natural rate of unemployment

Even when an economy is humming along at full strength — no recession, no boom, demand just right — there is still some unemployment. People are always between jobs, and some are stranded by skills mismatches. So 'zero unemployment' is neither possible nor desirable. The level of unemployment that remains in a healthy economy, once the ups and downs of the business cycle are stripped out, is the natural rate of unemployment.

Precisely, the natural rate is the sum of frictional unemployment (people searching for better matches) and structural unemployment (people mismatched by skill or location), but with no cyclical unemployment at all. It is the unemployment rate the economy gravitates toward in the long run, when the economy is at its potential output. If the natural rate is, say, 5 percent, then an economy running at 5 percent unemployment is essentially at full employment, even though one in twenty job-seekers is still without work. The natural rate is not a fixed law of nature; it drifts over time with demographics, technology, the generosity of benefits, and how flexible the labour market is.

The natural rate is one of the most important — and most slippery — concepts in macroeconomics. It is the benchmark against which actual unemployment is judged: above it suggests a weak economy with room to stimulate, below it suggests an overheating economy that may stoke inflation. The catch is that it cannot be measured directly; it can only be estimated, with wide uncertainty, and economists revise their estimates after the fact. Policy aimed at pushing unemployment below the natural rate for long tends to produce accelerating inflation rather than lasting extra jobs — a central insight behind the NAIRU.