In Discussion Paper No. 1507, Marika Karanassou and Dennis Snower make a distinction between two popular concepts of the natural rate of unemployment: (1) the stable, long-run equilibrium rate of unemployment; and (2) the equilibrium unemployment rate at which, given the exogenous variables, there is no tendency for this rate to change. Derivation of reliable estimates of the first definition of the natural rate is a virtual impossibility. This leads the authors to ask whether the second concept is a useful one, i.e. whether the natural rate is a practical reference point.

Karanassou and Snower’s choice of model structure is made with a view to encapsulating popular features of labour markets. Their analysis shows that, when using multi-equation labour-market models containing lagged endogenous variables, as well as exogenous variables with non-zero growth rates, the natural rate is not a reference point. The results derived therefore cast doubt on the usefulness of the natural-rate hypothesis, at least in terms of its predictive power.

Is the Natural Rate a Reference Point?
Marika Karanassou and Dennis J Snower