investment viewpoints

Is employment at the heart of US economic growth?

Is employment at the heart of US economic growth?
Florian Ielpo, PhD - Head of Macro, Multi asset

Florian Ielpo, PhD

Head of Macro, Multi asset

Every economist fetishises their chosen leading indicator for the US economy – be it the ISM manufacturing index, capacity utilisation rate or new home sales. We cannot overstate the dangers of this habit and prefer to base our analysis on nowcasting indicators. But if there is one indicator that represents a syncretism of the economy, it is the labour market. This week, Simply put applies an economic theory linking employment conditions to GDP growth to estimate US output for 2024.


Need to know:

  • Several leading indicators of US economic growth point to different scenarios, with robust consumer spending in recent quarters being buoyed by the budget deficit and resilient labour market
  • The jobs market is at the core of many such indicators. And there is one theory that links employment conditions with GDP growth: Okun’s Law
  • Using Okun's Law, we can expect US growth to exceed its potential in 2024, but urge investors to be wary of growth surprises


Okun’s Law

There can be no recession without unemployment and no expansion without strong job creation. So much so that this relationship generated an economic theory: Okun's Law, named after the economist who postulated it, Arthur Okun, Professor of Economics at Yale University and an adviser to former US President John F. Kennedy’s Council of Economic Advisers. The theory links the concept of the ‘employment gap’ and its relationship with economic growth, which is central to Okun’s Law. Under it, for instance, a 1% lower unemployment rate would result in 2% more economic growth. This week, Simply put looks at what this relationship indicates about US GDP growth in 2024.


The employment gap and economic growth

Every economist will tell you that unemployment is a lagging indicator of economic growth. From this point of view, looking at unemployment time series to read the future of growth is doomed to failure. However, a few small statistical adjustments can change this situation completely.

In absolute terms, unemployment usually tells us nothing in terms of the overall level of growth. However, when analysed as a deviation from its 'local' trend, a completely different picture emerges. This deviation is known as the employment gap, and it tells us something about the tensions in the labour market. These tensions, in turn, inform us about inflation and growth.

Regarding inflation, for example, they can show that a very negative employment gap means that the demand for labour exceeds supply, implying that wages should therefore rise and inflation with them. This is one of the mechanics of the Phillips curve.

A modernised Okun's Law, on the other hand, would predict stronger growth when the employment gap is also negative: an overheated labour market, leading to wage growth, would generate strong demand and support GDP growth. Given this relationship, Okun postulated that a 1% negative employment gap would lead to 2% additional growth.

Figure 1 shows how this relationship has played out in the US since 1977. Until the Covid-19 pandemic, the inverse relationship held up well, except for exaggerations in 1981 and 1983 due to fiscal stimulus.


FIG 1. US growth vs employment gap

Source: Bloomberg, LOIM at February 2024. For illustrative purposes only.


What does Okun’s Law tell us today?

Figure 1 shows the current employment gap at about -1%. With the US unemployment rate 1% below its equilibrium level, Okun’s Law infers that US real growth should be exceeding its long-term trend. It is reasonable to assume that the relationship between the employment gap and real growth is likely to be non-linear – i.e. that Okun's law of ‘1% for 2%’ is likely to hold overall but that an extremely small or large employment gap would mean particularly weaker (or stronger) growth than expected.

Figure 2 illustrates this empirical relationship from 1977-2024, comparing the historical deciles of the employment gap with US growth and comparing it with Okun's linear prediction. Clearly, this relationship is non-linear: a highly positive employment gap (indicating that unemployment is well above its trend) means a more than proportional collapse in economic growth. Today, we are in the historical second decile of the employment gap, which in the past corresponded to growth of 1.31% above trend.

However, according to the International Monetary Fund, this trend is currently close to 2%, implying expected growth for 2024 of about 3.3% if the jobs data are factored in. This reflects, of course, ‘partial equilibrium’ reasoning, since many other elements need to be considered to formulate a ‘general equilibrium’ forecast. But it nonetheless sends a message from the jobs market: real US growth could deliver a positive surprise.


FIG 2. Employment gap decile vs impact on US growth, 1977-2024

Source: Bloomberg, LOIM at February 2024. For illustrative purposes only.


Simply put, based on analysis stemming from the current employment gap, the US labour market is pointing to a positive growth surprise for 2024.

Nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.

Our nowcasting indicators currently show:

  • Continued growth as the economy still shows vigourous signs of strength 
  • Increasing inflation due to rising cost-related data
  • Steady monetary policy, especially in the US, with inflation data now showing the continuation of a moderation

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)


Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

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