Aspects of Economic Activity And Unemployment

Abstract

In a seminal paper, Okun (1962) investigated the relationship between potential GNP and levels of unemployment in order to identify the loss of national output due to unemployment. From this investigation, a significant macroeconomic relationship was established which received the name “Okun’s Law.” According to Okun’s Law, each percentage point of unemployment above 4 percent of the labor force implies a 3 percent gap of foregone potential output. The original study used quarterly data from 1947 to 1960 and employed ordinary least-squares analysis as its primary statistical method. Since Okun’s (1962) original work, several studies appears investigating the same issue and extending the original scope. Here we do not intent to survey the literature on Okun’s Law; a good summary of the various studies may be found in Tatom (1978). Instead, what we propose to do is first, to replicate Okun’s model for the period 1948-1979 and second, and more importantly, to use a superior econometric technique, namely Cochran-Orcutt regression analysis. This technique requires autocorrelation and allows for a better appraisal of the output-unemployment relationship in Okun’s original structural equations.