Nothing Natural About the Natural Rate of Unemployment
With unemployment reaching very low levels in major economies, despite low – and slowly rising – inflation, it's time for central banks to rethink their reliance on the so-called natural rate. No numerical target for this rate can serve as an anchor for monetary policy.
NEW YORK – Why is unemployment so low in countries where inflation remains subdued? For economists, this is a fundamental question. And when economists confront a fundamental question, fundamental disagreement often follows.
I was one of the rebel economists of the 1960s who rejected the macroeconomics we were taught in the 1950s – the “Keynesian” theory developed by J.R. Hicks, A.W. Phillips and James Tobin, according to which aggregate demand drove everything. High unemployment was caused only by deficient demand, and low unemployment only by abnormally high demand.
This bothered us, because the basic economic theory we were taught – the theory built by Alfred Marshall, Knut Wicksell, and Robert Solow – said everything was driven by structural forces. Faster technological progress and a greater preference to work or to save were to be welcomed, because they would boost the supply of labor and capital – and thus employment and investment. But the Keynesians maintained that structural forces were bad, because they cost people their jobs, unless policymakers manufactured enough demand to match the increase in supply.