The Natural Rate of Unemployment

The natural rate of unemployment is the unemployment rate that arises from the effects of frictional plus structural unemployment.

Cyclical unemployment is the deviation of the actual rate of unemployment from the natural rate due to downturns in the business cycle.

Because some frictional unemployment is inevitable and because many economies also suffer from structural unemployment, a certain amount of unemployment is normal, or “natural.” Actual unemployment fluctuates around this normal level. The natural rate of unemployment is the normal unemployment rate around which the actual unemployment rate fluctuates. It is the rate of unemployment that arises from the effects of frictional plus structural unemployment. Cyclical unemployment is the deviation of the actual rate of unemployment from the natural rate; that is, it is the difference between the actual and natural rates of unemployment. As the name suggests, cyclical unemployment is the share of unemployment that arises from the downturns of the business cycle.

Natural Unemployment Around the OECD

The Organization for Economic Cooperation and Development (OECD) is an association of relatively wealthy countries in Europe and North America that also includes Japan, Korea, New Zealand, and Australia. Among other activities, the OECD makes estimates of the natural rate of unemployment. The figure shows these estimates for 2013. The population-weighted average across the OECD is given by the purple bar.

While the U.S. natural rate of unemployment at 6.1% is below the OECD average of 7.7%, those of many European countries (including the major economies of Germany, Italy, and France) are above average. Many economists think that persistently high European unemployment rates are the result of government policies, such as high minimum wages and generous unemployment benefits, which discourage employers from offering jobs and discourage workers from accepting jobs, leading to high rates of structural unemployment.

Source: OECD.

We’ll see in Chapter 16 that an economy’s natural rate of unemployment is a critical policy variable because a government cannot keep the unemployment rate persistently below the natural rate without leading to accelerating inflation.

We can summarize the relationships between the various types of unemployment as follows:

Perhaps because of its name, people often imagine that the natural rate of unemployment is a constant that doesn’t change over time and can’t be affected by government policy. Neither proposition is true. Let’s take a moment to stress two facts: the natural rate of unemployment changes over time, and it can be affected by government policies.