Okun's Law: Theoretical Foundations and Revised Estimates

Okun's Law has been accepted as an empirical regularity that predicts a 3 percentage point increase in output for every 1 point reduction in the unemployment rate, but only because other facts, such as weekly hours, induced labor supply and productivity tend to rise as well. When output gaps are estimated for the U.S. economy with a production-function approach, using two different data sets for potential output and NAIRU, it is found that the marginal contribution of a 1 point reduction in unemployment is only about two-thirds percent increase in output. Changes in weekly hours and capacity utilization have independent effects on the output gap. Copyright 1993 by MIT Press.