Natural Unemployment

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What is natural unemployment?

Natural unemployment, or natural unemployment rate, is the minimum unemployment rate resulting from real or voluntary economic forces. Natural unemployment reflects the number of people who are unemployed due to the labor structure, such as those replaced by technology or those who do not have certain skills to get a job.

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Natural unemployment

The basics of natural unemployment

We often hear the term full employment, which can be achieved when the US economy is doing well. However, the term full employment is misleading because there are always workers looking for work, including college graduates or people displaced by technological advances. In other words, there is always a certain movement of labor throughout the economy. The movement of labor into and out of employment, voluntary or not, represents natural unemployment.

Any unemployment that is not considered natural is often called cyclical, institutional or political unemployment. Exogenous factors can lead to an increase in the natural unemployment rate; for example, a severe recession could increase the natural unemployment rate if workers lose the skills needed to find full-time employment. Economists sometimes call this “hysteresis”.

Milton Friedman, Edmund Phelps and Friedrich Hayek, all Nobel Prize winners, have largely contributed to the theory of natural unemployment. The work of Friedman and Phelps contributed to the development of the non-accelerated inflation rate of unemployment (NAIRU).

Why natural unemployment persists

Economists traditionally believed that if unemployment existed, it was due to a lack of demand for labor or workers. Consequently, the economy should be stimulated by fiscal or monetary measures to support business activity and, ultimately, the demand for labor. However, this way of thinking has fallen into disuse because it has been realized that even during periods of strong economic growth, there are still unemployed workers due to the natural flow of workers to and from businesses.

The natural movement of work is one of the reasons why true full employment cannot be achieved, as this would mean that workers were inflexible or immobile in the American economy.

In other words, 100 percent full employment is unattainable in a long-term economy. True full employment is undesirable, since a long-term unemployment rate of 0% requires a completely inflexible labor market, where workers cannot leave their current job or leave to find a better one.

According to the general equilibrium economic model, natural unemployment is equal to the unemployment level of a perfectly balanced labor market. It is the difference between workers who want jobs at the current wage rate and those who are willing and able to do such work.

Under this definition of natural unemployment, it is possible that institutional factors, such as the minimum wage or high levels of unionization, increase the natural rate in the long run.

Unemployment and inflation

Since John Maynard Keynes wrote “The General Theory” in 1936, many economists believe that 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, which represented the view that unemployment was moving in the opposite direction of inflation. In order for the economy to be fully employed, there has to be inflation and, conversely, if there is low inflation, unemployment must increase or persist.

The Phillips curve fell out of favor after the great stagflation of the 1970s, which, according to the Phillips curve, was impossible. During stagflation, unemployment rises while inflation increases. In the 1970s, stagflation was partly due to the oil embargo that had pushed up oil and gasoline prices while the economy sank into recession.

Economists today are much more skeptical about the implicit correlation between strong economic activity and inflation, or between deflation and unemployment. Many consider an unemployment rate of 4% to 5% as full employment and not particularly concerning.

Quick facts

  • Natural unemployment is the minimum unemployment rate resulting from real or voluntary economic forces.
  • It represents the number of unemployed due to the structure of the labor force, including those replaced by technology, or those who lack the skills to be hired.
  • Natural unemployment persists due to the flexibility of the labor market, which allows workers to move to and from companies.

The natural unemployment rate represents the lowest unemployment rate where inflation is stable or the unemployment rate that exists with unaccelerated inflation. Even today, however, many economists do not agree on the level of unemployment considered to be the natural unemployment rate.

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