Federal Reserve Bank of Cleveland
Press Release

For Release: October 1, 1997
Contact: John Martin, 216/579-2847 or June Gates, 216/579-2048

Low Unemployment, Robust GDP Growth Donít Always Mean Higher inflation

A widely accepted economic relationship called "Okun's Law" suggests that when unemployment is low and falling while GDP is expanding rapidly, higher inflation cannot be far behind. However, a recent Economic Commentary published by the Federal Reserve Bank of Cleveland suggests that the textbook relationship between unemployment, GDP, and prices is not stable or predictable, and hence may not provide a useful way to think about monetary policy.

The Commentaryís authors, economists David Altig, Terry Fitzgerald, and Peter Rupert, say that while historically there has been a negative correlation between output and unemployment, the relationship changes over time and has sometimes failed altogether. The authors emphasize that the output of an economy does not depend directly on the unemployment rate, but on a nation's labor force, its capital stock, and the level of technology.

Unemployment is related to GDP through the labor services channel, and the more complex relationship between output and labor services must be considered in assessing whether declines in unemployment at a given rate of GDP growth indeed signal increasing price pressures.

Altig, Fitzgerald, and Rupert say that the other factors which determine labor resource utilization, such as productivity, have often tended to undermine quantitative representations of Okun's Law. They show, in fact, that changes in productivity have produced results contrary to what Okun's Law would suggest.

Although Okun's Law expresses a general relationship between changes in unemployment growth and changes in output, the authors say it is not, and was not intended to be, an immutable law. Recognizing the instability in the unemployment/output relationship, they say, can go a long way toward helping us understand that an economy operating at low and falling unemployment, with robust growth and stable inflation, may be a very plausible and happy circumstance.

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