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Why has the natural rate of unemployment fallen to such a low level?

Summary:
We don’t know the precise natural rate of unemployment, but according to most estimates the natural rate has fallen from roughly 5%-6% during the 1980s to below 4% today. In Germany, the natural rate has fallen much more dramatically. We also don’t know all of the reasons for this decline. Perhaps the rise of the “gig economy” has made it easier for the unemployed to find jobs. The Wall Street Journal suggests another possible factor: The share of jobless people receiving unemployment benefits fell after the 2007-09 recession and has stagnated at a historically low level since. Last year, 28% of jobless people received benefits, down from 37% in 2000—a period of similarly low unemployment. Among the main reasons, experts say: After the last recession ended, state

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We don’t know the precise natural rate of unemployment, but according to most estimates the natural rate has fallen from roughly 5%-6% during the 1980s to below 4% today. In Germany, the natural rate has fallen much more dramatically.

We also don’t know all of the reasons for this decline. Perhaps the rise of the “gig economy” has made it easier for the unemployed to find jobs.

The Wall Street Journal suggests another possible factor:

The share of jobless people receiving unemployment benefits fell after the 2007-09 recession and has stagnated at a historically low level since. Last year, 28% of jobless people received benefits, down from 37% in 2000—a period of similarly low unemployment.

Among the main reasons, experts say: After the last recession ended, state legislatures passed policies reducing unemployment benefits and tightening eligibility requirements.

They also provide a chart:

Why has the natural rate of unemployment fallen to such a low level?

In 2014, Congress cut back on federal unemployment benefits.  Some Keynesians argued that this would reduce aggregate demand and therefore slow job growth. In April 2014, Paul Krugman criticized the view that lower benefits would boost employment:

Ben Casselman points out that we’ve had a sort of natural experiment in the alleged effects of unemployment benefits in reducing employment. Extended benefits were cancelled at the beginning of this year; have the long-term unemployed shown any tendency to find jobs faster? And the answer is no.

Let me parse this a bit more, and ask, how was it, exactly, that reduced benefits were supposed to encourage employment in the first place?

Making the unemployed miserable arguably increases labor supply, as workers become less choosy and more willing to take whatever job they can find. But the US labor market in 2014 isn’t constrained by supply, it’s constrained by demand: given what firms can sell, they have no need for as many hours of work as workers are willing to give.

I argued that the policy change would boost aggregate supply and increase job growth.  It turns out that I was correct; payroll employment growth in 2014 surged to 3 million, versus 2.3 million in 2013 and 2.2 million in 2012.

Both aggregate supply and aggregate demand play a big role in the labor market.

BTW, the WSJ article cites one of my colleagues at the Mercatus Center:

Some economists like Michael Farren, a research fellow at the right-leaning Mercatus Center at George Mason University, say the state unemployment-insurance cutbacks and policy changes have motivated jobless Americans to undertake faster searches for new work.

Absent the state changes, he said, “you end up with policies created in the crisis that may help smooth the passage through the crisis, but…actually help stall the recovery.”

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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