Question #1774

The Australian National Accounts data came out this week and showed that annual real GDP growth was running at 2.8 per cent per annum. Labour productivity growth over the last few years is around 1.3 per cent per annum, while the labour force has on average grown at 1.65 per cent per annum over the last two years. If the current GDP growth rate is sustained, average weekly working hours are unchanged, and the other aggregates behave according their recent averages then we should expect to see the unemployment rate rising.

True
False

Answer #8939

Answer: True

Explanation

The answer is True.

The facts were:

Real GDP growth to be maintained at its current growth rate of 2.9 per cent annum.

Labour productivity growth (that is, growth in real output per person employed) growing at 1.3 per cent per annum. So as this grows less employment in required per unit of output.

The labour force is growing by 1.65 per cent per annum. Growth in the labour force adds to the employment that has to be generated for unemployment to stay constant (or fall).

The average working week is constant in hours. So firms are not making hours adjustments up or down with their existing workforce. Hours adjustments alter the relationship between real GDP growth and persons employed.

The late Arthur Okun is famous (among other things) for estimating the relationship that links the percentage deviation in real GDP growth from potential to the percentage change in the unemployment rate - the so-called Okun's Law.

The algebra underlying this law can be manipulated to estimate the evolution of the unemployment rate based on real output forecasts.

From Okun, we can relate the major output and labour-force aggregates to form expectations about changes in the aggregate unemployment rate based on output growth rates. A series of accounting identities underpins Okun's Law and helps us, in part, to understand why unemployment rates have risen.

The approximate rule of thumb that is derived from Okun's law is that if the unemployment rate is to remain constant, the rate of real output growth must equal the rate of growth in the labour force plus the growth rate in labour productivity.

It is an approximate relationship because cyclical movements in labour productivity (changes in hoarding) and the labour-force participation rates can modify the relationships in the short-run. But it provides reasonable estimates of what happens when real output changes.

The sum of labour force and productivity growth rates is referred to as the required real GDP growth rate - required to keep the unemployment rate constant.

Remember that labour productivity growth (real GDP per person employed) reduces the need for labour for a given real GDP growth rate while labour force growth adds workers that have to be accommodated for by the real GDP growth (for a given productivity growth rate).

So in the example, the required real GDP growth rate is 2.95 per cent per annum and if real GDP growth continues at 2.8 per cent annum, then the output gap that emerges is 0.15 per cent per annum.

The unemployment rate will rise by this much (give or take) and reflects the fact that real output growth is not strong enough to both absorb the new entrants into the labour market and offset the employment losses arising from labour productivity growth.

The following blog may be of further interest to you:

What do the IMF growth projections mean?

That is enough for today!