The Unassuming Economist

In an update of our work, Laurence Ball, Daniel Leigh and I find that the link between output growth and employment growth holds strongly in most advanced economies. We find no evidence that this link—which goes by the wonkish name of Okun’s Law—broke down during 2008 to 2013, including in high unemployment countries like Ireland and Spain. On average across the 20 advanced economies we study, a 1 percentage point increase in output growth leads to a ½ percentage point increase in employment growth. We find that Okun’s Law survived the stress test of the Great Recession: there is little evidence that the link between growth and jobs changed appreciably over the course of the Great Recession. The alleged breakdown of Okun’s Law is often a jumping-off point for arguing that structural reforms are needed to make a major dent in unemployment. Our results suggest that while there may be good reasons to recommend structural reforms to boost employment, proposing them in the belief that Okun’s Law has broken down should not be one of them.

In related work, Laurence Ball, Joao Jalles and I find that forecasters believe in Okun’s Law. For the nine advanced economies we study, the estimates of the Okun’s coefficients from forecasts is fairly similar to that in the data for various countries.

“Reflecting structural factors both shared with many other countries and unique to Australia, real house prices have roughly doubled since 1990 (Figure 1). After growing broadly in line with real GDP per capita from 1960-90, real house price inflation picked up in the 2000s and exceeded income growth for much of the period up to the global financial crisis (Figure 2). As a result, the median house price to income ratio rose sharply from around 3 at the beginning of the 2000s (when based on the authorities’ preferred measure for all dwellings) peaking at just over 4 in 2009 (Figure 3). Since then the price/income ratio has eased back and international comparisons suggest that while Australia’s is on the high side it is not out of line with peers (Figure 4). Rising house prices were also accompanied by increased household borrowing with the debt to income ratio rising from among the lowest at 46 percent in 1990 to around 150 per cent in 2013,” according to the latest IMF’s annual report on Australia.

“The unconventional energy boom has had significant positive effects on Canada’s economic activity and has the potential to contribute even more in the future with the appropriate extension of infrastructure capacity,” according to a new IMF study. 

The study “(…) suggest that while limited exports capacity would result in output losses over the medium term, the potential output gains from a full market access of Canada’s energy products could reach about 2 percent of GDP over a ten year horizon. Actions can be taken on a number of fronts to resolve transportation constraints and address domestic market segmentation. These include diversifying international export markets for Canadian energy products, which would require building pipeline and export infrastructure to facilitate access to non-U.S. markets. Energy integration between Canada’s western and eastern provinces can be strengthened further, and recent initiatives in this direction are welcome. More generally, there appears to be an important scope to increase inter-industry linkages across Canada that would lead to wider sharing of benefits from the energy sector.”

“Household leverage remains high, and while house price and construction growth have come off their post-crisis peaks, high valuations and excess supply in a number of housing markets are a source of vulnerability. If maintained, the ongoing moderation in the housing market suggests little need for additional macro-prudential measures but it is important to remain vigilant. Over the longer term, rethinking the role of government-backed mortgage insurance may reduce the government exposure to housing sector risks and lead to a more efficient allocation of resources,” says the new IMF report on Canada.

More specifically on house prices and valuation measures, it says “Canada’s housing market has cooled but house prices remain overvalued, although with important regional differences. Despite picking up somewhat in mid-2013, in line with renewed strength in resale activity, Canada’s house price inflation and residential investment growth have slowed. On average across Canada, house prices grew about 4 percent (y/y) in November 2013, up from 2 percent in April but about half the pace two years ago. The slowdown involved all large metropolitan areas except Calgary, particularly Vancouver (where house prices in the first eleven months of 2013 were about 3 percent lower than a year ago). Housing starts have also picked up since April 2013, but are on a declining trend: as of November 2013, their 6-month moving average was about 10 percent below last year’s peak, mainly owing to weaker construction of multiple units, especially in Ontario. Despite the downward trend in growth, a few simple indicators continue to suggest overvaluation in the Canadian housing market. In particular, house prices are high relative to both income and rents, compared to historical averages and many other advanced economies. Staff estimates that, in real terms, average house prices in Canada are about 10 percent above what would be justified by fundamentals, with most of the gap coming from the real estate markets in Ontario and Québec.”