4. Okun\'s Law Suppose that the economy has a natural rate of unemployment of 5

Question

4. Okun's Law Suppose that the economy has a natural rate of unemployment of 5 percent. Suppose short-run output (the output gap) over the next four years is-3 percent, zero percent. 1I percent, and 4 percent. According to Okun's Law, what are the unemployment rates we would expect to see in this economy over the next four years? What is the cyclical unemployment rate in each of these four years? A. B. Suppose that we apply Okun's Law to the U.S. economy today. In June 2018, the actual U.S. unemployment rate was 4.0 percent. If the natural rate of unemployment is 5 percent, what is the size of the output gap in the U.S. in June 2018?

Explanation / Answer

when output gap is -3%, cyclical unemployment is (5-3.5)%= 1.5%

when output gap is 0%, cyclical unemployment is (5-5)%= 0%

when output gap is 1%, cyclical unemployment is (5-5.5)%= -0.5%

when output gap is 4%, cyclical unemployment is (5-7)%= -2%

6.The GDP gap is the difference between actual GDP and potential GDP. Okun's law suggests a GDP gap of -2% for every 1% that the unemployment rate exceeds its natural rate. In this case, the GDP gap is (4 – 5) x -2 = 2%.

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