Okun's Law, Productivity Innovations, And Conundrums in Business Cycle Dating

Abstract

The NBER business cycle dating process has traditionally mixed together the fundamental component of business cycles, changes in real output, with changes of employment. This paper makes the case that these long and variable lags disqualify for business cycle dating all the components of labor market behavior, including aggregate hours of work and payroll employment. By definition real GDP is equal to output per hour times aggregate hours of work. This “output identity ” can be extended to subdivide aggregate hours into the product of hours per employee, the employment rate, and the labor‐force participation rate (LFPR). This paper provides a consistent analysis of the output identity, taking as its point of departure Okun’s Law, a rough prediction that a cyclical deviation of output from trend would be divided between a 2/3 response of aggregate hours and a 1/3 response of productivity. In turn, the Okun characterization subdivided the 2/3 hours response into 1/3 for the employment rate, 1/6 for hours per employee, and 1/6 for the LFPR. The paper decomposes data on the components of the output identity into trends and deviations from trends, or “gaps”. Its regression analysis reveals regular features of postwar

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