The Natural Rate of Unemployment

Bush apologists used to note that the current unemployment rate is near the average during the Clinton years, which forgets that unemployment fell during Clinton’s Administration and has increased under the current Administration. Now they are comparing to the current 5.4% unemployment rate to the average rate since 1948, which has been 5.6%. This comparison is misleading for three reasons. One is that the average unemployment rate may overstate the natural rate especially during a time frame with nine recessions. The second reason is that the natural rate changes over time. Page 92 of the Economic Report of the President 2000 notes::

The short-term NAIRU, which has been centered around 5¾ percent over the postwar period and in the mid-1990s, probably fell into the 4 to 4½ percent range through the combination of the temporary help and Internet innovations to the labor market, the productivity surprise, falling relative import prices, and perhaps other factors. It is very difficult to quantify the long-term effects of the temporary help and Internet innovations to the labor market. For the purpose of its conservative forecast, the Administration estimates that they account for roughly a 0.5-percentage-point permanent reduction in the NAIRU from its historical average, to a range centered around 5.2 percent. In contrast, the effects of the productivity surprise and falling relative import prices are temporary and are expected to erode over the next several years. As a consequence, in the Administration’s conservative projection, the unemployment rate edges up to 5.2 percent by 2003 and remains at that level thereafter.

Given the continuing productivity increases, the natural rate may still be less than 5%.

The third reason has to do with the decline in civilian force labor participation rate from 67% to 66% during the jobless recovery. When I argued that the employment-population ratio is a better measure of the state of the labor market, Brad DeLong argued:

Taking 64% as the natural employment-to-population ratio-and thus as a goal for macroeconomic policy-seems to me to make sense. The failure of inflation to pick up faster after mid-1997 is a powerful argument that the natural employment-to-population ratio is not less than 64%. And the calculation that we have 3.5 million people out of jobs who ought-in a well-performing economy-be working seems a good estimate to me.

If the natural employment-to-population ratio is 64%, then the actual employment-to-population ratio currently at 62.3% is far below the natural rate.

In the upcoming Presidential debate, let’s listen to both candidates. I suspect Bush will tout his pseudo-optimism that all is just fine since he has no genuine plans for restoring full employment. Kerry will likely portray the real optimism that we can do better. I’m sure most Americans will be listening for him to say what policy steps he intends to implement to insure that we do.