What Is the Natural Unemployment Rate?
A clear, practical guide to what economists mean by “natural” unemployment, why it matters, how it differs from other kinds of unemployment, and steps policymakers, businesses, and workers can take to reduce its negative effects.
Key takeaways
– The natural unemployment rate is the lowest sustainable unemployment level produced by real, non-cyclical forces in the labor market (job search, skill mismatch, structural change).
– It is not zero: some frictional and structural unemployment is healthy for worker mobility and economic efficiency.
– Natural unemployment is linked to concepts such as full employment and the non-accelerating inflation rate of unemployment (NAIRU).
– Policy matters: training, labor-market matching, and institutional design can raise or lower the natural rate over time; deep recessions can raise it further through hysteresis.
Sources: Investopedia (natural unemployment overview) and Economic Policy Institute (minimum-wage updates) among others.
1. What “natural” unemployment means
– Definition: The natural unemployment rate is the minimum unemployment rate that arises from voluntary and structural factors in the economy rather than from cyclical downturns. It reflects normal job-to-job transitions (frictional unemployment) and mismatches between workers’ skills or locations and available jobs (structural unemployment).
– Conceptual origins: Key contributions came from Milton Friedman and Edmund Phelps (development of NAIRU) and are grounded in classical/modern labor-market theory. The idea is that even a healthy, well-functioning economy will have some unemployment.
2. Understanding the components
– Frictional unemployment: Short-term joblessness as workers search for better jobs or enter the labor force (graduates, re-entrants).
– Structural unemployment: Longer-term mismatch between worker skills/locations and job requirements (decline of industries, automation).
– Voluntary unemployment: Workers who choose not to accept available jobs for preferences or reservation-wage reasons.
– Institutional influences: Minimum wages, licensing, unionization, benefit rules, and labor regulations can affect the natural rate over the long run.
3. Causes of natural unemployment
– Job search and informational frictions (time to match workers and jobs).
– Skill and geographic mismatches due to technological change, industry shifts, or migration patterns.
– Demographic changes (aging workforce, youth labor market dynamics).
– Labor-market institutions and policies (minimum wage laws, occupational licensing, unemployment insurance design).
– Long recessions and firm closures that produce hysteresis—long-term loss of skills or discouraged workers—can push the natural rate up.
4. Full employment: a realistic interpretation
– “Full employment” in economics does not mean zero unemployment. Instead it is typically interpreted as the economy operating at or near its natural unemployment rate.
– Zero unemployment would imply no mobility and no ability for workers to switch jobs, which is undesirable for efficiency and wage growth.
5. Minimum wage and the natural rate
– Minimum-wage policies can influence the natural unemployment rate in some labor markets: if set above the equilibrium for certain low-skill jobs, they can raise structural unemployment among affected groups. At the same time, minimum-wage increases can raise incomes and boost demand. Policy design matters.
– Example: Twenty-one U.S. states raised their minimum wage on Jan. 1, 2025 (see Economic Policy Institute). The labor-market effects depend on local conditions, employer margins, and complementary policies.
6. Inflation, the Phillips curve, NAIRU, and hysteresis
– Classical Phillips-curve view: an inverse short-run relationship between inflation and unemployment (Keynesian intuition).
– NAIRU: Friedman and Phelps shifted thinking to a long-run framework: there is a non-accelerating inflation rate of unemployment—attempting to push unemployment below this rate risks accelerating inflation.
– Stagflation in the 1970s challenged a simple Phillips-curve tradeoff (both inflation and unemployment rising).
– Hysteresis: deep or prolonged downturns can permanently raise the natural rate by eroding skills or labor-market attachments.
7. Natural vs. cyclical unemployment
– Natural unemployment: the baseline level from structural/frictional factors (see above).
– Cyclical unemployment: the gap between actual unemployment and the natural rate; caused by insufficient aggregate demand (recessions/boom cycles).
– If actual unemployment > natural rate → cyclical unemployment is positive (economy below potential). If actual < natural rate → economy may face upward pressure on inflation.
8. Why the natural unemployment rate matters
– Policy guide: Central banks and governments use estimates of the natural rate (or NAIRU) to set monetary and fiscal policy—trying to balance output gaps and inflation risks.
– Labor-market design: knowing which portion of unemployment is structural vs. cyclical shapes interventions (training vs. demand stimulus).
– Social and distributional effects: high natural unemployment often signals persistent disadvantage for specific groups (e.g., low-skill workers, certain regions).
9. How a recovering economy impacts the natural rate
– Short-term recovery: as demand rebounds, cyclical unemployment falls and hiring picks up. This can reveal the underlying natural rate—if hiring stalls, structural problems may be limiting matches.
– Risk of hysteresis: if a long recession led to skill loss or discouraged workers exiting, the natural rate can stay elevated even as GDP recovers.
– Matching efficiency improves with active labor-market policies and better information (job-search platforms, mobility supports). If these improve during recovery, the natural rate can decline over time.
10. Practical steps — policymakers, businesses, and workers
A. For policymakers
1. Distinguish cyclical from structural unemployment with data (duration of unemployment, sectoral concentrations, labor-force participation).
2. Invest in active labor-market policies: job-search assistance, targeted retraining, apprenticeship programs, and portable benefits.
3. Support geographic mobility: relocation assistance, housing and transport policies, recognition of out-of-state credentials.
4. Design unemployment insurance to protect incomes while preserving job search incentives (balanced duration/benefits).
5. Support lifelong learning and sector-specific re-skilling tied to growth industries (e.g., green tech, care economy, digital services).
6. Monitor and recalibrate minimum-wage and licensing policies to avoid unnecessary barriers for entry-level workers while protecting living standards.
7. Use countercyclical fiscal and monetary policy to limit deep recessions and reduce hysteresis risk.
B. For businesses and employers
1. Invest in workforce development and on-the-job training to reduce skill mismatches.
2. Use apprenticeship and intern pipelines to tap and build local talent.
3. Offer flexible work arrangements and geographic flexibility where feasible to widen the candidate pool.
4. Partner with community colleges and training providers to ensure curricula match needs.
5. Use data to improve hiring matches and reduce time-to-fill (better job descriptions, assessment tools).
C. For workers (and job-seekers)
1. Invest in in-demand, transferable skills (digital literacy, communication, industry-specific certifications).
2. Use active job-search strategies and networks; consider short-term qualifications that improve employability.
3. Be open to geographic mobility or sector transitions if local demand is weak.
4. Take advantage of government retraining programs, apprenticeships, and community-college offerings.
5. Maintain labor-market attachment (even part-time or gig work can reduce long-term scarring).
D. For analysts and policymakers measuring the natural rate
1. Use multiple indicators: unemployment rate by duration, labor-force participation, job vacancy-to-unemployment ratios, wage growth, and sectoral employment trends.
2. Recognize uncertainty: NAIRU is not directly observable and estimates change over time. Adopt policy rules that allow flexibility and data-driven updates.
3. Watch for hysteresis signals (rising long-term unemployment, falling participation, structural declines in certain industries).
11. The bottom line
The natural unemployment rate describes the baseline level of unemployment consistent with a functioning labor market—reflecting job search, structural mismatches, and institutional features. It is not zero and can be influenced by policy, institutions, and long-term economic changes. Reducing the harmful effects of natural (structural) unemployment requires targeted training, active labor-market programs, well-designed safety nets, and policies that improve matching between workers and jobs while avoiding premature attempts to push unemployment below sustainable levels that would risk inflation.
Sources and further reading
– Investopedia — “Natural Unemployment” (overview and definitions).
– Economic Policy Institute — “Over 9.2 Million Workers Will Get a Raise on January 1 from 21 States Raising Their Minimum Wages.”
– Milton Friedman, “The Role of Monetary Policy” (1968) — introduction of natural-rate framework.
– Edmund Phelps — work on microfoundations of the natural rate and NAIRU.
– On Phillips curve and stagflation: historical coverage of Keynes, Phillips, and 1970s experience.
If you want, I can:
– produce a short checklist for policymakers or HR leaders based on the practical steps above, or
– run through how to estimate the natural rate for a specific region or country using available data (what indicators to collect and a simple methodology). Which would be most helpful?