Natural Rate of Unemployment

With the release of the most recent jobs report by the Bureau of Labor Statistics, the discussion of the headline unemployment number centered around the fact that unemployment had fallen to 5.5%, or equal to the so called "natural rate" of unemployment. With the rapid increase in hiring that has been seen over the past twelve months, an average jobs gain of 275,000 jobs per month, the unemployment rate has fallen substantially, reaching its lowest level since May 2008. Now that the unemployment rate has reached the natural rate level, the discussion around the Federal Reserve raising rates has increased. While the speculation is that the Fed will seek to take its foot off of the pedal of the economy to stabilize employment around this level, there may be benefits to increasing employment past the natural level.

Using the analysis of data provided by the St. Louis Federal Reserve Economic Database, there is an impressive relationship of the unemployment rate falling below the natural rate and the advent of a recessionary time period. A close analysis of the graph (below), shows that when the Civilian Unemployment Rate (red line) has fallen below the Long-Term Natural Rate of Unemployment (blue line), there has been a recessionary period. It is interesting to note that recessions further in the past, specifically ones before 1990, had significantly lower unemployment rates than the NROU before the onset of the recession. However, with the recent recessions, the unemployment rate has not been able to dip so far below the NROU before climbing with the economic contraction.

However, there has been increasing calls for the Fed to push the unemployment rate well below the natural rate level. Specifically, a paper from economics professor Laurence Ball at John Hopkins University argues that the fed should push the unemployment rate well below even the 5% mark. He argues that this recession is unique in that there are a significant number of long term unemployed and discouraged workers. His plan to push unemployment temporarily below 5% would help solve this problem:

It [the Fed] should seek to push the rate "well below 5%, at least temporarily," he writes. That could help bring some discouraged workers to reenter the labor market, as well as help the long-term unemployed find work and involuntary part-time workers find full time jobs, he said. "A likely side effect would be a temporary rise in inflation above the Fed's target, but that outcome is acceptable."

This is an interesting take on the economic issue that remains to be at hand, many years after the official end to the recession. While the headline number of unemployment, the U-3, has fallen significantly since 2010, other, more broad measures of unemployment such as the U-6 have not shown as much improvement. The plan that he suggests would be a greater focus on returning these more broad measures down to their "natural" levels. In addition, the side effect of an increase in inflation could be a positive for the economy. Currently, US inflation has been under the Fed's target for almost three years; for the Fed to come out and say that they are going to continue to pressure unemployment down, there could be an increase in expected inflation within the market, helping them get closer to their medium-term targets.