Natural Rate Of Unemployment

Published Jan 20, 2023

Definition of Natural Rate of Unemployment

The natural rate of unemployment is the rate of unemployment that exists when the labor market is in equilibrium. It is also sometimes referred to as the non-accelerating inflation rate of unemployment (NAIRU). That means it is the lowest rate of unemployment that an economy can experience without creating inflation. Natural unemployment consists of structural unemployment, frictional unemployment, and surplus unemployment.  Because of these components, it is impossible for any economy to reach zero unemployment in reality.

Example

To illustrate the concept of the natural rate of unemployment, let’s look at the US economy. In the US, the natural rate of unemployment is currently estimated to be around 4.4% (see also FRED economic data). That means if the actual rate of unemployment is lower than 4.4%, the economy is likely to overheat, and inflation will start to rise. On the other hand, if the actual rate of unemployment is higher than 4.4%, the economy is likely to slow down, and inflation will start to fall.

Why the Natural Rate of Unemployment Matters

The natural rate of unemployment is an important concept for economic policymakers. It helps them to understand the dynamics of the labor market and to make informed decisions about economic policy. If the actual rate of unemployment is higher than the natural rate, the government can implement policies to stimulate the economy and reduce unemployment. On the other hand, if the actual rate is lower than the natural rate, the government can implement policies to slow down the economy and reduce inflation.