What Is the Natural Rate of Unemployment in the US?

The natural rate of unemployment represents the theoretical lowest unemployment rate an economy can achieve without causing inflation to accelerate. It reflects a level of unemployment that persists even when the economy is considered healthy and operating at its full potential. This rate is not zero, as certain types of unemployment are a natural part of a dynamic labor market.

Defining and Deconstructing the Natural Rate of Unemployment

The natural rate of unemployment reflects the minimum unemployment level resulting from voluntary economic forces and structural aspects of the labor market. It differs from zero percent unemployment, which is unattainable due to the constant movement of workers and evolution of industries. This persistent unemployment rate is composed primarily of two types: frictional and structural unemployment.

Frictional unemployment occurs when individuals are temporarily between jobs or are searching for new employment that better aligns with their skills and preferences. This includes recent college graduates entering the workforce, individuals voluntarily leaving a job for better opportunities, or those re-entering the labor force. This type of unemployment is a normal aspect of a dynamic economy, allowing for improved job matches.

Structural unemployment, conversely, arises from a mismatch between the skills workers possess and the skills demanded by available jobs, or from geographical disparities between job seekers and openings. This can be caused by fundamental shifts in the economy, such as technological advancements rendering certain skills obsolete, or changes in industry composition like a decline in manufacturing. Structural unemployment is more long-lasting than frictional unemployment and can persist even during periods of economic growth, often requiring workers to acquire new skills or relocate.

Frictional and structural unemployment constitute the natural rate. They differ from cyclical unemployment, which is not part of the natural rate. Cyclical unemployment is tied to the business cycle, increasing during economic downturns and decreasing during periods of economic expansion. Policymakers aim to minimize cyclical unemployment, whereas frictional and structural unemployment are unavoidable components of a healthy labor market.

Estimating the Natural Rate in the US

The natural rate of unemployment is a theoretical construct and cannot be directly observed or precisely measured. Economists and institutions like the Congressional Budget Office (CBO) and the Federal Reserve use various models and statistical approaches to estimate it. These estimates are crucial for understanding the labor market’s health and informing economic policy.

A common framework for estimating the natural rate is the Non-Accelerating Inflation Rate of Unemployment, or NAIRU. NAIRU represents the unemployment rate at which inflation tends to stabilize, meaning it neither accelerates nor decelerates. If unemployment falls below the NAIRU, inflationary pressures are expected to build, while unemployment above NAIRU may indicate disinflationary pressures.

Estimation methods often involve statistical filtering techniques to remove short-term cyclical fluctuations from unemployment data, revealing longer-term trends. Macroeconomic models that incorporate labor market dynamics also contribute to these estimations. For instance, the CBO estimates the natural rate by analyzing the historical relationship between unemployment and changes in inflation, as well as shifts in the composition of the labor force. The Federal Reserve derives its assessments by evaluating inflation forecasts and broader labor market dynamics.

Despite these sophisticated methodologies, challenges remain in precisely determining the natural rate. Estimates can vary among different institutions and over time due to differing model assumptions, evolving economic structures, and data limitations. Consequently, the natural rate is often presented as a range rather than a single, fixed number. For example, CBO estimates for the U.S. natural unemployment rate have recently been around 4.4% to 4.553%.

The Natural Rate’s Role in Economic Analysis

The natural rate of unemployment serves as a significant analytical benchmark for economists and policymakers in the United States. Its importance lies in its function as an indicator of “full employment” from a macroeconomic perspective. This implies that the economy is operating at its maximum sustainable output capacity without generating upward pressure on inflation.

Understanding the natural rate provides a crucial tool for assessing the current state of the labor market and the broader economy. If the actual unemployment rate is above the estimated natural rate, it indicates slack in the economy, suggesting labor resources are underutilized and there is potential for non-inflationary growth. This situation often points to an output gap where actual economic output is below its potential.

Conversely, if the actual unemployment rate falls below the natural rate, it may signal that the economy is overheating. In this scenario, employers may face difficulties finding workers, leading to increased competition for labor and potentially accelerating wages and prices. This can result in inflationary pressures as the demand for labor outstrips the sustainable supply. Such a situation indicates that the economy’s actual output might be exceeding its sustainable potential, creating an inflationary gap.

Historical Trends of the US Natural Rate

The estimated natural rate of unemployment in the United States has evolved across different historical periods, reflecting underlying changes in the structure and dynamics of the U.S. labor market.

During the 1970s and 1980s, the natural rate was generally higher compared to more recent periods. Estimates indicate it hovered slightly below 6% in the 1960s, then rose to exceed 7% by the late 1970s, before gradually declining through the 1980s and 1990s. From the 1990s up until the Great Recession, the natural rate was relatively stable, typically ranging between 4.5% and 5.5%.

These shifts are influenced by a combination of factors. Demographic changes within the labor force, such as the entry of baby boomers and women into the workforce, and the overall aging of the population, have played a role. Structural transformations in the economy, including the move away from manufacturing towards service industries and ongoing technological advancements, also contribute to changes in the natural rate. Additionally, changes in labor market institutions or improvements in job matching efficiency due to technological innovations like the internet have been cited as influencing factors.