David Altig presented some projections of the unemployment rate based on various monthly increments in employment. It was a crude estimate because it did not include inherent fluctuations in the growth of working age population and labor force participation rate. It is much better to use Okun’s law linking unemployment and the real GDP growth.
Previously in this blog, we presented a version of Okun’s law for the rate of unemployment in the USA since 1955 as defined by real GDP per capita. We have estimated Okun’s law coefficients in two different segments using a standard LSQ technique. The reason behind the split into two segments was the change in realGDP estimation procedure introduced around 1978 - the definition of the GDP deflator was dramatically changed. We discussed this important methodical issuein our blog.
The best-fit (dynamic) model minimizing the RMS error of the cumulative model is as follows:
du = -0.406dlnG + 1.113, t<1979
du = -0.465dlnG + 0.866, t>1978
This model suggests a smaller shift in the slope and a larger change in the intercept around 1979. This Okun’s law is characterized by a standard error of 0.53% for the period between 1958 and 2010. The average rate of unemployment for the same period is 5.6% with an average annual increment of 1.06%.
Using the relationship for the period after 1979, one can estimate the evolution of the unemployment rate for various growth rates o real GDP per capita. We have selected three different values: 1% per year, 1.86% per year, and 3% per year. The first value is approximately equal to the mean growth rate between 2000 and 2010 (11 years) which is 0.93% per year. The second value provides a constant rate of unemployment, as defined by the ratio of coefficients 0.866/0.465 and is slightly higher than the mean rate after 1980 (1.63% per year). The third value is very high and just demonstrates the condition to reduce the rate of unemployment to 4% by 2020. Figure 1 depicts the predicted and observed rate of unemployment after 1980 and these three projections. This is a more accurate projection than that by David Altig.
I do not see any opportunity for the rate of unemployment to fall any time soon. In the long run, unemployment will remain high. For the slow growth scenario expected by the FRB, u may reach 13% by 2020.
Figure 1. Observed, predicted and projected rate of unemployment in the USA.