If So, Will GDP Dip by Double Digits?
In 1962, an American Economist from Yale University, Arthur Okun, did an empirical study and proved there was a negative short-run relationship between the unemployment rate and real GDP. Many studies subsequently confirmed Okun’s findings and referred to the phenomenon as “Okun’s Law, ” which became a staple in many macroeconomics textbooks. (Okun also served as the chairman of the Council of Economic Advisers between 1968 and 1969 in the Johnson administration.)
Specifically, Okun’s law says an increase of a country’s unemployment rate of 1% will cause its GDP to dip 2%.
With COVID-19, the unemployment rate has escalated from 4.4% in early March to approximately 16% in mid-April. It will likely remain at the high level at least through the second quarter of this year.
If so, based on Okun’s law, the real GDP will dip by 23.6% during Q2 2020. (Using the formula, 2% X (16-4.4%) = -23.6%.)
Real GDP May Decline
If, as some experts believe, the unemployment rate is actually higher than 16%, possibly 20% or more as discouraged workers and ongoing applicants are excluded from the number, the real GDP may decline by 27.6% or more. In 1932, the worst year of the Great Depression of 1929, the unemployment rate was 23.60% and real GDP declined 12.90% incrementally from the previous year. In 2009, the worst year of the Great Recession of 2008, the unemployment rate was 10% and real GDP declined 4%.
Whether the current Pandemic is a long-term Depression or a short-term Recession depends on how soon we can contain the coronavirus and when the economy will reopen in a significant way. Each recession and depression is different. With a digital economy, we certainly don’t expect to have a long-term depression, but the magnitude of this pandemic recession can certainly be called a short-term depression in its own category.
That means GDP will be in severe negative territory for a significant period of this year, a potential travesty for the U.S. economy and all Americans. In the meantime, the unprecedented stimulus package should expedite the recovery by providing liquidity to the most damaged sectors of the economy – travel/tourism, state/local governments, and small/medium companies.