What happens when the actual unemployment rate is equal to the natural unemployment rate?

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Inhaltsverzeichnis Show

Actual Unemployment Versus the Natural Rate
Frictional and Structural Unemployment
Supply Policies Affect Natural Unemployment Rates
Definition and Examples of the Natural Rate of Unemployment
How the Natural Rate of Unemployment Works
Should an Unemployment Rate of Zero Be the Goal?
How Recessions Impact the Natural Unemployment Rate
Key Takeaways
When the actual unemployment rate is equal to the natural unemployment rate?
What happens if the natural rate of unemployment exceeds the actual rate of unemployment?
Which unemployment can be defined as a rate at which the rate of unemployment is equal to the actual rate of inflation and the expected rate of inflation?
Are natural rate of unemployment and full employment the same thing?

Updated on September 24, 2018

Economists often talk about the "natural rate of unemployment" when describing the health of an economy, and specifically, economists compare the actual unemployment rate to the natural rate of unemployment to determine how policies, practices, and other variables are affecting these rates.

Actual Unemployment Versus the Natural Rate

If the actual rate is higher than the natural rate, the economy is in a slump (more technically known as a recession), and if the actual rate is lower than the natural rate then inflation is expected to be right around the corner (because the economy is thought to be overheating).

So what is this natural rate of unemployment and why is not just an unemployment rate of zero? The natural rate of unemployment is the rate of unemployment that corresponds to potential GDP or, equivalently, long-run aggregate supply. Put another way, the natural rate of unemployment is the unemployment rate that exists when the economy is in neither a boom nor a recession—an aggregate of the frictional and structural unemployment factors in any given economy.

For this reason, the natural rate of unemployment corresponds to a cyclical unemployment rate of zero. Note, however, that this doesn't mean that the natural rate of unemployment is zero since frictional and structural unemployment can be present.

It is important, then, to understand that the natural rate of unemployment is merely a tool used to determine what factors are affecting the unemployment rate that is making it perform better or worse than what is expected given the current economic climate of a country.

Frictional and Structural Unemployment

Frictional and structural unemployment are generally viewed as a result of the logistical features of an economy as both exist in even the best or worst of economies and can account for a large part of the unemployment rate that happens despite current economic policies.

Frictional unemployment is mainly determined by how time-consuming it is to match with a new employer and is defined by the number of people in an economy currently moving from one job to another.

Similarly, structural unemployment is largely determined by workers' skills and various labor market practices or a reorganizing of the industrial economy. Sometimes, innovations and changes in technology affect the unemployment rate rather than supply and demand changes; these changes are called structural unemployment.

The natural rate of unemployment is considered natural because it's what unemployment would be if the economy were in a neutral, not too good and not too bad, state without external influences like global trade or dips in the value of currencies. By definition, the natural rate of unemployment is that which corresponds to full employment, which of course implies that "full employment" doesn't actually mean that everyone who wants a job is employed.

Supply Policies Affect Natural Unemployment Rates

Natural unemployment rates cannot be shifted by monetary or management policies, but changes in the supply side of a market can affect the natural unemployment. This is because monetary policies and management policies often alter investment sentiments in the market, which make the actual rate deviate from the natural rate.

Before 1960, economists believed that inflation rates had a direct correlation with unemployment rates, but the theory of natural unemployment developed to point to expectations errors as the main cause of deviations between the actual and natural rates. Milton Friedman posited that only when actual and expected inflation are the same could one accurately anticipate the inflation rate, meaning you would have to understand these structural and frictional factors.

Basically, Friedman and his colleague Edmund Phelps furthered our understanding of how to interpret economic factors as they relate to the actual and natural rate of employment, leading to our current understanding of how supply policy is truly the best way to effect a change in the natural rate of unemployment.

Definition and Examples of the Natural Rate of Unemployment

The natural unemployment rate is the lowest level sustainable without creating inflation. In a healthy economy, workers are always coming and going, looking for better jobs. Until they find that new job, this jobless status is the natural rate of unemployment.

The natural rate of unemployment has been declining since the 1980s. One reason is that the percentage of older workers (age 55 and over) has increased, from 12.1% in 2000 to 23.6% in 2020. Older workers who lose their jobs are more likely to retire and leave the labor force instead of adding to unemployment levels.

The Cleveland Federal Reserve noted that "job polarization" has shifted the labor force into either low-skill or high-skill occupations. The middle-skill occupations have been replaced by technology, while high-skill workers are less likely to be laid off, which lowers the natural unemployment rate.

How the Natural Rate of Unemployment Works

Even in a healthy economy, there is some level of unemployment for three main reasons:

Frictional unemployment: There are always some workers who are in between jobs. Examples are new graduates looking for their first job, or workers who move to a new town without lining up another position. Some people may quit abruptly, knowing they'll get a better job shortly. Others might decide to leave the workforce for personal reasons such as retirement, pregnancy, or sickness. When they return and start looking again, the Bureau of Economic Analysis (BEA) counts them as unemployed.
Structural unemployment: As the economy evolves, there is an unavoidable mismatch between workers' job skills and employers' needs. It happens when workers are displaced by technology, like when automation takes over manufacturing jobs. It also occurs when factories move to cheaper locations. For example, the U.S. auto industry lost 350,000 jobs after the North American Free Trade Agreement (NAFTA) was signed. Structural unemployment remains until workers receive new training.
Surplus unemployment: This occurs whenever the government intervenes with minimum wage laws or wage/price controls. It can also happen with unions because employers must pay the mandated wage while staying within their payroll budget. The only way to do this is to let some workers go. It's the consequence of an unfunded mandate.

Note

There are also six other serious types of unemployment: cyclical, long-term, real, seasonal, classical, and underemployment.

Should an Unemployment Rate of Zero Be the Goal?

When setting interest rates, the Federal Reserve seeks to balance unemployment with growth and inflation. It uses 2% as the target inflation rate. Economists agree that the ideal gross domestic product growth rate is around 2%.

The Fed does not have a specific target for unemployment. It found that employers can find innovative ways to attract workers without raising wages.

The only way an economy could have a 0% unemployment rate is if it is severely overheated. Even then, wages would probably rise before unemployment fell to absolute zero.

The U.S. has never experienced zero unemployment. The lowest unemployment rate recorded was 2.5% in May and June of 1953. It occurred because the economy overheated during the Korean War. When this bubble burst, it kicked off the recession of 1953.

How Recessions Impact the Natural Unemployment Rate

The natural rate of unemployment typically rises after a recession. Frictional unemployment increases once the downturn is over. Workers become confident they can quit their jobs and find a better one. Structural unemployment can also increase as the numbers of long-term unemployed rise. Their skills and experience became outdated.

The financial crisis of 2008 wiped out 8.7 million jobs and increased the unemployment rate to 10.2% in 2009. Many experts wondered if the severity of the recession would contribute to a higher natural rate of unemployment.

The Cleveland Federal Reserve found that the recession shifted the natural rate a bit higher, but less so than expected given its severity. Long-term trends that drive down the rate of natural unemployment outweighed the short-term impact of the recession.

Key Takeaways

The natural rate of unemployment is the lowest level that a healthy economy can sustain without creating inflation.
Natural unemployment contains three components: structural unemployment, surplus unemployment, and frictional unemployment.
Zero unemployment is unattainable because employers would raise wages first.
The 2008 financial crisis did not offset the long-term trends that are lowering the U.S. natural rate of unemployment.

When the actual unemployment rate is equal to the natural unemployment rate?

The economy is considered to be at full employment when the actual unemployment rate is equal to the natural rate. When the economy is at full employment, real GDP is equal to potential real GDP.

What happens if the natural rate of unemployment exceeds the actual rate of unemployment?

Which unemployment can be defined as a rate at which the rate of unemployment is equal to the actual rate of inflation and the expected rate of inflation?

So, it can be stated that at the natural rate of unemployment, cyclical unemployment is absent. Here, it is given that the actual unemployment rate in the economy is the same as the natural rate of unemployment, so we can conclude that the cyclical unemployment in the economy is zero.

Are natural rate of unemployment and full employment the same thing?

Natural unemployment, or natural rate of unemployment, is the unemployment rate that persists in a well-functioning, healthy economy that is considered to be at “full employment.” It is a hypothetical rate of unemployment and suggests that there is never zero unemployment in an economy.