Natural rate of unemployment

The natural rate of unemployment is the unemployment rate that occurs in even a healthy economy. That's because workers are always coming and going, looking for a better job, and often they are unemployed until they find that better job.

The Natural Rate of Unemployment is the rate of Unemployment when the labour market is in equilibrium. The natural rate of unemployment is caused by a combination of frictional unemployment and structural unemployment.

The reason why the natural rate can change over time (or differ across countries) is because of changes or differences in economic policies that impact frictional unemployment (the ease with which firms can layoff workers, the ability and incentive for laid-of workers to find jobs, the adequacy of job retraining programs, the ease with which unemployed workers can link up with firms that have job vacancies) or structural unemployment (technological changes that impact industries, the education and retraining programs available to support workers in obsolete industries, the level of inter-generational mobility (how does the layoff affect the education and income prospects of the laid-of worker's children).

Policies to Lower the Natural Rate

Lower minimum wages: Helps reduce the job losing rate. If we think about it from the firm's point of view. During times of hardship, a firm may not have to let workers go if they can pay them a little bit less. This does not mean that the minimum wage is bad. As a society, we may be entitled to set a wage that is adequate for taking care of basic needs and set up a safety net for those who are unable to find jobs at that wage.

Better information: Set up job finding centers that allow workers to find potential matches, quickly and efficiently. Helps increase the job-finding rate.

Better training of workers: This can help in both reducing the job losing rate and in increasing the job finding rate.

Remove disincentives to work: Excessive unemployment benefits, strong labor market regulations, although improving the quality of life of the employed can bring about high unemployment through reductions in the job finding rate because of shortfalls in both labor supply and labor demand. Once again this does not mean that unemployment benefits or regulations that enhance worker's bargaining power with the employers are a bad thing - it is important to find the tradeoff between providing enough unemployment benefits to provide a safety net and providing so much that you are effectively providing a disincentive to gain employment.

Reductions in payroll taxes: Social Security is paid partly by the employer and partly by the employee. Lower payroll taxes may help reduce unemployment by reducing the cost of hiring workers and by increasing incentives for people to return to work.


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