Natural Rate of Unemployment, Its Components, and Recent Trends
Why Zero Unemployment Isn't as Good as It Sounds
The natural rate of unemployment is a combination of frictional, structural, and surplus unemployment. Even a healthy economy will have this level of unemployment because workers are always coming and going, and looking for better jobs. This jobless status, until they find that new job, is the natural rate of unemployment.
The Federal Reserve estimates this rate to be 3.5%–4.5%, and both fiscal and monetary policymakers use that rate as the goal of full employment. They use 2% as the target inflation rate and consider the ideal gross domestic product growth rate to be 2%–3%. The goal is to balance these three goals when setting interest rates. The Fed encourages Congress to consider all three goals when setting tax rates or spending levels.
Three Components of the Natural Rate of Unemployment
Even in a healthy economy, there is some level of unemployment for three main reasons:
- Frictional Unemployment: Some workers are in between jobs. Examples are new graduates looking for their first job, or workers who move to a new town without lining up another position. Some people quit abruptly, knowing they'll get a better job shortly, and others might decide to leave the workforce for personal reasons such as retirement, pregnancy, or sickness. When they return and start looking again, the BEA counts them as unemployed.
- Structural Unemployment: As the economy evolves, there is an unavoidable mismatch between workers' job skills and employers' needs. It happens when workers are displaced by technology, like when robots take over manufacturing jobs. It also occurs when factories move to cheaper locations. That's what happened after the North American Free Trade Agreement was signed. When baby boomers reached their 30s and had fewer children, there was less need for daycare workers. Structural unemployment remains until workers receive new training.
- Surplus Unemployment: This occurs whenever the government intervenes with minimum wage laws or wage/price controls. It can also happen with unions because employers must pay the mandated wage while staying within their payroll budget. The only way to do this is to let some workers go. It's the consequence of an unfunded mandate.
Why You Don't Want Zero Unemployment
The only way an economy could have a 0% unemployment rate is if it is severely overheated. Even then, wages would probably rise before unemployment fell to absolute zero.
The United States has never experienced zero unemployment. The lowest unemployment rate recorded was 2.5% in May and June 1953, and it occurred because the economy overheated during the Korean War. When this bubble burst, it kicked off the recession of 1953.
Why the Recession Didn't Raise the Natural Unemployment Rate
The financial crisis of 2008 wiped out a staggering 8.3 million jobs. The unemployment rate rose from 4.7% to 10.1% at its peak in 2009. This considerable loss meant that many of the unemployed stayed that way for six months or more. Long-term unemployment made it even more difficult for them to get back to work. Their skills and experience became outdated, leading to structural unemployment.
Research done by the Cleveland Federal Reserve found that the recession would leave a higher natural rate of unemployment because job turnover slowed. Throughout the recession, those with jobs were less likely to leave them. In fact, by 2011, the separation rate was as low as it was during the boom before the recession.
The reasons were different, though. During the boom, people didn't leave jobs because they liked them and received good wages. Employers had a difficult time finding new employees, so they made sure the workers were happy. During the recession, workers were afraid to leave and look for better employment, so they put up with long hours and no raises to keep their jobs.
The natural rate of unemployment typically rises after a recession. Frictional unemployment increases since workers can finally quit their jobs, confident they can find a better one now that the recession is over. Structural unemployment rises when workers have been unemployed for so long their skills no longer match the needs of businesses.
Between 2009 and 2012, the natural rate of unemployment rose from 4.9% to 5.5%, which was higher than during the recession itself. Researchers grew concerned that the length and depth of the recession meant the natural rate would remain elevated, but by 2014, it had fallen to 4.8%.
The Bottom Line
The ideal real unemployment rate for the United States is 3.5% - 4.5%. Zero unemployment wouldn’t be ideal, also almost impossible, because it would indicate a severely overheating economy.
Three types of unemployment make up the general natural unemployment figures. These are expected to occur in a healthy economy:
- Structural unemployment.
- Cyclical unemployment.
- Frictional unemployment.
Although the 2008 recession drastically increased unemployment figures for years, it did not permanently increase the natural rate of unemployment in the United States.
Federal Reserve Bank of St. Louis. “Natural Rate of Unemployment (Long-Term),” Accessed Jan. 7, 2019.