Okun's Law and Output gaps

recessionary gap

Y*>Y

expansionary gap

Y>Y*

cyclical unemployment Uc

u-u*

natural rate of unemployment

Y-Y* = 0

during recessionary gap

Y < Y*

U > U*

Uc is positive

during expansionary gap

Y>Y*

U<U*

Uc is negative

Okun’s Law

each extra percentage point of cyclical unemployment is associated with about a 2% point increase in the output gap

Formula

Y-Y*/Y* = -2(u-u*)

full employment/natural rate

Y=Y*

U=U*