The natural rate of unemployment is the level of joblessness that persists when an economy is operating at potential output, with inflation stable. It reflects frictional unemployment (workers between jobs, new entrants searching) and structural unemployment (skills mismatch, geographic immobility, labor-market regulation), but excludes cyclical unemployment caused by demand shortfalls.
The concept was developed independently by Milton Friedman in his 1967 American Economic Association presidential address ("The Role of Monetary Policy," published 1968) and by Edmund Phelps in work from the late 1960s. Both argued that there is no permanent trade-off between unemployment and inflation: attempts by central banks to push unemployment below its natural rate via expansionary policy will only generate accelerating inflation as expectations adjust. This insight reshaped the Phillips curve debate and earned Phelps the 2006 Nobel Memorial Prize in Economic Sciences.
A closely related operational concept is the NAIRU (Non-Accelerating Inflation Rate of Unemployment), often used interchangeably though some economists distinguish them. The natural rate is not directly observable and must be estimated; bodies such as the U.S. Congressional Budget Office and the OECD publish regular estimates. CBO estimates for the United States have generally ranged between roughly 4% and 6% in recent decades, but the figure shifts with demographics, technology, labor-force participation, and institutional factors like unionization or unemployment-insurance generosity.
Policy implications are significant:
- Monetary policy: Central banks, including the Federal Reserve and ECB, treat the natural rate as a benchmark when judging whether labor markets are "tight."
- Fiscal policy: Structural reforms (training, job-search assistance, deregulation) rather than demand stimulus are the appropriate tools for lowering it.
- Forecasting: The gap between actual and natural unemployment feeds into output-gap calculations.
Critics, including post-Keynesian economists and more recently figures associated with the Federal Reserve's 2020 framework review, note that the natural rate is unstable, hard to measure in real time, and can be lowered by sustained tight labor markets that pull marginal workers into employment (hysteresis in reverse).
Example
In its February 2024 Budget and Economic Outlook, the U.S. Congressional Budget Office estimated the natural rate of unemployment at roughly 4.4%, used as a benchmark for assessing labor-market slack.