion


This essay is split into three sections. In section 1, Okun's law will be examined, by looking at both of its forms. In section 2, the Okun's law coefficient will be analysed with particular reference to the factors which can affect the coefficient. In section 3, Okun's law will be applied in the context of a monetary contraction.

Explain Okun's law:

What is Okun's law? Surprisingly, it is not even actually a law as such, but a ?rule of thumb? which remained valid for so long that it became commonly called a law (Ho,2002:76). Okun's law is a relationship linking output and employment negatively, which was proposed by Arthur Okun in 1962 (Attfield and Silverstone,1998:625). Below is a graph showing a typical best-fit line for an Okun's law scatter plot, although the scatter plot points have not been included on this diagram. This is just a demonstration of the general relationship between the change in the unemployment rate and the change in output. As we can see from the graph, this is a negative relationship.

[...] The Okun's law coefficient, which has been previously mentioned, is the mechanism which affects unemployment for a given deviation of output growth from normal. The Okun's law coefficient has been described as for the gap equation, and for the growth equation. As already mentioned, the value for both coefficients has been stated as 0.4 in the US, so it means that we can just treat them as the same thing. However, the question refers to ?output growth?, so we shall use here, and analyse it in the context of the growth rate equation. [...]

[...] This involves using other models as well as Okun's law as Okun's law is a relation between inflation and unemployment, whereas we need to look at interest rates to see the effects of monetary policy. This is because changing the real interest rate is how governments perform monetary expansions or contractions (De Long and Olney,2006:347). De Long and Olney present a basic version of the Taylor rule (2006:347), which can combine with Okun's law, and the IS curve to help analyse monetary policies. [...]

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