Challenges to the Natural Rate Framework

By most estimates, the U.S. unemployment rate is currently below its “natural rate.” The implication is the economy is operating at an unsustainably high level of resource utilization. Capacity levels are being strained, tending to put upward pressure on wages and prices. In anticipation of these rising inflationary pressures, the Federal Reserve has firmed monetary policy several times over the past year. In recent research, I have examined the natural rate framework in detail, presenting new estimates of the natural rate of unemployment and discussing monetary policy implications (Weiner 1993, 1994). I believe it is fair to say that a majority of mainstream macroeconomists are comfortable with the natural rate framework, in part because it has tracked inflation successfully over the past 35 years. All four inflationary episodes since the early 1960s have been marked by the actual unemployment rate falling below the natural unemployment rate. Moreover, there have been no false signals. Not once has the actual unemployment rate fallen below the natural rate without inflation eventually accelerating. Despite its excellent record in tracking inflation turning points, the natural rate framework has not been without critics. In the past year, nonbelievers have advanced a number of arguments for why mounting inflationary pressures should not be a concern at this time. It is useful, therefore, to consider these arguments and offer some counterarguments.