What is Natural Unemployment

Natural unemployment, or the natural rate of unemployment, is the minimum unemployment rate resulting from real, or voluntary, economic forces. It can also be defined as the minimum level of calculable unemployment in the Walrasian system of general equilibrium, after accounting for labor and commodity movements, market imperfections, stochastic variability and other supply and demand considerations built into the model.


Natural Unemployment

BREAKING DOWN Natural Unemployment

Any unemployment not considered to be natural is often referred to as cyclical, institutional or policy-based unemployment. Variables exogenous to the labor market cause an increase in the natural rate of unemployment; for example, a steep recession might increase the natural unemployment rate if workers begin to lose skills or the motivation to find full-time work again. Economists sometimes call this “hysteresis.”

Important contributors to the theory of natural unemployment include Milton Friedman, Edmund Phelps and F.A. Hayek, all Nobel winners. The works of Friedman and Phelps were instrumental in developing the non-accelerating inflation rate of unemployment (NAIRU).

Why Natural Unemployment Persists

One hundred percent full employment is unattainable in a market economy over the long run. Such employment is actually undesirable, because a 0% long-run unemployment rate requires a completely inflexible labor market, where laborers are unable to simply 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 of a labor market at perfect equilibrium. This is the difference between workers who want a job at the current wage rate and those who are 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.

Unemployment and Inflation

Ever since John Maynard Keynes wrote “The General Theory” in 1936, many economists believe there is a special and direct relationship between the level of unemployment in an economy and the level of inflation. This direct relationship was once formally codified in the so-called Phillips curve.

The Phillips curve fell out of favor after the great stagflation of the 1970s, which the Phillips curve suggested was impossible. During stagflation, unemployment climbs back up at the same time inflation increases.

In 2016, economists are much more skeptical of the implied correlation between strong economic activity and inflation, or between deflation and unemployment. Many consider a 5% unemployment rate to be de facto full employment and not particularly concerning.

Catallactic or Market-Generated Unemployment

The Austrian School of Economics prefers the definition of “catallactic unemployment,” which it contrasts with institutional unemployment. Catallactic unemployment is synonymous with market-generated unemployment, meaning the unemployed voluntarily choose to not work at any present wage rate. Any other unemployment is considered institutional, involuntary and likely based on poor policy.