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What are the main differences between the 'natural rate of unemployment' and the 'NAIRU' hypotheses?

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Introduction

Unemployment Short Questions (250 words max) 1. What are the main differences between the 'natural rate of unemployment' and the 'NAIRU' hypotheses? The main differences between the two concepts relate to the fact that they belong to different models; the Friedman's or the Neo-Classical model (the natural rate of unemployment) and the imperfect competition model developed by New Keynesian economists (NAIRU). The existence of the differences between the NAIRU and the natural rate of unemployment, hence, depends on the theoretical perspective. For the Monetarist and Neo-Classical economists, the two concepts are identical because the economy is always at full employment. From the New Keynesian perspective, however, the equilibrium can settle at a level below the full employment; thus making the natural rate of unemployment a special case of NAIRU that occurs at full employment. In both models, there is a point, at which the level of inflation is constant, that is it is possible to draw a vertical long run Philips curve in each model. The natural rate is the point of labour market clearing, where there is no voluntary unemployment and any temporary disequilibrium is quickly eliminated. The NAIRU, on the other hand, is the rate of unemployment at which the competing claims of labour and firms in the economy are consistent. With NAIRU, the notion of market power and the effect of unemployment on the latter are significant. ...read more.

Middle

Hysteresis is often referred to in discussions of European unemployment in the 1970s, when rising oil prices and other unfavourable factors increased the natural unemployment rate, which led to high actual unemployment rate. When the European countries returned to the long-run equilibrium with full employment, the actual unemployment was the new higher natural rate. Essay question Explain the fact that European countries have relatively higher unemployment rates than other OECD countries. Do these higher unemployment rates reflect constraints on labor market flexibility or have they emerged because Europe has been exposed to more shocks than some other OECD countries? Let us begin with the consideration of the dynamics of the European unemployment. Against the background of some fluctuations of until recently low unemployment in the US and Japan, the aggregate unemployment rate of the European economies has increased almost continuously since the 1970s. The European unemployment rate has indeed risen from 2.6% in 1970 to approximately 11% in 1996, with peaks in the 1970s, the early 1980s and the mid 1990s, which represents a clearly marked increase in unemployment. However, it should be noted that the unemployment rates are not homogeneous across the European economies: Spain is an 'unemployment disaster' reaching the unemployment of 20% and the Netherlands is an 'employment miracle' with unemployment of around 5%. Still, on average, the unemployment figures are much higher in Europe than in other OECDs, including the US. ...read more.

Conclusion

High interest rates that reached 17% in 1980 in the UK, which contributed to severe recession in the UK manufacturing sector, with the loss of 23% of manufacturing jobs. The NAIRU starts from a position of imperfectly competitive markets (product and labour markets with many agents in the economy `price makers' rather than 'price takers': the NAIRU can be affected by similar factors that shift the NRU but by other factors as well, such as import prices of oil. The high interest rates that reached 17% in 1980 in the UK, which contributed to severe recession in the UK manufacturing sector, with the loss of 23% of manufacturing jobs. Hysteresis is often referred to in discussions of European unemployment in the 1970s, when rising oil prices and other unfavourable factors increased the natural unemployment rate, which led to high actual unemployment rate. When the European countries returned to the long-run equilibrium with full employment, the actual unemployment was the new higher natural rate. Europe has experienced a sequence of adverse shocks since the early 1970s in the form of oil price rises, the productivity slowdown and the rapid increases in tax rate, each of which had a permanent effect on the unemployment rate, as a result the equilibrium unemployment rate increased substantially. Overall, it seems that both the labour market rigidities, a number of shocks and factors peculiar to the European economies are responsible for the high levels of unemployment in certain countries. European economies vary quite significantly making it is difficult to generalise. ...read more.

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