JPMorgan economist Jim Glassman asks, “How can we reconcile soft GDP figures with solid, actually impressive, job figures?”
It’s a good question. Some of the big banks are looking for GDP growth of less than 2% this quarter, yet the economy added 284,000 jobs in January and 227,000 in February.
Another way to look at things is through the lens of Okun’s Law, a rule of thumb about the relationship between GDP and unemployment. As it currently tends to be formulated by economists, Okun’s Law suggests that a fall in GDP of 1 percent relative to normal trend growth—2.7% over the past 30 years—is associated with a rise in the unemployment rate of about 0.5 percentage point after four quarters. The 3.5% GDP drop in 2009 was 6.2 percentage points below trend, meaning the unemployment rate should have risen by 3.1 percentage points to 10.4% from 7.3% at the end of 2009. Instead, it rose to 10% in October of that year.
In 2010, GDP increased by 3%, just a smidgen above trend, which means the unemployment rate should been flat. Yet it fell to 9.4% by year’s end vs. 9.9% at the end of 2009.
In 2011, GDP rose by 1.7%, or a point below trend. But instead of the unemployment rising by 0.5 percentage point to 9.9%, it fell to 8.5% from 9.4%.
So, again, the labor market seems to be doing better than GDP growth would suggest.
A few possible explanations:
1. The official, U-3 unemployment rate is not a good labor market gauge right now because of the collapse in the size of the U.S. labor force as a share of total population.
2. Trend or potential growth is actually below 2.7%—perhaps the result of years of crony capitalist favoring of banks and housing—which means it takes less growth to affect the unemployment rate (via Bloomberg):
Okun’s law indicated the unemployment rate should have remained steady when the rate unexpectedly dropped 1.7 percentage points from a recent peak, Andrew Tilton, a senior economist in New York at the firm, said in an interview today on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “For a long time, we and most other economists used Okun’s Law as a rule of thumb for deciding what kind of unemployment rate we should expect given a GDP outlook,” Tilton said, calling the recent loss of correlation “really quite striking. We’ve actually had growth almost exactly in line with that over the last couple of years, just below 2½ percent,” Tilton said. “That would historically have suggested unemployment would be relatively steady. But, instead, it’s down almost 2 points from the peak in late 2009, early 2010.” The gauge reflects lower potential growth over that period, said Tilton.
3. Maybe the GDP figures are wrong, and growth is actually much stronger than we think right now. Glassman:
The GDP figures often are the last round of broad economic indicators to catch up with the true state of the economy. For that reason, preliminary GDP estimates should always be treated with some caution. Last year’s significant downward revisions to real GDP in the 2008-09 recession come to mind. That came as no surprise to those who had been tracking the job market. At the time, employment trends were much weaker than the impression left by the real GDP trends. That was three years after the fact. With the economy now recovering, there is a high probability that preliminary estimates of national output eventually will be revised up.
Which do you think is correct?