Natural Rate of Unemployment

What Is Natural Rate of Unemployment?

The natural rate of unemployment is the level of joblessness that persists even in a healthy, fully functioning economy. It reflects the reality that some people are always between jobs or looking for work that matches their skills, so unemployment never falls to zero even in good times. The natural rate combines two components: frictional unemployment, the short-term joblessness of workers moving between jobs, and structural unemployment, which comes from a mismatch between workers' skills and the jobs available. It excludes cyclical unemployment, the kind driven by recessions. Economists treat the natural rate as the baseline the economy tends toward when it is neither overheating nor in a downturn, though the exact figure is an estimate that shifts over time with demographics, technology, and labor-market conditions.

Why It Matters

The natural rate of unemployment matters because it defines what full employment realistically means. Since some frictional and structural unemployment is unavoidable, a zero unemployment rate is neither achievable nor desirable, so policymakers aim for the natural rate rather than for no unemployment at all. The Federal Reserve uses the concept when balancing its dual mandate: if unemployment falls well below the estimated natural rate, the labor market may be overheating in a way that adds to inflation, while unemployment far above it suggests cyclical weakness that easier policy might address. Because the natural rate cannot be observed directly and drifts with changes in technology, education, and the workforce, it is one of the harder-to-pin-down but most useful reference points in reading the labor market.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• What term describes unemployment that persists even in a healthy economy, from normal job transitions and mismatches?
  The "natural rate" of unemployment (includes frictional and structural unemployment)
• In AP Macroeconomics, the natural rate hypothesis — that there is no long-run tradeoff between inflation and unemployment — was advanced independently in the late 1960s by Milton Friedman and which other economist?
  Edmund Phelps