Question #2524

Say, we form the view that over the next year: (a) the average working week will be constant in hours; (b) real GDP growth rate will be 3 per cent; (c) output per unit of labour input (persons) will grow at 1.5 per cent; and (d) the labour force will maintain a growth rate of 1.5 per cent per annum. We would project that the unemployment rate

Will rise in the coming year by 1.5 per cent.
Will fall in the coming year by 1.5 per cent.
Will be unchanged.

Answer #12560

Answer: Will be unchanged.

Explanation

The answer is Option (c) - the unemployment rate will be unchanged.

The assumptions made about the aggregates over the next 12 months were:

Real GDP growth growth rate of 3 per cent annum.

Labour productivity growth (that is, growth in real output per person employed) growing at 1.5 per cent per annum. So as this grows less employment in required per unit of output.

The labour force is growing by 1.5 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 real GDP growth rate doesn't relate to the labour market in any direct way. 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.

In accounting terms, total output must equal the total hours of work times the productivity of each hour worked.

Arthur Okun converted that fact into a rule of thumb which related shifts in unemployment to changes in the aggregates (output, hours worked, labour productivity).

The rule of thumb is as follows:

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 3 per cent per annum and so the actual real GDP growth is also equal to this required real GDP growth rate. In other words, the unemployment rate will remain unchanged.

Unemployment would still be rising but the rate of unemployment will be constant.

The following blog post may be of further interest to you:

What do the IMF growth projections mean?

That is enough for today!