News was released today that unemployment was 6.2% in July. How close are we to the natural rate of unemployment, or as some might say the NAIRU.
In my research into effective demand, I track the natural rate of unemployment. How do I determine the natural rate of unemployment? ... By comparing unemployment to the UT index, which measures spare capacity of labor and capital up to the effective demand limit. The unemployment rate when spare capacity goes to 0% is the natural rate of unemployment.
The graph shows data from 1967 to the 2nd quarter 2014. (quarterly data) The red dots represent recent data... The blue dots show past data... The yellow dots show the very slow return of employment during the recovery.
The graph shows that the natural rate of unemployment was roughly 4.75% in the past (y-intercept of the equation for the lower trend line). The recent data is moving in a polynomial path whose trend line is showing a natural rate of unemployment of 6.2%. So according to this graph, the unemployment rate of 6.2% is near a new natural rate which is higher than in the past.
At the natural rate, we would normally see a slowdown in output and a rise in inflation. We are seeing a slowdown in output, but inflation is muted because wage growth is still low.
Josh Zumbrun at the WSJ's Real Time Economics wrote about the unemployment forecasts of the Brookings Institute. Here is a graph posted with that article.
Economists on average were expecting a continued fall in the unemployment rate. The Brookings Institute is seeing the unemployment rate tick back up to 6.2% for many months more. The Brookings Institute was spot on for July's 6.2% released today. But the broader picture is that the Brookings Institute is seeing unemployment stall around 6.2% for many months more, which agrees with my model given above.
The Brookings Institute is not saying that 6.2% is the natural rate however. I am saying that the natural rate is close to 6.2%. Now unemployment can still go below 6.2%, but when unemployment pushes below its natural level, the economy tends to overheat and become unstable. At which point, the economy would like to return to the natural level. The path of that process can involve inflation, reduced output, falling capacity utilization and even tighter monetary policy.