Formula shows why it's so hard to cut jobless rate
There's just one problem: Growth would have to equal 5 percent for all of 2010 just to lower the average jobless rate for the year by 1 percentage point.
And economists don't think that's possible.
Most analysts say economic activity will slow to 2.5 percent or 3 percent growth for the current quarter as the benefits fade from government stimulus efforts and from companies drawing down less of their stockpiles.
That's why the Federal Reserve and outside economists think it will take until around the middle of the decade to lower the double-digit jobless rate to a more normal 5 or 6 percent.
Another way of looking at it: A net total of about 3 million jobs would have to be created this year to lower the average unemployment rate by 1 percentage point for 2010, economists estimate. Yet even optimists think the creation of 1 million net jobs is probably out of reach this year.
High unemployment poses a risk to the unfolding recovery because it leads consumers to spend less, keeping economic growth weak. A sharp pullback in spending might even push the economy back into recession. Joblessness also represents a danger for President Barack Obama's Democratic Party in this fall's congressional elections.
The National Association for Business Economics and the International Monetary Fund think gross domestic product will rise just under 3 percent for all of this year. GDP, the best gauge of economic activity, measures the value of all goods and services produced in the United States.
To get a sense of just how deep a dent the worst recession since the 1930s has made in the economy, consider this: The economy shrank 2.4 percent for all of 2009 — the sharpest drop since 1946. It was also the first annual decline since 1991.
Mark Zandi, chief economist at Economy.com, and Bill Cheney, chief economist at John Hancock, agree that the economy would have to grow roughly 5 percent for all of 2010 just to ratchet down the average unemployment rate for the year by 1 percentage point — to a still-high 9 percent.
Their math is based on Okun's law, named for economist Arthur Okun. In 1962, Okun produced a formula for the connection he saw between unemployment and economic activity.
Exactly how much GDP growth is needed to lower the unemployment rate for a given period varies. That's because the formula involves several factors besides GDP growth. It also considers, for example, businesses' productivity growth.
When the economy was recovering from the 2001 recession, it took two years to reduce the unemployment rate by nearly a full percentage point: It fell from 6 percent in 2003 to 5.1 percent in 2005. GDP growth averaged just over 3 percent.
Economists say the formula hasn't always held up perfectly in recent decades. Rather, it's relied upon as a rough rule of thumb for determining how much growth will be needed to lower unemployment.
But a near-textbook case occurred in 1976, when the economy expanded at a 5.4 percent pace. As Okun would have predicted, that growth drove down the unemployment rate by nearly a full percentage point: from 8.5 percent in 1975 to 7.7 percent.