The Natural Rate of Unemployment (NRU) refers to the level of unemployment consistent with a stable labor market where there is no inherent pressure for wages to either increase or decrease. According to the theory underlying the Phillips Curve, this is the equilibrium rate at which the labor market is balanced.
Theory under the Phillips Curve
Essence of the Phillips Curve
The Phillips Curve posits an inverse relationship between the rate of unemployment and the rate of inflation. In essence, when unemployment is low, inflation tends to be high and vice-versa. However, beyond a certain threshold, reducing unemployment further does not decrease inflation but may increase it due to wage pressures.
NRU and Equilibrium
At the Natural Rate of Unemployment, the labor market is at equilibrium. This means:
- There is no upward or downward pressure on wage rates.
- Unemployment is at a level where inflation is stable, also known as zero inflation.
- Unemployment is not zero but includes frictional and structural unemployment.
Types of Unemployment
Frictional Unemployment
This type of unemployment arises from the normal job search process as workers move between jobs, careers, or locations.
Structural Unemployment
It occurs when there are mismatches between the skills of workers and the demands of the job market, often due to technological advances or changes in the economy.
Cyclical Unemployment
Cyclical unemployment fluctuates with the economic cycle, rising during recessions and falling in periods of economic growth. It is not part of the Natural Rate as it reflects deviations from the equilibrium.
Historical Context and Application
The concept of the NRU became prominent in the 1960s and 1970s when economists observed that inflation did not decrease linearly with increasing unemployment. The NRU provided a framework to understand a stable unemployment rate where the economy operates efficiently without accelerating inflation.
Comparison with Other Economic Terms
Full Employment
Full employment occurs when all who are willing and able to work at prevailing wages can find employment. It does not imply zero unemployment but refers to the level compatible with the NRU.
NAIRU (Non-Accelerating Inflation Rate of Unemployment)
NAIRU is a closely related concept that defines the unemployment rate at which inflation does not accelerate. It is essentially equivalent to the NRU.
FAQs
What factors influence the Natural Rate of Unemployment?
Can the NRU change over time?
References
- Friedman, M. (1968). The Role of Monetary Policy. The American Economic Review.
- Phillips, A. W. (1958). The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom. Economica.
Summary
The Natural Rate of Unemployment (NRU) is a critical concept in economics, representing the equilibrium level of unemployment where the labor market is balanced, and inflation remains stable. Understanding the NRU helps policymakers and economists make informed decisions about labor market policies and economic strategies to maintain stable inflation.
This entry provides a detailed explanation of the Natural Rate of Unemployment, its relationship with the Phillips Curve, and its importance in economic theory and labor market analysis.
