The natural rate of employment is the lowest intensity that a healthy economy is able to sustain without leading to inflation. However, for economists, it is a combination of structural, frictional, and excessive unemployment.
But what is the natural rate of employment? In this article, we are going to discuss the natural rate of employment and when the natural rate of employment is achieved.
Natural Rate of Employment: An Overview
The natural rate of employment is at the minimum sustainable without leading to inflation. The natural rate of employment is achieved when a nation with a healthy economy has workers who come and go to look for better jobs. So, until they find the right job, they have a jobless status in terms of the natural rate of unemployment.
Since the 1980s, the natural rate of unemployment has been on a decline. A reason behind this is an increased percentage of older workers. In 2000 it was 12.1%, and it increased to 23.6 in 2020. Older workers losing their jobs might retire and leave the labor force rather than adding to unemployment levels.
According to the Cleveland Federal Reserve, job polarization has forced the labor force to either high or low-skill occupations. Technology has taken over middle-skill occupations, but high-skill workers have lesser chances of being laid off. Thus, it lowers the natural unemployment rate.
What are the Components of Natural Rate of Employment?
There are primarily three reasons behind unemployment. Check them out below.
- Frictional Unemployment
Frictional unemployment might occur when someone is in-between jobs. This means when someone in the workforce is looking for a job but is not being able to find one. It comprises recent employees and graduates who are encountering unexpected layouts and are searching for jobs actively. For reducing frictional unemployment, the government has to emphasize its resources to decrease information costs to increase the amount of job market information present in the nation.
- Structural Unemployment
This refers to unemployment caused by a mismatch between skills offered by workers and those demanded by employers. A great example of structural unemployment is a situation when a software engineer is an expert at an outdated programming language that results in unemployment. Providing training programs and subsidizing education to build skills is a way to truncate structural unemployment.
- Surplus Employment
It is caused by minimum wage laws and wage rigidity. For instance, in case the authorities decide on increasing the minimum wage by $2 at a specific time, some workers might be laid off because of reducing labor demands. It can lead to natural unemployment.
Is Zero Unemployment Rate the Right Goal?
While deciding the interest rate, the Federal Reserve looks to balance unemployment with inflation and growth, and as the target inflation rate, it uses 2%. Economists have agreed that the growth rate of the ideal gross domestic product is 2%.
The Fed doesn’t have a decided target for unemployment. It has been discovered that employers can use innovative ways to grab workers without increasing their wages. Thus, the economy will have 0% unemployment when it is seriously overheated. But even in such a time, wages are going to increase before unemployment falls to 0%.
The United States has not ever encountered 0% unemployment. They had recorded the lowest unemployment in May and June 1953, with the figure standing at 2.5%. It happened because the Korean War had caused the economy to heat up. As soon as the bubble burst, it led to the recession of 1953. Thus, the natural rate of employment is achieved when the country is witnessing growth year by year.
What can have an Effect on Natural Unemployment Rate?
Here are the factors that can affect the natural unemployment rate.
- Technological and Productivity Advancements
A shift in the worker’s productivity decides the labor demand. This, in turn, can have an effect on the natural employment rate. An unusual increase in productivity might lead to a higher labor demand at a certain wage rate. In case this sustains in the long-term, it will reduce the natural rate of unemployment.
- Public Policies
Public policy and governments can have a considerable effect on the natural unemployment rate. By decreasing information costs, governments can easily make the job markets accessible to prospective candidates. This can reduce frictional unemployment and the time people are spending to look for jobs.
Again, supporting vital practical skills learning and subsidizing training programs at corporations is another step that any government can take for decreasing structural unemployment in the economy and thus, decreasing the natural rate of unemployment.
The government, on the other hand, might also improve the natural employment rate in case the unemployment benefits are helpful for the workers. In case unemployment benefits offer workers products and services that are enough, the opportunity cost of not being employed might be a little low. This will motivate the workers to look for jobs.
Effect of Recession on Natural Unemployment Rate
Usually, after a recession, the natural rate of unemployment rises. Frictional unemployment will increase when the downturn is over. It makes the workers confident that they are going to lose their job and look for a better one. As the long-term unemployed increase, structural unemployment might also increase.
In 2008, the financial crisis led to 8.7 million people losing their jobs. It increased the unemployment rate to 10.2% in 2009. Several experts have wondered if the severity of the recession is going to lead to a higher natural rate of unemployment.
According to the Cleveland Federal Reserve, the recession had caused the unemployment rate to be a little higher. But it was less than what had been expected. Long-term trends that led to the drop in natural unemployment were able to outweigh the recession’s short-term impact.