Understanding the Natural Unemployment Rate: Why Zero Unemployment Is Unreachable

Julia Kagan is a financial and consumer journalist, formerly senior editor of personal finance at Investopedia.

What Is the Natural Unemployment Rate?

The natural unemployment rate represents the lowest level of unemployment that an economy can sustain due to inherent labor market dynamics. It includes individuals transitioning between jobs, those displaced by technological changes, or workers lacking the skills required for available positions.

Key Insights

• The natural unemployment rate reflects unemployment caused by structural and voluntary factors in the labor force.
• It accounts for workers moving between jobs and those replaced by automation or lacking necessary skills.
• This type of unemployment is a normal part of a healthy labor market.
• Unemployment caused by economic downturns or policy changes is not considered natural.
• Because of natural unemployment, achieving 100% employment is impossible.

Grasping the Concept of Natural Unemployment

The idea of "full employment" is often misunderstood; it doesn't mean zero unemployment but rather a state where unemployment is at the natural rate. This includes ongoing job transitions, new labor market entrants like recent graduates, and workers displaced by innovation.

Unemployment spikes caused by recessions or economic shocks—known as cyclical unemployment—are distinct from natural unemployment. Severe downturns may lead to hysteresis, where unemployment remains elevated even after recovery due to skill erosion or permanent job losses.

Notable economists such as Milton Friedman, Edmund Phelps, and Friedrich Hayek have significantly contributed to understanding natural unemployment and its relationship with inflation, including the development of the NAIRU concept.

Important Note

Natural unemployment arises from both voluntary job changes and involuntary factors. Extended economic crises can exacerbate natural unemployment through hysteresis effects.

What Causes Natural Unemployment?

Economists once believed unemployment was solely due to insufficient labor demand, fixable by fiscal or monetary stimulus. However, even in strong economies, workers naturally transition between jobs, contributing to a baseline unemployment level.

The Myth of Full Employment

True full employment, defined as zero unemployment, is unattainable and undesirable because it implies a rigid labor market where workers cannot freely change jobs. The natural unemployment rate reflects the equilibrium where job seekers and available positions balance at prevailing wages.

Institutional factors like minimum wage laws and unionization can influence the natural unemployment rate by affecting labor market flexibility.

Minimum Wage Updates

As of January 1, 2025, twenty-one U.S. states have increased their minimum wages, including Alaska, California, New York, and Washington, among others.

Inflation’s Impact on Unemployment

John Maynard Keynes' 1936 work suggested a link between unemployment and inflation, later formalized by the Phillips curve, which posited an inverse relationship between the two.

However, the 1970s stagflation challenged this view, showing that inflation and unemployment can rise simultaneously, complicating the inflation-unemployment dynamic.

Natural vs. Cyclical Unemployment

Cyclical unemployment measures the difference between the current unemployment rate and the natural rate, reflecting economic fluctuations.

Why the Natural Unemployment Rate Matters

The natural unemployment rate indicates the lowest sustainable unemployment level without triggering inflation, serving as a benchmark for economic health.

Effect of Economic Recovery on Natural Unemployment

After recessions, the natural unemployment rate may increase as workers feel more confident transitioning between jobs during economic recovery phases.

Conclusion

The natural unemployment rate is the baseline level of unemployment caused by real economic forces and labor market structure. It is an unavoidable aspect of a functioning economy, making zero unemployment unattainable. Understanding this rate helps distinguish between normal labor market turnover and unemployment caused by economic downturns or policy changes.

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