Working Paper: CEPR ID: DP1507
Authors: Marika Karanassou; Dennis J. Snower
Abstract: 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.
Keywords: unemployment; natural rate hypothesis; labour markets; employment; capital accumulation; population growth; adjustment costs
JEL Codes: E30; E37; J32; J60; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Natural Rate of Unemployment (NRU) (J64) | Equilibrium Unemployment Rate (J64) |
| Equilibrium Unemployment Rate (J64) | Natural Rate of Unemployment (NRU) (J64) |
| Dynamic Adjustment Costs and Growth in Exogenous Variables (O49) | Equilibrium Unemployment Rate does not approach Natural Rate of Unemployment (NRU) (J64) |