Principles of Macroeconomics / Unit 10 MAC 0911 worked example, 60 to 90 seconds
Reading a Natural Rate from Data
The idea
Given paired inflation and unemployment figures over several periods, find the natural rate. The method follows from the vertical curve: if unemployment always returns to one value while inflation takes many values, that recurring value is the natural rate. Look for the rate the data keeps coming back to, not the average and not the lowest.
In practice
Take six periods for a course-built economy. Unemployment runs 5.4, 4.1, 5.4, 6.8, 5.4 and 4.3 percent. Inflation over the same periods runs 2.0, 4.5, 5.0, 3.2, 7.5 and 9.0 percent. Unemployment returns to 5.4 three times, and at those three moments inflation is 2.0, 5.0 and 7.5 percent, which are far apart. One unemployment rate is consistent with three very different inflation rates, so the natural rate is 5.4 percent. The periods at 4.1 and 4.3 are below it and the period at 6.8 is above it, and none of those lasted.
Where people slip
The average of the six unemployment figures is about 5.2 percent, close enough to 5.4 to be mistaken for it, and that closeness is a coincidence of this table rather than a method. Averaging fails whenever the periods below and above potential are unevenly spread. Take the recurring value.
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