Principles of Macroeconomics / Unit 5 MAC 0420 worked example, 60 to 90 seconds
Reading the Rate Against the Natural Rate
The idea
Comparing the actual unemployment rate with the natural rate tells you where output sits relative to potential, and the relation runs in the opposite direction. If the actual rate is above the natural rate, there is cyclical unemployment and real GDP is below potential. If the actual rate is below the natural rate, the economy is working beyond its sustainable level and real GDP is above potential. If the two are equal, there is no cyclical unemployment and output is at potential. Subtract the natural rate from the actual rate: a positive answer means a recessionary gap.
In practice
Worked example: the natural rate is estimated at four and a half percent. An actual rate of seven percent leaves two and a half points of cyclical unemployment, so output is below potential. An actual rate of three and a half percent is a point below the natural rate, so output is above potential and cannot stay there. An actual rate of four and a half percent means output is at potential.
Where people slip
The natural rate is an estimate, not an observation. It is inferred from the behavior of wages and prices and is revised afterwards, so a gap of half a point is inside the margin of error and should not be read as a finding.
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