What best describes the natural rate of unemployment, and which factors can shift it?

• A. They only affect monetary policy, not fiscal.
• B. The rate that occurs during a recession; shifting factors include government deficits.
• C. The rate when actual output equals potential output; shifting factors include wage rigidity, job search frictions, skill mismatches, and demographics.
• D. The rate determined by cyclical unemployment only; shifting factors include interest rates.

Answer: (C)

The natural rate of unemployment is the level of unemployment that exists when the economy is producing at its potential output and inflation is stable; it reflects the normal frictions in the labor market, not the ups and downs of the business cycle. It can move over time as structural conditions change. Factors that can shift it include wage rigidity (sticky wages that slow down reemployment), job search frictions (how long it takes to match workers with openings), skill mismatches (workers’ skills not aligning with available jobs), and demographics (age structure and education of the workforce). These elements alter how easily people find and keep jobs, shifting the natural rate up or down. This differs from cyclical unemployment, which varies with the business cycle, and from monetary or fiscal policy effects, which influence the level of overall unemployment but not the underlying natural rate itself.