What We Know and Do Not Know About the Natural Rate of Unemployment

Blanchard and Katz assess three decades of research on the determinants of the natural rate of unemployment and reach two main conclusions: that there has been considerable theoretical progress, organized around a framework in which the labor market’s constant “traffic” of flows generates frictional unemployment while wage-setting that departs from pure competition pins down an additional, non-frictional component; and that empirical knowledge “sadly lags behind,” with economists lacking a good quantitative understanding of the natural rate’s determinants either across time or across countries. They show the standard macroeconometric wage equation used to estimate the natural rate – in which wage inflation depends on lagged price inflation and the unemployment rate, with no separate role for the level of productivity – is in some tension with the supply-wage theory the paper develops, since on U.S. aggregate time-series data the estimated long-run adjustment coefficient toward a productivity-and-unemployment-determined wage level is actually negative, while regional panel evidence (replicating and reassessing the “wage curve” literature of Blanchflower and Oswald) suggests a long-run relation does exist, but with much slower adjustment than Blanchflower and Oswald estimated. On the rise in European unemployment since 1970, from roughly 3 percent to over 10 percent with no corresponding acceleration in inflation, they survey the leading explanations – oil and productivity shocks, taxes, labor market rigidities, skill-biased technological change, and hysteresis – and conclude that while “many suspects have been identified… none has been convicted,” closing with a call for closer integration between the empirical work of labor economists and the theoretical work of macroeconomists.

Lawrence F. Katz | Macro Paper Warehouse

What We Know and Do Not Know About the Natural Rate of Unemployment