Okun's law
/ Okun = OH-kun /
There is a sensible-sounding link between joblessness and the size of the economy: when lots of people are out of work, the economy is producing less than it could, and when more people are working, the economy produces more. The economist Arthur Okun put a rough number on this link in the 1960s. Okun's law is the empirical observation that changes in unemployment and changes in a country's total output (GDP) move together in a fairly steady proportion.
Stated as a rule of thumb, Okun's law says that for every 1 percentage point that the unemployment rate rises above its natural rate, real GDP falls roughly 2 percent below its potential (the exact ratio varies by country and era — often quoted between 2 and 3). The intuition runs deeper than just 'fewer workers, less output': in a downturn firms also cut hours, idle machines, and use their remaining staff less intensely, so output drops by more than the headcount of the unemployed alone would suggest. The law lets economists translate between two of the most-watched numbers: knowing the output gap, you can estimate unemployment, and vice versa.
Okun's law is useful precisely because it is simple, and it is honest about being only a rule of thumb, not an iron law. The 2-to-1 ratio is an average that shifts over time and differs across economies, and the relationship can break down in unusual episodes. Still, it is one of the most reliable regularities in macroeconomics and a workhorse for forecasting: policymakers use it to ask how much extra growth would be needed to bring unemployment down by a point, or how much unemployment a recession of a given depth is likely to cause.
An economy's unemployment rate climbs from its natural 5 percent to 8 percent during a recession — 3 points above normal. Using Okun's rough 2-to-1 ratio, economists estimate output is running about 6 percent below its potential, meaning a large amount of goods and services simply never got produced.
Okun's law links the unemployment gap to the output gap — a handy translation between the two.
Okun's law is an empirical rule of thumb, not an exact law: the ratio varies across countries and over time, and can break down, so treat the 2-to-1 figure as a ballpark, not a precise constant.