WHAT ARE ESTIMATES OF THE NATURAL RATE OF UNEMPLOYMENT MEASURING?*

DOIhttp://doi.org/10.1111/j.1468-0084.1983.mp45002002.x
AuthorA. P. Thirlwall
Date01 May 1983
Published date01 May 1983
WHAT ARE ESTIMATES OF THE NATURAL RATE
OF UNEMPLOYMENT MEASURING?*
A. P. Thiriwall
The natural rate of unemployment is supposed to be that rate of
unemployment 'ground out by the Wairasian system of general equili-
brium equations',1 determined by real factors: in particular, by the
level of frictional and structural unemployment, and by the rate of
growth of labour productivity in a growing economy. Unemployment,
it is argued, cannot be reduced below this rate without ever-accelerating
inflation This rate is estimated empirically from a wage or price
equation which assumes a wage-price coefficient of unity if inflation
is fully anticipated by wage earners.
This Note makes two points. The first is that the empirical estimates
made of the natural rate of unemployment are likely to reflect both
real (structural) and monetary (demand) influences and will vary
cyclically with the pressure of demand. This is a fairly obvious point
but has tended to be overlooked in discussion. The constant term in
the equations from which estimates of the natural rate of unemploy-
ment are estimated will contain a mixture of factors and will not be
invariant to the pressure of demand. Thus, estimates of the natural rate
are not measuring what Friedman originally intended, namely the level
of frictional and structural unemployment in general equilibrium.
There are three important corollaries of this: first, that variations in
estimates of the natural rate over relatively short periods of time
probably have little to do with changes in the structure of labour
markets or the nature of unemployment, but are more likely the
product of cyclical variations in demand associated with the gap between
increases in money wage and prices rising in slumps and narrowing in
booms;3 secondly, that reducing the estimated natural rate of unemploy-
*1 am grateful for helpful discussion with Professor A. J. Brown, John Brothwell, Bob Dixon,
Alan Carruth and Professor Kaldor, without implicating them in the analysis or conclusions.
'M. Friedman(1968).
2This rate sometimes goes by the acronym NAIRU - the non-accelerating inflation rate of
unemployment. The natural rate as originally defined by Friedman is a more rigorous concept
theoretically since NAIRU may not define a position of general equilibrium, but there is no
empirical difference between them because they are estimated in the same way. What is said
here about empirical estimates of the natural rate therefore applies to NAIRU too.
This would be associated with labour's share of national income tending to rise in slumps
and fall in booms.
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