Natural rate of unemployment

The natural rate of unemployment or Non-Accelerating Inflation Rate of Unemployment (NAIRU) is the rate of unemployment at which inflation will remain constant. The natural rate of unemployment can be thought of as the unemployment that will always be there, even in the long run.

The natural rate of unemployment corresponds to the natural level of output.

There are typically three reasons for unemployment:

  • Structural unemployment
  • Frictional unemployment
  • Cyclical unemployment

The first two are the ones which are “natural” and the latter is the one which causes inflation to either accelerate or un-accelerate.

Structural unemployment

Structural unemployment is the unemployment which is caused by minimum wages, unions, efficiency wages or welfare benefits.

The reason why this unemployment is considered “natural” because these barriers will always exist. For example, consider the minimum wage. Minimum wages set the price of labor higher than its value. Therefore, firms decide not to hire these workers because it would cost them more. This isn’t going to change in the long-run.

frictional unemployment

Frictional unemployment is the unemployment that occurs from people looking for jobs. This is typically not seen as a bad thing as it is usually only temporary and involves people moving from one job to another. However, since there is always typically a certain fraction of the labor market looking for a new job this unemployment will persist into the long run.

Cyclical unemployment

This is the unemployment which is not part of the natural rate of unemployment. This is the unemployment that is caused by the “boom and bust” cycle or by shocks to either short run aggregate demand or short run aggregate supply. In the long run, this unemployment would be zero.

Why is it called non-accelerating rate of unemployment

This is because when there is cyclical unemployment we are in a situation of dis-equilibrium. And when you are in disequilibrium you will eventually return to equilibrium and as you return to equilibrium the price level changes and a change in price level causes inflation. Thus the inflation “accelerates” back to equilibrium.

In summary, because frictional and structural unemployment will always exist, there will always be a “natural” level of unemployment.

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