The Natural Rate of Unemployment

Question 1

The government is charged with making policies that will see the countrys economy prosper as well as provide its citizens with conducive environment for doing business and employment. One of the objectives relates to keeping the unemployment rates low enough to achieve full unemployment equilibrium. Thus, full employment refers to a situation where everyone willing to work stands a chance of getting a job. As such, it would mean that the unemployment rate stands at zero for the very simple fact that those not willing to work should not be counted as unemployed (Tucker, 2014). Therefore, to be considered employed, one should be actively looking for a job. However, it should be noted that not everyone in the working age bracket is employed. There are people in this bracket who leave the labor force for unavoidable reasons, such as women on maternity leave. Practically, however, having a 0% unemployment rate in an economy is impossible. This, therefore, makes the task of defining full employment a difficult one. Economists propose that an economy with unemployment rate of 3% or below qualifies as full employment. Nevertheless, this is a figure that the United States of America has not achieved for a very long time. According to estimates from the Federal Reserve Bank of St. Louis, the Natural Rate of the Unemployment rate for the USA for the first quarter of 2015 stands at 5.39%. Currently, the unemployment rate for the United States of America stands at 5.5% (Employment & Unemployment, 2015). Lack of a 0% unemployment rate can be attributed to the existence of frictional unemployment in the economy at any given point (Tucker, 2014).

Source: Federal Reserve Bank of St. Louis (Natural Rate of Unemployment (Short-Term), 2015).

Frictional unemployment can be defined as a situation where people actively look for jobs that they think are best for them. Frictional unemployment is not necessarily a bad thing because it is better for people to take time looking for the best job instead of accepting the first job opportunity that presents itself (Tucker, 2014). Frictional unemployment may also be referred to as search unemployment because people who often seek employment spend some time doing so. For instance, when graduates graduate from college, they enter the labor market but they are not guaranteed immediate employment at jobs that match their skills. Therefore, the period within which the student is unemployed but actively searches for a job is what economists call frictional unemployment. The same will also occur as people go from one job to another for various reasons. Economists call this voluntary unemployment because it is the choice of workers to remain unemployed instead of just taking the first job that comes their way. According to economists, frictional unemployment in the economy is not bad since it would make sense for people to get the right job no matter how much time it takes to achieve it rather than jump for a job that one may be overly skilled for (Tucker, 2014).

While frictional unemployment may be voluntary unemployment, the same cannot be said for structural unemployment. Structural unemployment is a situation where unemployment stands on a more permanent level as a consequence of other forces not related to the business cycle. One of the main reasons for structural unemployment may be a shift in the economy that may make it difficult for a certain group in the population to get employed. It may also be caused by an incompatibility between the jobs available and the skills exhibited by those unemployed (Tucker, 2014). It is important that policy makers carefully consider the consequences of structural employment because it has a tendency of increasing unemployment rate for any economy. Secondly, this situation may lead to an increase in the natural rate of unemployment. One of the major reasons why structural unemployment in the United States of America has increased is the countrys technological advancement over the last century. The industry that best fits this scenario is the newspaper industry as employees in this industry have been forced to go for further training or have been laid off completely. This happens because companies today opt for web based advertising rather than print advertising.

All these types of unemployment are used to determine whether an economy has achieved full employment equilibrium. In order to do this, it is critical to compare estimated natural rate of unemployment to actual rate of unemployment. As shown in the chart at the beginning of this paper, the estimated natural rate of unemployment as at May 2015 was 5.39%. In most cases, the actual unemployment rate exhibits more volatility than the natural rate and this can be attributed to the fact that the natural rate overlooks volatility that is a consequence of short-lived fluctuations in the economy. Whenever actual unemployment dips below estimated natural rate, the economists refer to this as a tight labor market. When the opposite happens, the labor market is referred to as being soft. However, it is difficult to make a comparison between actual unemployment rates with estimated natural rates of unemployment since the latter is only an estimate. Therefore, it is impossible to be measured explicitly. That being said, it is important to note that the only way to determine whether an economy has achieved full employment is by making this key comparison. For the USA, the countrys rate of unemployment data for both actual rates and natural rates are 5.575% and 5.39% respectively. By comparing these figures closely, it is clear that the United States has not achieved full employment equilibrium because the wage and price pressures that are important determinants of full employment have not been seen by policymakers at the Federal Reserve even with the unemployment rate going below 5.6%.

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Question 2

It is possible for the natural rate of unemployment to change over a period in response to economic fundamentals such as economic crisis. One of the major reasons why the natural rate of unemployment has increased during the economic crisis was the availability of extended unemployment insurance benefits. This was a policy created in response to heightened cyclical unemployment. During the 2007-2009 recession, the period of receipt of unemployment benefits increased as this duration could go on for weeks (Daly, Hobijn, Sahin, & Valletta, 2012). This policy acted to increase the rate of unemployment on two fronts. Primarily, people eligible for extended unemployment benefits led to lowered intensity of job search by job seekers. This happens because the extended unemployment benefits provide a source of income that is relatively enough to maintain a household at acceptable levels.

Structural unemployment is another reason natural unemployment rate has increased during the crisis and after. More specifically, the mismatch existing between the skills required by a job and the skill set of the unemployed (Daly et al., 2012). Structural unemployment will remain permanent during a financial crisis as people find it difficult to get jobs. Most people resort to applying for any jobs that they could get an opportunity to. While some jobs require low skills-set, highly skilled people still apply, and this brings about a mismatch. As a result, employers may be reluctant to employ highly skilled people who demand relatively high wages for jobs that require low skills. This consequently might lead to structural unemployment that in turn increases natural rate of unemployment.

During a crisis, equally important was the uncertainty of economic conditions during the recession, and this induced firms to direct their energies to increasing productivity and output without necessarily hiring new employees. Firms have fixed hiring and firing costs that are budgeted for, and if they operate in highly uncertain environments, the option to hire new workers is lowered significantly (Daly et al., 2012). This, in turn, puts negative pressure on job creation. A firm may opt to incur the cost of investing in workers as and when production is needed. However, this option is reduced according to the uncertainty levels. Furthermore, uncertainty prompted selective filling of vacancies by companies that created such vacancies. Therefore, this decreased the number of people hired per vacancy created. With many people were left unemployed in the labor market, the natural rate of unemployment increased significantly during the crisis.

• Economic News Releases : U.S. Bureau of Labor Statistics
• Natural Rate of Unemployment (Short-Term) (NROUST) | FRED | St. Louis Fed

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