vol. 63, no. 1 (July), 1997, pp.
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
, 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
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.
Roger W. Garrison
1. Rod Cross, ed., Unemployment, Hysteresis and the Natural
Rate Hypothesis. Oxford: Blackwell, 1988.