Theoretical and Applied Economics (Feb 2011)
The Natural Rate of Unemployment and its Implications for Economic Policy
Abstract
The analysis of the inflation-unemployment tradeoff has undergone several stages during the post-war era. The first was marked by the acceptance of A.W. Phillips’ 1957 hypothesis and the subsequent Phillips curve. The next stage – marked by Friedman’s contributions – revealed a vertical long-run Phillips curve and introduced the natural rate of unemployment, designating that level of unemployment consistent with stable inflation. This paper explores the theoretical and empirical implications that have emerged since the introduction of the natural rate concept. At the theoretical level, we find that, far from questioning its existence, the theoretical debates revolve around two main questions: Can we actually determine the precise level of the natural rate and what are the appropriate techniques? and How does the natural rate change over time and what are the factors that influence it? Empirical knowledge, on the other hand, lags behind. Despite numerous empirical studies, economists are a long way from an appropriate quantitative understanding of the determinants and variability of the natural rate, either across time or across countries.
