Is the natural rate a reference point?
This paper explores the two common concepts of the natural rate of unemployment: (i) the stable, long-run equilibrium rate of unemployment; and (ii) the equilibrium unemployment rate at which there is no tendency for this rate to change, given the exogenous variables. The first concept (common in the theoretical literature) is impractical for empirical assessment, since it is generally impossible to find reliable estimates of the long-run values of the exogenous variables and since it is inherently unable to provide an analysis of how the NRU changes through time. Consequently, the second concept is used in empirical studies. The paper shows that this latter natural rate is not necessarily a reference point (a value towards which the equilibrium unemployment rate tends with the passage of time). Specifically, it is not a reference point in multi-equation labour market models containing lagged endogenous variables and exogenous variables with non-zero long-run growth rates. Since these features are exceedingly common, our analysis casts serious doubts on the usefulness of the natural rate hypothesis as a predictive tool.
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- Karanassou, Marika & Snower, Dennis J., 1995. "A Contribution to Unemployment Dynamics," CEPR Discussion Papers 1176, C.E.P.R. Discussion Papers.
- Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005.
"Unemployment: Macroeconomic Performance and the Labour Market,"
Oxford University Press, number 9780199279173, June.
- Layard, Richard & Nickell, Stephen & Jackman, Richard, 1991. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780198284345, June.
- Assar Lindbeck & Dennis J. Snower, 1989. "The Insider-Outsider Theory of Employment and Unemployment," MIT Press Books, The MIT Press, edition 1, volume 1, number 026262074x.
- Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
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