The natural rate of unemployment should happen when the GDP output reaches the Effective Demand limit. But if unemployment slides along the effective demand limit, where then is it? When should we start to see inflation? Let me explain...
11 months ago I wrote a post (link) saying that capacity utilization would start dropping according to a graph that I use.
Here was the graph posted a year ago which plots the monthly movement of unemployment with capacity utilization. As the business cycle was progressing, Unemployment was falling and capacity utilization was rising. It looks as though the natural rate of employment was just below 6%. (94% in y-axis.)
Now, the plot in the graph was hitting two limits... the effective demand limit and the profit maximization limit. As the plot hit these limits, it would theoretically start to move up the orange line to keep profits increasing. Capacity utilization would start dropping while unemployment continued to fall.
So a year ago I wrote...
"My sense is that firms are in a race to maintain profit shares at the end of a business cycle. They felt the chill of declining profits in September (2014). From here on out, firms will have to contract in order to maintain profit shares, as seen by the plot hitting the orange line. Now firms will have to contract capital utilization while trying to maintain the same output in order to maintain profit rates."
What has happened in the past year? Exactly as I had forecasted.
Yet, ever since last year, the plot has moved along the orange line. Capacity utilization has dropped and unemployment has fallen.
Note: In this graph I flipped the y-axis of unemployment to make it hopefully easier to read.
So where would the natural rate of unemployment be on this graph if unemployment is still within the effective demand limit? Unemployment has fallen to 5.1% but we still do not see any inflation. And aren't we supposed to see inflation when unemployment falls below its natural limit? Not always. Back in the 70's inflation occurred but there were other factors causing it, which are not present now. And I am bouncing around a thought in my head that inflation occurs when the plot actually goes well beyond these limits like happened back in the 1970's.
So we now have unemployment at 5.1%. The Fed is saying that we are just now hitting the natural rate of unemployment. They are now expecting inflation. But I see that we actually hit it around 5.7%. Yet, even so, we are not going to see inflation. Forces to cause inflation just are not present. The business cycle is riding its production limits to increase profits. So supply is being controlled. It is a matter of time for a recession to pull the plot off of the orange line, which has been the pattern since the 1960's.
For further background on this story...
Reaching the limits of the Profit Rate... The Nitty Gritty of Effective Demand, Edward Lambert, December 2014.