This suggests that nominal interest rates are leading indicators of recessions. A scatterplot reveals a negative relationship between the cyclical components of real GDP and the unemployment rate. Okun's Law simply reflects the idea that additional production of goods and services requires more employed workers. As production goes up, workers are drawn into the labor force, thereby reducing unemployment. Quarterly changes in real GDP growth are often thought to provide information about the future course of inflation.
Conventional wisdom holds that if the economy grows too fast, there is a danger of higher inflation.
A scatterplot of the cyclical components of real GDP and the inflation rate provides some support for this idea. Although there is evidence of a weak positive relationship, the link between the two variables is much less precise than the one observed for Okun's Law. For example, the recessions of 1974 and 1980 violated the conventional wisdom because real GDP was low relative to trend, while inflation was very high. In particular, they believe that monetary policy should be used to keep real GDP and unemployment close to their trend levels at all times. People eventually adjust their expectations to take into account the Fed's policy actions, and unemployment returns to its long-run trend level.