Natural rate of unemployment

Natural rate of unemployment
See also
Economic situation Demand shock Inflation target Autonomous Investment Monetarism Effects of unemployment Austrian business cycle theory Cyclic variation Engel's law

Natural unemployment or the natural unemployment rate - this is the size of unemployment in conditions of balance in the labor market. It is a percentage of the workforce that includes those who do not want to work at a real wage that provides balance and are voluntarily unemployed. According to this concept, attempts to reduce the rate of natural unemployment below a certain level by means of appropriate monetary instruments are unsuccessful and usually lead to an increase in inflation. In the growth model, the natural unemployment rate is the limit for the amount of available labor as an effort in the production process. The natural rate of unemployment has been increasing steadily since the mid-sixties. The natural unemployment rate is a typical unemployment rate, around which the actual unemployment rate fluctuates. (Paul R.Krugman, 2012, p.99) Importantly, it changes over time, and government policy can affect its level.

The natural unemployment rate is not possible to be completely reduced. Even when the surplus of workplaces with a labor force is present, it is at a level of around 2 to 3%. The reason for this is that even at times of the greatest economic growth, jobs are created or eliminated. Then frictional Unemployment is created. (Paul R. Krugman, 2012, p. 93) In the simplest terms, it is a situation in which employees look for a job as a result of losing or changing jobs without accepting the first offer they have encountered. Natural unemployment is also shaped by Structural Unemployment. Thus, natural unemployment is shaped by:

• frictional unemployment and
• structural unemployment.

The theory of NAIRU

The NAIRU theory is connected with the natural unemployment rate. This theory applies to the unemployment rate that does not accelerate inflation. She says that there is a certain level of unemployment in the economy that does not affect the rate of price increase. This is due to the fact that below a certain level of unemployment there is pressure from employees and trade unions to increase wages. When this pressure persists in a constant relation to changes in the generation capacities of the economy, the level of inflation remains at a stable level.

Measurement of the natural unemployment rate

The simplest measure of the natural unemployment rate is the average unemployment rate for decades. Under normal conditions, i.e. when real GDP equals potential GDP, the natural unemployment rate is described by the formula $u={\frac {b}{e}}$

where:

• u- natural unemployment rate
• b- job loss rate
• e-the rate of finding a job

When examining the differences in the unemployment rate (e.g. in time), one should look at the differences between the rate of job loss and the rate of finding a job. The high rate of deviation from work on the market (high inflow and low outflow of the unemployed) increases the natural rate of unemployment, which will also be high in an economy with a low rate of finding a job. The high rate of employment, reduces the natural rate of unemployment.

If the rates of job loss and the rate of finding a job are permanent, then the economy automatically reaches the natural rate of unemployment. The outflows and inflows of the labor force also have an impact on the natural unemployment rate.

Factors shaping the natural unemployment rate

The natural unemployment rate for the whole economy is influenced by many factors. Four specific factors affect its growth by lowering the rate of job finding:

• Effective wages
• Wage benefits from belonging to trade unions
• Minimum wages
• Insurance against unemployment
• Employment agencies
• Technological changes

Changes in the natural unemployment rate

Factors determining the natural unemployment rate are variable, respectively, under the influence of their changes, the natural rate of unemployment also undergoes certain transformations. When numerous restructuring processes take place in the economy, when the workforce is characterized by an unusually high number of young workers with high turnover rates or when the minimum wages and benefits would be higher, the natural unemployment rate should be high. The decrease should be caused by the decrease in the share of employees belonging to trade unions. Trade unions negotiate wages above the equilibrium level, which may be the reason for the increase in structural unemployment.

Unemployment rates for people with more experience are usually lower than the unemployment rates of employees with low professional experience. It results from the principle that employees with longer seniority strive to stabilize and stay in a given place for a long period of time, and therefore do not cause a rise in frictional unemployment. Older employees are characterized by greater stability of work due to the fact that in many cases they are the only breadwinners of the family. (Paul R. Krugman, 2012, p. 101)

Government policy also contributes to changing the natural rate of unemployment. For example, high unemployment benefits may result in an increase in frictional and structural unemployment and, as a consequence, increase in natural unemployment. In order to reduce the natural unemployment rate, the government may run training programs or subsidize employment for the unemployed. (Paul R.Krugman, 2012, p. 2013)

Current trends in the economy most likely indicate a decline in the natural unemployment rate.

Examples of Natural rate of unemployment

• Frictional Unemployment: This is a form of unemployment that occurs when workers are transitioning between jobs. It is caused by the mismatch in skills and locations between jobseekers and available job opportunities. This type of unemployment is often the result of people searching for their ideal job and can take time to resolve.
• Structural Unemployment: This type of unemployment occurs due to changes in the structure of the economy that render certain skills and occupations obsolete. This could be caused by a shift in the demand for certain goods and services as well as advances in technology that make certain jobs redundant.
• Seasonal Unemployment: This type of unemployment is caused by seasonal changes in the economy. For example, people who work in the tourism industry may be unemployed during the winter months when there is less demand for their services.
• Cyclical Unemployment: This type of unemployment is caused by the ups and downs of the business cycle. During an economic downturn, businesses may lay off workers or reduce their hours, leading to higher levels of unemployment.

Advantages of Natural rate of unemployment

A natural rate of unemployment has numerous benefits for the economy. These include:

• Increased Labor Mobility: A natural rate of unemployment allows workers to more easily move from one job to another, allowing for a more efficient allocation of labor resources. This contributes to economic growth by ensuring that workers are employed in roles that best meet their skills and interests.
• Reduced Wage Inflation: A natural rate of unemployment reduces the potential for wage inflation, as employers are less likely to offer higher wages in order to attract workers when the pool of available workers is larger. This helps to keep prices stable and contributes to a healthier economy.
• Improved Job Security: A natural rate of unemployment helps to improve job security, as employers are less likely to lay off workers when the pool of available labor is larger. This helps workers to feel secure in their positions and allows them to focus on their job performance.
• Greater Wage Equity: A natural rate of unemployment contributes to greater wage equity, as employers are more likely to offer competitive wages when the pool of available workers is larger. This helps to ensure that workers are paid fairly and that their wages reflect the value of their work.

Limitations of Natural rate of unemployment

The natural rate of unemployment has certain limitations that should be taken into consideration. These include:

• The natural rate of unemployment is an estimate and can vary from country to country and over time. It is not a scientifically derived number, but rather an educated guess.
• It does not take into account the effect of technological change or structural changes in the labor force, such as an aging population.
• It does not take into account the effect of new economic policies or government interventions, such as changes to minimum wages or unemployment benefits.
• It does not account for changes in the labor market due to changes in consumer demand or shifts in the global economy.
• It does not take into account the effects of inflation or changes in the cost of living on wages.
• It does not reflect the full range of factors that influence unemployment, such as changes in the education system or business cycles.

Other approaches related to Natural rate of unemployment

• The Natural Rate of Unemployment is also studied in terms of its structural and cyclical components. Structural unemployment is caused by structural factors such as changes in technology or changes in the economic structure. Cyclical unemployment is caused by lack of demand due to economic downturns and recessions.
• The Natural Rate of Unemployment can also be viewed from a macroeconomic perspective, taking into account the labor force participation rate and the unemployment rate. The labor force participation rate is the ratio of the number of people employed to the size of the population. The unemployment rate is the ratio of the number of unemployed people to the size of the labor force.
• The Natural Rate of Unemployment can also be studied from a microeconomic perspective, looking at the factors that cause individuals to be unemployed. These include lack of skills, geographical immobility, and age and gender discrimination.
• The Natural Rate of Unemployment can also be examined from the perspective of labor market imperfections such as frictional unemployment, which is caused by the difficulty of finding a job that matches with one's skills and preferences.

In conclusion, the Natural Rate of Unemployment is a complex phenomenon that can be studied from multiple perspectives. It is important to understand the structural and cyclical components of unemployment as well as the micro and macroeconomic perspectives, in order to be able to develop policies that are effective in reducing the natural rate of unemployment.

References

• Salop, S. C. (1979). A model of the natural rate of unemployment. The American Economic Review, 69(1), 117-125.
• Blanchard, O., & Katz, L. F. (1997). What we know and do not know about the natural rate of unemployment. Journal of Economic Perspectives, 11(1), 51-72.
• Staiger, D. O., Stock, J. H., & Watson, M. W. (1997). How precise are estimates of the natural rate of unemployment?. In Reducing inflation: Motivation and strategy (pp. 195-246). University of Chicago Press.