What Is the Natural Unemployment Rate?

The natural unemployment rate is the minimum unemployment rate resulting from real or voluntary economic forces. Natural unemployment reflects workers moving from job to job, the number of unemployed replaced by technology, or those lacking the skills to gain employment.

Understanding Natural Unemployment

The term “full employment” is often a target to achieve when the U.S. economy is performing well. The term is a misnomer because there are always workers looking for employment, including new college graduates or those displaced by technological advances. There is always movement of labor throughout the economy that represents natural unemployment.

Unemployment is not considered natural if it is cyclical, institutional, or policy-based unemployment. An economic crash or steep recession might increase the natural unemployment rate if workers lose the skills necessary to find full-time work or if certain businesses close and are unable to reopen due to excessive loss of revenue. Economists call this effect “hysteresis.”

Important contributors to the theory of natural unemployment include Milton Friedman, Edmund Phelps, and Friedrich Hayek, all Nobel prize recipients. The works of Friedman and Phelps were instrumental in developing the non-accelerating inflation rate of unemployment (NAIRU).

Causes of Natural Unemployment

Economists commonly held that if unemployment existed, it was due to a lack of demand for labor or workers and the economy would need to be stimulated through fiscal or monetary measures. However, history reveals the natural flow of workers to and from companies even during robust economic periods.

According to the general equilibrium model of economics, natural unemployment is equal to the level of unemployment in a labor market at perfect equilibrium. This is the difference between workers who want a job at the current wage rate and those willing and able to perform such work. Under this definition of natural unemployment, it is possible for institutional factors, such as the minimum wage or high degrees of unionization, to increase the natural rate over the long run.

Effects of Inflation on Unemployment

John Maynard Keynes wrote The General Theory of Employment, Interest and Money in 1936, leading many economists to believe there is a direct relationship between the level of unemployment in an economy and the level of inflation.

This direct relationship was formally codified in the Phillips curve, which showed that unemployment moved in the opposite direction of inflation. If the economy was to be fully employed, there must be inflation, and conversely, with periods of low inflation, unemployment must increase or persist.

The Phillips curve fell out of favor after the great stagflation of the 1970s. During stagflation, unemployment and inflation both rise, questioning the implied correlation between strong economic activity and inflation, or between deflation and unemployment.

The Bottom Line

The natural unemployment rate is the minimum unemployment rate stemming from real or voluntary economic forces. It is common in the labor market as workers flow to and from jobs or companies, and because of natural unemployment, full employment is unattainable in an economy. Unemployment is not considered natural if it is cyclical, institutional, or policy-based unemployment.