Definition: The natural rate of unemployment is the unemployment rate that occurs in even a healthy economy. That's because workers are always coming and going, looking for a better job, and often they are unemployed until they find that better job. The only way an economy could have a zero percent unemployment rate is if it is severely overheated. Even then, wages would probably rise before there could actually be no unemployment.
In fact, the lowest the unemployment rate has been in the U.S. is 2.5%. That was in May and June 1953 when the economy overheated due to the Korean War. When this bubble burst, it kicked off the Recession of 1953. For this reason, economists often say the natural rate of unemployment should be no less than 4%.
Even in a healthy economy, there will always be some level of unemployment for three reasons:
1. Frictional Unemployment - Workers leave jobs because they leave town without lining up another job. Others decide they don't like their job, and quit before they get a new one. Still others might decide to leave the work force for personal reasons such as retirement, pregnancy or sickness. They drop out of the labor force. When they decide to return, they are counted as unemployed as long as they are looking for a job and haven't found one.
2. Structural Unemployment - As long as economic needs change and worker skills change, there will always be a mis-match between job skills and job availability. Workers will be displaced by technology, as when robots take over manufacturing jobs. Factories move to cheaper locations, as happened when NAFTA was signed. Another example was when Baby Boomers reached their 30s, and had fewer children, there was a shrinking need for day care workers. This caused structural unemployment until these workers were retrained.
3. Surplus Unemployment - This is caused by minimum wages laws and unions. When wages are set at a higher level, unemployment can often result. Why? To keep within the same payroll budget, the company must let go of some workers to pay the remaining workers a higher salary.
Has the Recession Changed the Natural Rate of Unemployment?
The recession caused by 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 huge loss meant that many of the unemployed stayed that way for six months or more, making it more difficult for them to get back to work. That's because their skills and experience become outdated. Does this mean that the recession will leave, as its legacy, a higher natural rate of unemployment?
Research done by the Cleveland Federal Reserve says yes, this could be the case. That's because job turnover is slowing. Throughout this recession, those with jobs have been less likely to leave them -- for any reason. In fact, by 2011 those leaving jobs (the separation rate) was as low as it was during the boom before the recession. However, the rate of those finding new jobs has not bounced back like it has during other recessions.
As a result, the Federal Reserve researchers have computed that the new natural rate of unemployment will hover between 5.6%-5.7%. As jobs are slowly created, the unemployment level will drop. However, it won't go below this level for two reasons.
- The separation rate will remain low. People are still afraid to quit their jobs, even though they'd like to.
- There are many discouraged workers who have just dropped out of the labor pool. They gave up looking for a job, and so the Bureau of Labor Statistics no longer counts them as unemployed. (For more on why this is, see How Does the BLS Measure Unemployment?)When they re-enter the labor force, they will be counted as unemployed again. This will keep the unemployment rate higher.
Also Known As: structural unemployment rate, frictional unemployment rate