Watch for the US Natural Unemployment Rate to Rise

The concept of a "natural unemployment rate" follows from looking at unemployment as a search process. According to this theory, people search for a new job so long as the expected benefits of additional search exceed the expected costs of additional search. Once the expected costs of additional job search exceed the expected benefits, people stop searching and take the best offer they have found (and that is still available) to that point.

 If people's expectations are in line with reality (on average), then each person's optimal amount of job search gives rise to "the natural unemployment rate" for the economy as a whole. If the expected costs of additional search fall, or if the expected benefits of additional job search rise, then people will tend (again, on average) to search longer (i.e. remain unemployed longer). And that is exactly what happens when unemployment compensation benefits are raised.

Unemployment compensation benefits can be raised in several ways:

1. The amount of time before being laid-off that one must work to qualify for receiving benefits can be shortened.
2. The size of the benefits per week can be increased. And/or
3. The number of weeks an unemployed person receives compensation can be increased.

In Canada, one reason the natural unemployment rate seems to have declined from its peak in the 1980s is that EI ("employment insurance", the current euphemism for unemployment benefits) has become less lucrative and other policies have also been altered with the result of somewhat lowering the height of the social safety net. One result has been that people search less and for shorter periods of time when they are unemployed, thus lowering the unemployment rate.

Now it looks as if the US will be moving in the opposite direction, increasing the height of the social safety net with the result that there will be more job search. From the NYTimes,

President-elect Barack Obama and Congressional Democrats are considering major expansions of government-assisted health care insurance and unemployment compensation as they begin intensive work this week on a two-year economic recovery package.

One proposal, as described by Democratic advisers, would extend unemployment compensation to part-time workers, an idea that Congressional Republicans have blocked in the past.

Other policy changes would subsidize employers’ expenses for temporarily continuing health insurance coverage to laid-off and retired workers and their dependents, as mandated under a 22-year-old federal law known as Cobra, and allow workers who lose jobs that did not come with insurance benefits to be eligible, for the first time, to apply for Medicaid coverage.

Many of these policy proposals, designed to help people who lose their jobs and who are searching for new jobs, help to raise the height of the social safety net. But in the process they will also induce some/many job seekers to search longer, thus raising the natural unemployment rate. As this happens, let us hope that policy makers accept the result and don't try to increase aggregate demand even more a year or two from now. Otherwise, fasten your seatbelts as the US goes for a huge ride on a major inflationary roller coaster two and three years from now.

Comments

[Gabriel]

The thing is, both too long and too short searches are not OK from a welfare point of view... I know of little literature on the optimal search duration, from an efficiency point of view, though.

[KipEsquire]

Unemployment compensation benefits can be raised in several ways...

Note, meanwhile, that the debates in the U.S. over extending benefits are increasingly focused, not on the "automatic stabilizer" paleo-Keynesian argument, but instead on neo-liberal notions of "humaneness."

If you subsidize something, you get more of it. So yes I too think the natural rate of unemployment in the U.S. will undoubtedly rise.

[Ironman]

It would appear that the natural rate of unemployment in the U.S. has already risen. Using King's math ( http://tinyurl.com/7nxa62 ) with data through October 2008 (the most recent for which the JOLTS data is available), I would estimate that the natural rate to be 6.76%. Using the default data for the tool for June 2007, the natural rate of unemployment then was 4.31%.

And yes, it would seem I have a bug to fix. At least the numeric portion of the tool is still working!...