Abstract:The unemployment rate is the composite of three distinct types of unemployment: frictional, cyclical, and structural. This fact poses a potentially serious problem for government policymakers because ...The unemployment rate is the composite of three distinct types of unemployment: frictional, cyclical, and structural. This fact poses a potentially serious problem for government policymakers because high unemployment rates are not necessarily indicative of a slack economy. Structural change as well as cyclical factors affect the unemployment rate. If policymakers are not able to distinguish higher unemployment rates due to a change in the structure of employment from higher unemployment rates due to a weak economy, then they run the risk of implementing expansionary policies at the wrong time, thereby creating or adding to inflationary pressures. Hence, to adequately gauge the state of the economy, it is necessary to know what portion of the current unemployment rate is due to purely cyclical phenomena as opposed to structural and frictional. The natural rate of unemployment is defined simply as the rate of unemployment that is compatible with a steady inflation rate. The natural rate can therefore be thought of as the rate of unemployment that would occur in the absence of cyclical fluctuations. In other words the natural rate is essentially the sum of structural and frictional unemployment. Because structural and institutional factors change over time, the natural rate of unemployment will also vary. However, the need to understand the determinants of the natural rate and its relation to the actual rate of unemployment is quite real as the cost of error may be accelerating inflation or deflation. The purpose of this article is to answer the question: What is the natural rate of unemployment? The answer relies heavily on the pioneering work of Lilien (1982) and is in two parts. First, a working definition of the natural rate of unemployment is developed. Second, with this definition, estimates of the natural rate of unemployment are calculated. The analysis indicates that the natural rate of unemployment has been quite variable over the last 27 years, reaching a high of 7.01 percent in the third quarter of 1981 and attaining a low of 3.48 percent in the first quarter of 1966. But to understand the performance of the economy, it is the difference between the natural rate and actual rate of unemployment that is significant. This difference has varied widely over time. From 1958 through 1966 the natural rate was well below the actual; the reverse held from 1967 to 1973. From 1974 through 1976 the actual rate again exceeded the natural rate although in more recent years the reverse appears once more to be the case. Because the difference between the natural and actual rates of unemployment is thought to be indicative of the degree of tightness in the labor market, this measure should be positively correlated with the inflation rate. Indeed, the correlation coefficient between the difference and the inflation rate as measured by the Consumer Price Index is 0.46. This compares with an almost zero correlation of inflation with the actual unemployment rate.Read More
Publication Year: 1986
Publication Date: 1986-01-01
Language: en
Type: article
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Cited By Count: 13
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