What Is the Natural Unemployment Rate?
The natural unemployment rate is the minimum unemployment rate resulting from real or voluntary economic forces. Natural unemployment reflects workers moving from job to job, the number of unemployed replaced by technology, or those lacking the skills to gain employment.
- The natural unemployment rate is the minimum unemployment rate resulting from real or voluntary economic forces.
- It represents the number of people unemployed due to the structure of the labor force, such as those replaced by technology or those who lack the skills to get hired.
- Natural unemployment is commonplace in the labor market as workers flow to and from jobs or companies.
- Unemployment is not considered natural if it is cyclical, institutional, or policy-based unemployment.
- Because of natural unemployment, 100% full employment is unattainable in an economy.
Understanding Natural Unemployment
The term “full employment” is often a target to achieve when the U.S. economy is performing well. The term is a misnomer because there are always workers looking for employment, including new college graduates or those displaced by technological advances. There is always movement of labor throughout the economy that represents natural unemployment.
Unemployment is not considered natural if it is cyclical, institutional, or policy-based unemployment. An economic crash or steep recession might increase the natural unemployment rate if workers lose the skills necessary to find full-time work or if certain businesses close and are unable to reopen due to excessive loss of revenue. Economists call this effect “hysteresis.”
Important contributors to the theory of natural unemployment include Milton Friedman, Edmund Phelps, and Friedrich Hayek, all Nobel prize recipients. The works of Friedman and Phelps were instrumental in developing the non-accelerating inflation rate of unemployment (NAIRU).
Natural unemployment can occur from both voluntary and involuntary factors. Hysteresis often occurs following extreme or prolonged economic events such as a recession, where the unemployment rate may continue to increase despite economic growth.
Causes of Natural Unemployment
Economists commonly held that if unemployment existed, it was due to a lack of demand for labor or workers and the economy would need to be stimulated through fiscal or monetary measures. However, history reveals the natural flow of workers to and from companies even during robust economic periods.
Full employment means 100% of the workforce is employed. History shows that this is unattainable as workers move from job to job. A zero unemployment rate is also undesired as it requires an inflexible labor market, where workers cannot quit their current job or leave to find a better one.
According to the general equilibrium model of economics, natural unemployment is equal to the level of unemployment in a labor market at perfect equilibrium. This is the difference between workers who want a job at the current wage rate and those willing and able to perform such work. Under this definition of natural unemployment, it is possible for institutional factors, such as the minimum wage or high degrees of unionization, to increase the natural rate over the long run.
Effects of Inflation on Unemployment
John Maynard Keynes wrote The General Theory of Employment, Interest and Money in 1936, leading many economists to believe there is a direct relationship between the level of unemployment in an economy and the level of inflation.
This direct relationship was formally codified in the Phillips curve, which showed that unemployment moved in the opposite direction of inflation. If the economy was to be fully employed, there must be inflation, and conversely, with periods of low inflation, unemployment must increase or persist.
The Phillips curve fell out of favor after the great stagflation of the 1970s. During stagflation, unemployment and inflation both rise, questioning the implied correlation between strong economic activity and inflation, or between deflation and unemployment.
What Is Natural vs. Cyclical Unemployment?
The cyclical unemployment rate is the difference between the natural unemployment rate and the current rate of unemployment as defined by the U.S. Bureau of Labor Statistics.
Why Is the Natural Unemployment Rate Significant?
The natural rate of unemployment is considered the lowest acceptable level that a healthy economy can sustain without creating inflation.
How Does a Recovering Economy Impact the Natural Unemployment Rate?
The natural rate of unemployment typically rises after a downturn in the economy or a recession as workers become more confident that they can move from job to job.
The Bottom Line
The natural unemployment rate is the minimum unemployment rate stemming from real or voluntary economic forces. It is common in the labor market as workers flow to and from jobs or companies, and because of natural unemployment, full employment is unattainable in an economy. Unemployment is not considered natural if it is cyclical, institutional, or policy-based unemployment.