US Natural Rate Dynamics Reconsidered*

This chapter reconsiders several features of the U.S. natural rate of unemployment through specification and testing of econometric models. Traditionally, the choice has been between a wage Phillips curve model, PCM, or an equilibrium correction wage curve model, WECM. The models proposed in the chapter feature extended equilibrium correction which reduces the consequences for natural rate dynamics of choosing between wage models. In order for the difference between PCM and WECM to become important, the extended equilibrium correction mechanism must be ‘switched off’ by restrictions. These restrictions are rejected when tested. The analysis supports the view that natural rates are system dependent — rather than being derivatives of a single (wage) Phillips curve. The econometric model indicates a reduction of the natural rate in the course of the 1990s, due to low worker bargaining power and other structural changes. The estimated reduction is approximately 0.5–0.8 percentage points, which is less than existing results based on Phillips curve estimation.