Natural Rate of Unemployment

Examples of Natural Rate of Unemployment in the following topics:

• The Long-Run Phillips Curve

  • The long-run Phillips curve is a vertical line at the natural rate of unemployment, so inflation and unemployment are unrelated in the long run.
  • Graphically, this means the Phillips curve is vertical at the natural rate of unemployment, or the hypothetical unemployment rate if aggregate production is in the long-run level.
  • The natural rate of unemployment theory, also known as the non-accelerating inflation rate of unemployment (NAIRU) theory, was developed by economists Milton Friedman and Edmund Phelps.
  • At point C, the rate of unemployment has increased back to its natural rate, but inflation remains higher than its initial level.
  • The unemployment rate cannot fall below the natural rate of unemployment, or NAIRU, without increasing inflation in the long run.

• Reasons for Unemployment

  • The natural level of unemployment is the unemployment rate when an economy is operating at full capacity.
  • The reason why the natural rate of unemployment is still positive is due to frictional and structural unemployment.
  • Of course, the economy may not be operating at its natural level of employment, so unemployment may be above or below its natural level.
  • In this case the long-run demand for labor is higher than the temporary demand, so the rate of unemployment is higher than its natural rate .
  • Over time, unemployment has returned to about 5%, which is the approximate natural rate of unemployment.

• Relationship Between Expectations and Inflation

  • Assume the economy starts at point A at the natural rate of unemployment with an initial inflation rate of 2%, which has been constant for the past few years.
  • Now assume that the government wants to lower the unemployment rate.
  • In the short run, it is possible to lower unemployment at the cost of higher inflation, but, eventually, worker expectations will catch up, and the economy will correct itself to the natural rate of unemployment with higher inflation.
  • Assume the economy starts at point A, with an initial inflation rate of 2% and the natural rate of unemployment.
  • However, eventually, the economy will move back to the natural rate of unemployment at point C, which produces a net effect of only increasing the inflation rate.According to rational expectations theory, policies designed to lower unemployment will move the economy directly from point A to point C.

• Types of Unemployment: Frictional, Structural, Cyclical

  • The unemployment rate is a percentage, and calculated by dividing the number of unemployed individuals by the number of all currently employed individuals in the labor force.
  • Structural unemployment is one of the main types of unemployment within an economic system.
  • The natural unemployment rate, sometimes called the structural unemployment rate, was developed by Friedman and Phelps in the 1960s.
  • The natural rate of unemployment is a combination of structural and frictional unemployment.
  • The natural unemployment rate occurs within an economy when disturbances are not present.

• Defining Full Employment

  • In macroeconomics, full employment is the level of employment rates where there is no cyclical or deficient-demand unemployment.
  • Full employment represents a range of possible unemployment rates based on the country, time period, and political biases .
  • The full employment unemployment rate is also referred to as "natural" unemployment.
  • In an effort to avoid this normative connotation, James Tobin introduced the term "Non-Accelerating Inflation Rate of Unemployment" also known as the NAIRU.
  • The NAIRU has been called the "inflation threshold. " The NAIRU states the inflation does not rise or fall when unemployment equals the natural rate.

• Employment Levels

  • Full employment, in macroeconomics, is the level of employment rates when there is no cyclical unemployment.
  • It is defined by the majority of mainstream economists as being an acceptable level of natural unemployment above 0%, the discrepancy from 0% being due to non-cyclical types of unemployment.
  • Unemployment above 0% is advocated as necessary to control inflation, which has brought about the concept of the Non-Accelerating Inflation Rate of Unemployment (NAIRU).
  • For example, the 20th century British economist, William Beveridge, stated that an unemployment rate of 3% was full employment.
  • Frictional unemployment is always present in an economy, so the level of involuntary unemployment is properly the unemployment rate minus the rate of frictional unemployment.

• Measuring the Unemployment Rate

  • The labor force is the actual number of people available for work; economists use the labor force participation rate to determine the unemployment rate.
  • Economists use the labor force participation rate to determine the unemployment rate.
  • The unemployment rate is updated on a monthly basis.
  • Bureau of Labor Statistics uses six measurements when calculating the unemployment rate.
  • Bureau of Labor Statistics used the six employment measures to calculate the unemployment rate in the United States from 1950 to 2010.

• Defining Unemployment

  • During periods of recession, an economy usually experiences high unemployment rates.
  • Hidden: the unemployment of potential workers that is not taken into account in official unemployment statistics because of how the data is collected.
  • The final measurement is called the rate of unemployment .
  • When unemployment rates are high and steady, there are negative impacts on the long-run economic growth.
  • Socio-political: high unemployment rates can cause civil unrest in a country.

• Shortcomings of the Measurement

  • Unemployment is measured in order to determine the unemployment rate.
  • In order to find the rate of unemployment, four methods are used:
  • The method is not the preferred method to use when calculating the rate of unemployment.
  • By not including all underemployed or unemployed individuals in the measurement of the unemployment rate, the calculation does not provide an accurate assessment of how unemployment truly impacts society.
  • The unemployment rate is the percentage of unemployment calculated by dividing the number of unemployed individuals by the number of individuals currently employed in the labor force.

• The Short-Run Phillips Curve

  • As unemployment rates increase, inflation decreases; as unemployment rates decrease, inflation increases.
  • When the unemployment rate is 2%, the corresponding inflation rate is 10%.
  • As unemployment decreases to 1%, the inflation rate increases to 15%.
  • The idea of a stable trade-off between inflation and unemployment in the long run has been disproved by economic history.
  • Contrast it with the long-run Phillips curve (in red), which shows that over the long term, unemployment rate stays more or less steady regardless of inflation rate.