[April 22, 2014]SAN FRANCISCO (Reuters) — The U.S.
jobless rate in recent years has been a good gauge of slack in the
economy, according to a paper published Monday by the Federal
Reserve Bank of San Francisco that takes aim at critics who have
argued otherwise.
Indeed, the unemployment rate has responded to GDP growth since the
financial crisis in essentially the same way that it has in every
recession since the 1970s, the paper's authors found, rising when
economic output slows, and falling when it speeds up.
"The unemployment rate remains a good summary measure of overall
economic slack," wrote Mary Daly, No. 2 in the San Francisco Fed's
research department, and John Fernald, a senior research advisor at
the San Francisco Fed, in the latest issue of the bank's Economic
Letter.
Figuring out the exact extent of slack in the economy is one of the
most pressing questions for monetary policymakers, Fed Chair Janet
Yellen has said.
If policymakers underestimate it, they might miss the chance to give
the economy the extra juice it needs. If they overestimate it, they
could end up over-stimulating the economy and sparking inflation.
And, as policymakers including Yellen have noted throughout the
recession, the unemployment rate has given confusing signals.
Indeed, its behavior after the Great Recession appeared to fly in
the face of well-established economic theory, known as Okun's Law
after Arthur Okun, who in 1962 showed that a two-percentage-point
drop in GDP growth generally leads to a one-percentage point
increase in the unemployment rate.
That relationship appeared to get out of whack after the financial
crisis, with the jobless rate initially rising much faster than the
law would have predicted, and more recently falling much more
rapidly than the rule would anticipate.
That roller coaster experience convinced more than a few economists
that something had shifted fundamentally in the economy. It's one
reason that the Fed has shifted away from using the unemployment
rate as its main read on economic health, turning instead to a
broader basket of labor market indicators to gauge slack.
But in the paper published Monday, Daly and Fernald showed that much
of the apparent disconnect between the jobless rate and GDP growth
can be traced to incomplete real-time economic data and temporary
deviations from Okun's Law that occur during many recessions.
Revised GDP data suggest the long-standing relationship between the
jobless rate and output remains intact, they wrote.
"Our findings suggest that Okun's law is working about the same as
it always has," they wrote.
(Reporting by Ann Saphir; editing by Chizu Nomiyama)
