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Having an unemployment rate below the natural rate of unemployment (NRU) leads to wage inflation and a reduction in productivity. Seeing the consequences of that, and knowing that one of the roles of a central bank is to control unemployment and inflation, central banks must accurately determine what the unemployment is currently at and see whether it is above or below the NRU.

I ask this because after looking at the Bureau of Labor Statistics' data on U-3 and U-6 (seasonally-adjusted) between the years 2010 and 2020, the lowest U-3 got was 3.5% in 2019Q4, whereas U-6 was 6.5%. However, the NRU in 2019Q4 4.45%

So, what measurement is used by central banks and what would be the best way to measure unemployment so that it can best be compared to the NRU?

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The phrase “natural rate of unemployment” has been largely replaced by NAIRU or similar concepts. Each country has its own definition of the unemployment rate, the U.S. “headline” measure is U-3.

Nobody has created an estimate for NAIRU that is based on a function of other variables, instead it is estimated based on the behaviour of the economy and the chosen unemployment rate measure. This implies that a NAIRU estimate is defined relative to the unemployment rate used in the estimation procedure. In the United States, most researchers would run their estimation versus U-3, but one might need to validate this.

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  • $\begingroup$ On the wikipedia, it says that estimates for the NAIRU in the U.S. to be around 4-6%. If comparisons are usually done with U-3, what, if anything, did the Federal Reserve do to keep unemployment at the NAIRU? $\endgroup$ – MrMineHeads Jul 31 '20 at 1:59
  • $\begingroup$ If one follows actual Fed deliberations, there is massive uncertainty about the level of NAIRU. As for what the Fed does, they have a policy announcement every six weeks describing their policy actions. Historically, they raised or lowered the target for the Fed Funds rate, in 2020, what they are doing changes at a rapid pace. $\endgroup$ – Brian Romanchuk Jul 31 '20 at 2:05
  • $\begingroup$ I would note that many people - including myself - argue that the NAIRU (or equivalent) do not exist. This is consistent with the extremely poor track record of NAIRU-based policy analysis since the 1990s. $\endgroup$ – Brian Romanchuk Jul 31 '20 at 2:07
  • $\begingroup$ Oh, why would that be? Any resources where I can read more about that? I am trying to get into some basic macroeconomic theory. $\endgroup$ – MrMineHeads Jul 31 '20 at 2:08
  • $\begingroup$ The text “Full Employment Abandoned” by William (Bill) Mitchell and Joan Muysken has a long explanation of the evolution and flaws of the natural rate of unemployment belief. It’s an academic text, and not cheap. Bill Mitchell has a blog where he probably covers most of the material in smaller chunks. $\endgroup$ – Brian Romanchuk Jul 31 '20 at 2:14

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