1. Has the U.S. economy achieved full employment equilibrium yet? Explain
how we define ‘full employment’ and how you can tell whether that goal has been
achieved. Use appropriate data to support your answer. Be sure to cite the sources of
your data in your essay.
– Use the Federal Reserve Bank of St. Louis estimate of the Natural Rate of Unemployment (short-term) at http://research.stlouisfed.org/fred2/series/NROUST.
Drag your cursor across the graph to find the estimate of the natural rate of unemployment for the fourth quarter of 2018 (2018 Q4). (The graph shows estimates
of the natural rate from 1950 to 2027).
– Use the Bureau of Labor Statistics website (bls.gov) to find the most recent estimate of the Actual Unemployment Rate.
2. Read the Introduction (pages 3 to 5) of the article “A Search and Matching Approach
to Labor Markets: Did the Natural Rate of Unemployment Rise?” by Mary C. Daly, B.
Hobijn, A. Sahin, and R. G. Vallet (see below). How does this article explain the
pattern in the Natural Rate of Unemployment graph from 2007 to 2012?
wa_2_natural_rate.pdf

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The Natural Rate of Unemployment
Due in NetTutor via the link in Blackboard learn.wsu.edu Sunday, February, 17,
by 11:50 pm (PST)
1. Has the U.S. economy achieved full employment equilibrium yet? Explain
how we define ‘full employment’ and how you can tell whether that goal has been
achieved. Use appropriate data to support your answer. Be sure to cite the sources of
your data in your essay.
– Use the Federal Reserve Bank of St. Louis estimate of the Natural Rate of Unemployment (short-term) at http://research.stlouisfed.org/fred2/series/NROUST.
Drag your cursor across the graph to find the estimate of the natural rate of unemployment for the fourth quarter of 2018 (2018 Q4). (The graph shows estimates
of the natural rate from 1950 to 2027).
– Use the Bureau of Labor Statistics website (bls.gov) to find the most recent estimate of the Actual Unemployment Rate.
2. Read the Introduction (pages 3 to 5) of the article “A Search and Matching Approach
to Labor Markets: Did the Natural Rate of Unemployment Rise?” by Mary C. Daly, B.
Hobijn, A. Sahin, and R. G. Vallet (see below). How does this article explain the
pattern in the Natural Rate of Unemployment graph from 2007 to 2012?
Grading Rubric
Please include your name, instructor’s name (Dr. Prera), course and section number
(EconS 102) and writing assignment (Assignment 2) on the top of your assignment. The
table on the next page shows the criteria your essay will be judged against. I expect four to
seven paragraphs, double-spaced.
Your essay will be assessed as either ‘Meets expectations’ or ‘Needs improvement’ on each of
the criteria in the table below. If your essay needs improvement, you will be given feedback
from NetTutor to help you revise it. You have one week from the time you receive
your feedback to revise and re-submit the essay to NetTutor for another try but you only get one second chance. You’ll need to accumulate three acceptable writing
assignments to fulfill the writing portion of the course requirements.
1
Criteria
Meets Expectations
Ideas are well-organized. Transition sentences effectively connect
one idea to the next.
The essay is free of typos and grammatical errors.
Writing
Application
of
economic
analysis
Analysis
data
of
The definition of the term full employment is thorough and correct.
Draws the correct conclusion from
her comparison of the actual and
natural rates of unemployment.
Discusses the reasons for the
changes in the natural rate of unemployment from 2007 to 2012 completely and correctly.
Accurately reports the natural rate
of unemployment and the actual
rate of unemployment and cites the
source for both.
2
Needs Improvement
The writing is difficult to follow
and/ or poorly organized.
Transition sentences are absent or
ineffective.
Typos and/ or grammatical errors
distract the reader.
The definition of the term full employment is vague, incomplete, or
incorrect.
Draws the wrong conclusion from
her comparison of the actual and
natural rates of unemployment.
Fails to identify the reasons for the
changes in the natural rate of unemployment from 2007 to 2012, or
does so incompletely or incorrectly.
Inaccurately report the natural
rate of unemployment and/or the
actual rate of unemployment, or
does not cite the source of the data.
Journal of Economic Perspectives—Volume 26, Number 3—Summer 2012—Pages 3–26
A Search and Matching Approach to
Labor Markets: Did the Natural Rate of
Unemployment Rise?
Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and
Robert G. Valletta
T
he increase in the U.S. unemployment rate associated with the 2007–2009
recession is unprecedented during the post–World War II era. The unemployment rate rose by 5.6 percentage points from a low of 4.4 percent in late
2006 and early 2007 to 10.0 percent in October 2009; this exceeds the net increase of
5.2 percentage points between mid-1979 and late 1982 (which spans two recessionary
episodes). Moreover, in contrast to relatively rapid labor market recoveries following
prior, deeper, post–World War II recessions, two and a half years into this recovery,
as of early 2012, the unemployment rate had declined by only about 1.7 percentage
points. Such persistently anemic labor market conditions are partly a reflection of the
sluggish overall economic recovery, a common occurrence following financial crises
(Reinhart and Rogoff 2009; Jordà, Schularick, and Taylor 2011). The lackluster pace
of job creation has barely kept up with trend labor force growth and therefore has
not generated enough jobs to make a significant dent in the unemployment rate or
substantially reduce unemployment duration. Moreover, as we will discuss in more
detail later, the unemployment rate has remained high relative to its historical relationship with other business cycle indicators, such as job vacancy rates.
The disconnect between the unemployment rate and other indicators of aggregate economic conditions has raised the concern that rather than being purely
cyclical, U.S. unemployment now contains a substantial structural component that
will persist even after the U.S. economy has fully recovered from the recession. In
Mary C. Daly is Associate Director of Research and Group Vice President, Bart Hobijn is
Senior Research Adviser, and Robert G. Valletta is Research Adviser, all at the Federal Reserve
Bank of San Francisco, San Francisco, California. Ayşegül Şahin is Assistant Vice President,
Federal Reserve Bank of New York, New York City, New York. Daly is the corresponding
author at 〈mary.daly@sf.frb.org 〉.

http://dx.doi.org/10.1257/jep.26.3.3.
doi=10.1257/jep.26.3.3
4
Journal of Economic Perspectives
turn, this concern implies that the full employment or “natural” rate of unemployment is now higher than it was before the recession. The distinction is crucial from
a policy perspective, because in general, short-run monetary and fiscal stabilization policies are designed to address a cyclical shortfall in labor demand rather
than structural factors in the labor market; such structural factors may include a
mismatch between workers’ skills or geographic locations and employers’ labor
needs, or the effects of changes in the generosity of social welfare programs.
However, understanding how much of the sustained high level of unemployment is
cyclical or structural is a challenging task, a point emphasized by Diamond (2011)
in his recent Nobel Prize Lecture and illustrated by the wide span of views on the
topic held by economists and policymakers.
In this paper, we use a search and matching framework to assess the degree to
which the natural rate of unemployment has changed and the reasons underlying
any changes. In the first section, we discuss the implications of a standard textbook
model of frictional unemployment based on a search and matching framework
(Pissarides 2000, chap. 1). This model specifies two curves—the Beveridge curve
and the job creation curve—that capture labor supply and labor demand factors, as
reflected in the unemployment and job vacancy rates, and that interact to determine
equilibrium frictional unemployment. Using this framework, we estimate that the
natural rate of unemployment has increased over the recession and recovery, but by
far less than unemployment has risen. Our preferred estimate indicates an increase
in the natural rate of unemployment of about one percentage point during the
recession and its immediate aftermath, putting the current natural rate at around
6 percent. Importantly, even at the maximum of our range of plausible estimates,
we find the natural rate increased by only about one and a half percentage points,
which would boost the current natural rate to about 6.6 percent. For context, the
highest natural rate in the last few decades as estimated by the Congressional Budget
Office (2011) was 6.3 percent in 1978.
In the second part of the analysis, we focus on the three primary factors that
economists have offered that may account for an increase in the natural rate of
unemployment: 1) a mismatch between the characteristics of job openings, such as
skill requirements or location, and the characteristics of the unemployed; 2) the
availability of extended unemployment insurance benefits, which may reduce the intensity
of job search or cause some recipients to claim they are looking for work, which is
a requirement for benefits receipt, when they have in fact effectively left the workforce; and 3) uncertainty about economic conditions,, which may have induced firms to
focus their efforts on raising productivity and output without extensive hiring of
new employees.1 We argue that the increase in mismatch has been quite limited. We
find a larger contribution arising from extended unemployment insurance benefits,
although this effect is likely to disappear when such benefits are allowed to expire.
1
More broadly, this evidence will draw upon our previous work on the labor market during the recession
and recovery: Daly and Hobijn (2010), Elsby, Hobijn, and Şahin (2010), Kwok, Daly, and Hobijn (2010),
Valletta and Kuang (2010a, b), as well as Wilson (2010).
Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta
5
Finally, we provide speculative evidence that the unusual degree of uncertainty may
be contributing to elevated unemployment through the resulting suppression of
hiring; again, this factor would be expected to ease as these uncertainties are resolved.
Overall, we conclude that although the natural rate of unemployment has risen
to a moderate degree over the last few years, substantial slack remains in the labor
market and is likely to persist for several years. Moreover, since most of the increase
in the natural rate appears to be transitory, we expect that as the cyclical recovery
in the labor market proceeds, the natural rate will fall back to a value close to its
pre-recession level of around 5 percent.
The Equilibrium Natural Rate of Unemployment in a Search Model
The equilibrium natural rate of unemployment is the average rate of unemployment that would prevail in the absence of business cycle fluctuations (Brauer
2007). Underlying the natural rate is frictional unemployment, which reflects
the normal time that the unemployed spend in job search, and structural unemployment, which reflects mismatches between employers’ labor demand and the
skills and geographic location of the unemployed; the two terms are often used
synonymously. The natural rate is conceptually similar but not identical to the nonaccelerating inflation rate of unemployment, or NAIRU, which defines equilibrium
unemployment as the rate at which price inflation is not changing.
The concept of a natural rate was originally introduced by Milton Friedman
(1968) and Edmond Phelps (1968) as a way to distinguish between cyclical swings
in unemployment that monetary policy can affect and structural changes that it
cannot. Under the standard neoclassical assumption of fully flexible prices for
factors of production and output, the natural rate is primarily determined by the
characteristics of workers and the efficiency of the labor market matching process.
These factors affect the rate at which jobs are simultaneously created and destroyed,
the rate of turnover in particular jobs, and how quickly unemployed workers are
matched with vacant positions. Given the severe shock to labor markets in the most
recent recession and the unusually vigorous expansion in a narrow set of housingrelated and financial sectors that preceded the downturn, it is reasonable to ask
whether some of these noncyclical factors have been altered in a way that increases
the natural rate of unemployment in either the short or the long term.
Frictional Unemployment in Equilibrium
To assess the factors affecting the unemployment rate in the short run as well as
its longer-run level, we rely on the model of equilibrium frictional unemployment
from Pissarides (2000, chap. 1). In this model, equilibrium unemployment is determined by the intersection of two curves: the Beveridge curve (BC), which depicts
a negative relationship between vacancies (job openings) and the unemployment
rate, and the job creation curve (JCC), which reflects employers’ decisions to
create job openings and can loosely be interpreted as an aggregate labor demand

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