vol. 63, no. 1 (July), 1997, pp. 339-340
The Natural Rate of Unemployment: Reflections on 25 Years of he Hypothsis
edited by Rod Cross
Cambridge: Cambridge University Press, 1995, Pp. xiv, 382
Twenty-five economists, guided by Rod Cross of the International Centre of Macroeconomic Modelling, University of Strathclyde (Glasgow), reflect on the development of both theory and evidence concerning the so-called natural rate of unemployment. In Part 1, "The theoretical framework," Edmund Phelps provides a helpful background report together with thoughtful reminiscences about this "slice [of reality] that, despite so many years, has gone on yielding rich insights into the determination of unemployment" [p. 29]. The book would have been further enriched by a complementary retrospective by Milton Friedman, who named this enduring concept in acknowledgment of its kinship to Knut Wicksell's natural rate of interest and whose seminal definition of the natural rate ("the level [of unemployment] that would be ground out by the Walrasian system of general equilibrium equations...") is quoted in full no fewer than a half-dozen times. The other three contributors to Part 1 (James Tobin, Frank Hahn, and Huw Dixon) are decidedly unsympathetic to Friedman and Phelp's fundamentally classical slice of reality.
In addition to editing the book and supplying the introductory chapter, Rod Cross asks, "Is the natural rate hypothesis consistent with hysteresis?" His answer: "No." Hysteresis, a termed coined by nineteenth-century physicist James Ewing in the context of electromagnetism, derives from systemic non-linearities and path dependencies. With hysteretic forces in play, an allegedly natural rate of unemployment can be permanently changed by two consecutive shocks equal in magnitude but opposite in direction. Reflecting the editor's continuing interest [1], the entry for hysteresis in the book's index contains 14 sub-entries with a total of 29 references to material appearing on 59 pages together with cross references to "adjustment; memory; persistence; [and] remanence." Four other chapters, provided by eight contributors, make up this 126-page Part II, "Adjustment, ranges of equilibria and hysteresis."
Part III, "Empirical tests and macro models," consists of four contributions, including David Peel and Alan Speight's "Non-linear dependence in unemployment, output and inflation: empirical evidence for the UK." These two empiricists pit the natural-rate hypothesis (real effects of nominal shocks are limited to the short run) against the hysteresis hypothesis (nominal shocks can have permanent real effects). True to the book's theme, the hypothesis that implicitly assumes away the non-linearities comes up short.
Part IV, "Political Economy," offers a blend of theory and policy. In these final chapters, non-linearities and path dependencies give way to Keynesian fundamentalism as a basis for denying the validity of the separation. Meghnad Desai [p. 350] adopts from the General Theory a (real) aggregate supply function which includes among its arguments the (nominal) supply of money. It follows, then (trivially and by construction) that an economy described with the aid of this supply function cannot be characterized as having a natural rate of unemployment�and that such an economy can experience permanent real effects from monetary stimulation. Without claiming the effects are actually permanent, Barry Corry [p. 370] sees "quite a strong case for the efficacy of macro intervention strategies." "[Despite the Friedman-Phelps model], it could still be argued that government-inspired increases in the demand for output would lower unemployment in the short run at the cost of increased inflation, and society might well decide that this cost is well worth paying." Finally, writing about a monetarily united Europe, Maria Demertzis and Andrew Hughes Hallett [p. 342] reach the general conclusion that "a laissez-faire approach of relying on wage-price flexibility to resolve any difference [among European countries] can be expected to be both ineffective and damaging to EU's overall performance."
The general thrust of this collection of reflections-cum-ambush is captured in Paul Samuelson's imagery, as quoted by Dixon [p. 58]: "Mine was the great advantage of having been a jackass.... I was a classical monetary theorist...between the ages of 17 and 22...." With Phelps the principal exception, the contributors to this volume seem to regard all natural-rate theorists as jackasses; their message to them is the one appropriate for most 17-22 year olds: Grow up!�which in the present context means: Let the jackass morph in the direction of the elephant. Though without the clinching reference to Samuelson or Dixon, Cross [p. 190] explains: "[T]he equilibrium rate of unemployment retains a selective memory of past shocks: it neither forgets all past shocks, as in the natural rate hypothesis; nor does it, like the elephant, remember all past shocks. The selective memory property is such that...the last major expansionary and contractionary shocks will continue to affect the present equilibrium..." [emphasis deleted]�and, it can be added, will continue to justify further expansions and/or contractions. The jackass is a laissez-fairist; the elephant an interventionist. This Cross-bred macro menagerie will amuse the American reader, who is sure to be reminded of our political-party mascots. The jackass and elephant of the Democratic and Republican parties have undergone dramatic role reversals!
Despite its idiosyncratic focus and lack of balance, this volume contains much thought-provoking material and, without so intending, offers evidence that the parallels between Wicksell's natural rate of interest and Friedman's natural rate of unemployment may be even stronger and farther-reaching than is commonly recognized. The heterogeneity of labor and of capital create conceptual and empirical problems in measuring both of these abstractly defined inputs. The status of the two natural rates as unobserveables creates corresponding empirical difficulties in gauging divergences between actual and natural rates. And the possibility of multiple equilibria in the market for labor parallels the possibility of multiple rates of interest that fueled the infamous Cambridge capital controversy. Parallelism, that is, characterizes the separate critiques of the two theories as well as the theories themselves.
Frank Hahn [p. 54] remarks that "One can only be amazed at the neglect of investment and of the capital stock in theories of the natural rate." The other (Wicksellian) natural rate is mentioned rarely and only in passing throughout the volume. But given the nature of the criticism of Friedman-Phelps, the reader is left to wonder if a composite theory might enhance the plausibility of both natural rates and yield even richer insights into the determination of the employment of labor and the utilization of capital.
1. Rod Cross, ed., Unemployment, Hysteresis and the Natural Rate Hypothesis. Oxford: Blackwell, 1988.