Okun's Law Model

Evidence and data

Use unemployment, hours, participation, productivity, potential output, and revisions. The coefficient should be estimated for the country and period.

Calibration or measurement

The Okun coefficient is reduced-form. It moves with labor hoarding, participation behavior, productivity, sector mix, and labor-market institutions.

Boundaries

• The relation is not a causal theory of recessions.
• Hysteresis can move the natural rate after a long slump.
• Real-time potential-output estimates can be heavily revised.

Use guidance

When sufficient

Rough cross-country or cross-cycle translation between output gaps and unemployment gaps at annual or quarterly frequency in a stable labor market. When potential output and the natural unemployment rate are both well-estimated and the labor force is not undergoing a structural shift, Okun's coefficient provides a quick cyclical check on whether the output and labor-market stories are consistent (Okun 1962; Ball, Leigh, and Loungani 2013).

When sketch only

Do not use where the labor market is undergoing structural change. Labor-force participation shifts, sectoral reallocation, and hysteresis after a deep recession can all move the coefficient. It is a reduced-form correlation, not a causal theory: a recession causes both the output fall and the unemployment rise; the relationship does not explain either.

When to switch

Switch to a search-and-matching model (Mortensen-Pissarides) when job-creation and job-destruction margins are the object of interest. Switch to a hysteresis-augmented Phillips curve or a model with state-dependent natural-rate estimation when a long slump has plausibly shifted the structural unemployment rate.

Falsification signal

The post-2009 US jobless recovery showed unemployment falling slowly even as output recovered, implying a much flatter Okun coefficient than historical norms. The post-2020 recovery reversed the pattern: output rebounded before employment, then employment came back faster than the output gap predicted. A sustained decoupling that persists across multiple cycles in the same country would suggest the coefficient has shifted structurally.