Economics: Natural Rate of Unemployment

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Much of the change in the unemployment rate is due to the business cycle. Booms are associated with more people getting and keeping jobs, and busts, with people losing jobs and being between work. If the government wants to try and mitigate the effects of the business cycle, it needs some target. How do we find the right unemployment rate to aim for? The answer that economists provide is called the natural rate of unemployment. The natural rate of unemployment is simply that component of unemployment that's left when we strip away the part that's due to the business cycle. Leaving aside cyclical unemployment, we're left with frictional unemployment and structural unemployment. Isolating those components gives us what economists call the natural rate of unemployment.
If we think about the natural rate of unemployment, we'll see that factors in the economy will influence it. First of all, there's demographics. When the workforce gets older--and older workers tend to keep their jobs for longer periods of time and to be between work less often--then we would expect there to be less frictional unemployment and for the natural rate of unemployment to be lower. This would also be the case if we have job training policies. With job training support, we would find that people leaving declining industries are able to get the skills to get a job in a new industry faster--that is, less structural unemployment and a lower natural rate of unemployment. Finally, there's the effect of government policy itself. With unemployment insurance, workers are inclined to stay unemployed longer because the cost of being unemployed may be lower. That would tend to raise the natural rate of unemployment. The same would be true if there were policies that discourage firms from hiring workers quickly, perhaps some kind of taxation or regulation. In that case, if firms were reluctant to hire workers more quickly, the natural rate of unemployment would be higher.
What does the natural rate of unemployment look like over time? When economists study unemployment, they try to isolate the component that's due to business cycles. If we look here at the historical unemployment rate from 1960 to the present, and if we use statistical methods to call out that portion of unemployment that is due to changes in the business cycle, we can isolate this blue line, which we call the natural rate of unemployment. This tracks the impact of frictional and structural unemployment over time. What has happened to the natural rate? It looks like at some points it's actually been higher and at other points it's falling and has been lower. Why might that be? Well, nowadays, with the baby boomers aging, we've got more workers, older workers, inclined to keep their jobs longer and be between jobs less often; so, less frictional unemployment, and a lower natural rate. Also, it's the case that with historically high rates of incarceration among young people we actually have a workforce that's slanted towards older workers; once again, demographic factors leading to a lower natural rate of unemployment because fewer people are between jobs less often. There's also the issue of government supports: as we have more and less support for job training policies, there would be changes in the rate. However, nowadays, as our economy has changed structurally from manufacturing to much more employment in the white-collar service sectors, we might expect there to be less frictional unemployment and perhaps even less structural unemployment because general education allows people to move between various white-collar service jobs more easily and more often. These factors would contribute to less frictional unemployment and a lower natural rate.
Now that we've got the idea of the natural rate of unemployment in our conversation, we're ready to take a closer look at the relationship between inflation and unemployment.
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Understanding the Natural Rate of Unemployment Page [1 of 1]