A government desires to reduce the unemployment rate over the next year and gears its macroeconomic policy to maintaining trend real GDP growth, which is 3.5 per cent per annum. If we know that labour productivity is growing at 2 per cent per annum, the labour force is growing at 1.5 per cent per annum, and the average working week is constant in hours, the government will succeed in its aim if real GDP is sustained at the trend.
Answer: False
The answer is No.
The facts were:
Of-course, the trend rate of real GDP growth 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.
Take the following output accounting statement:
(1) Y = LP*(1-UR)LH
where Y is real GDP, LP is labour productivity in persons (that is, real output per unit of labour), H is the average number of hours worked per period, UR is the aggregate unemployment rate, and L is the labour-force. So (1-UR) is the employment rate, by definition.
Equation (1) just tells us the obvious - that total output produced in a period is equal to total labour input [(1-UR)LH] times the amount of output each unit of labour input produces (LP).
Using some simple calculus you can convert Equation (1) into an approximate dynamic equation expressing percentage growth rates, which in turn, provides a simple benchmark to estimate, for given labour-force and labour productivity growth rates, the increase in output required to achieve a desired unemployment rate.
Accordingly, with small letters indicating percentage growth rates and assuming that the average number of hours worked per period is more or less constant, we get:
(2) y = lp + (1 - ur) + lf
Re-arranging Equation (2) to express it in a way that allows us to achieve our aim (re-arranging just means taking and adding things to both sides of the equation):
(3) ur = 1 + lp + lf - y
Equation (3) provides the approximate rule of thumb - 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 3.5 per cent per annum and even if policy initiatives achieve that rate of growth, the nation's output gap would remain at zero.
Which means that while that will be sufficient to maintain the current unemployment rate, it will not generate enough employment to reduce the rate.
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