In this exercise, you are going to examine the historical data on Okun's Law, which we used in our discussion of the costs of unemployment. The level form of Okun's Law in Eq. (3.5) states that the output gap, \(\frac{\bar{Y}-Y}{\bar{Y}}\), equals cyclical unemployment, \(u-\bar{u}\), multiplied by 2.

First, get the Congressional Budget Office's quarterly estimates of the natural rate of unemployment (FRED series NROU) and real potential GDP (FRED series GDPPOT) from the FRED database. Second, collect quarterly data on real GDP from the FRED database in each quarter beginning in 1960, and then use it with the CBO potential output data series to calculate the output gap at each date. Third, download the quarterly average of monthly data on the unemployment rate from the FRED database beginning in 1960 . Use those quarterly data and the CBO's natural rate series to calculate cyclical unemployment. Fourth, draw a graph of the output gap (on the vertical axis) versus cyclical unemployment (on the horizontal axis). Also, on the same set of axes, draw a straight line through the origin with a slope of 2. Do the data points lie close to this line?

Eq. (3.5)

Transcribed Image Text:

Y-Y 2(u - u). Y