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Monetarism: Natural rate of unemployment

Summary

Monetarism became popular amongst, famously, US and UK politicians in the 1980s, coinciding with a period of severe stagflation, and is, to this day, a controversial school of Economics, paradoxically known because of its affinity to various legislatures despite being a firm advocate of the separation between politics and economics.

Monetarism:

New expectations:

The term natural rate of unemployment was introduced by Milton Friedman in 1968, in his article “The Role of Monetary Policy”, following his presidential address delivered at the annual meeting of the American Economic Association, in 1967. It is based in Knut Wicksell’ concept of “natural” rate, which defines how there will be no permanent changes in the considered variable below or above its natural level.

The natural rate of unemployment defines the level at which unemployment will remain, no matter how great the effects of monetary policy. The only way to permanently keep unemployment under its natural rate is to resort to higher and higher inflation rates, which in turn would be highly hazardous for the economy. This can be easily understood using an expectations-augmented Phillips curve.

Even though the natural rate of unemployment is usually merged in the economic literature with the term NAIRU, there are a few differences between both terms. These differences are summarized in the following grid:

	Natural rate of unemployment (NRU)	NAIRU
Theoretical starting point	perfect competition	imperfect competition
Origins of deviation	solely in labour market rigidities	in labour market rigidities; supply-side inflation
Inflationist mechanism	monetary policies	monetary policies; supply-side inflation
Type of unemployment	voluntary (therefore NRU can be assimilated to level of full employment)	voluntary; involuntary
Uniqueness of equilibrium	unique	multiple equilibria when considering open economies

To sum up, monetarism meant a huge change on how economic policies were seen. It took back some of the premises from neoclassical economics and used them to demonstrate that economic policies are to be undertaken carefully, since their consequences can be of paramount importance.

Monetarism: Expectations-augmented Phillips curve