What is the natural rate hypothesis regarding unemployment and inflation?

• A. In the long run, unemployment gravitates toward its natural rate; only unexpected inflation affects real variables in the short run.
• B. Inflation determines the natural rate of unemployment in the long run.
• C. The natural rate of unemployment is always zero in a modern economy.
• D. The natural rate is unaffected by expectations or monetary policy in any way.

Answer: (A)

The natural rate hypothesis says that the unemployment rate in the long run moves toward a natural level determined by structural factors in the labor market (like matching, skills, and institutions). In the short run, inflation can affect real variables only if the inflation outcome is a surprise. If actual inflation is higher or lower than what people expected, real wages and hiring can be affected temporarily, but once expectations adjust, unemployment returns to its natural rate. This is why the long-run relationship between inflation and unemployment is flat—the long-run unemployment is the natural rate, and only unanticipated inflation can create a temporary deviation.

That’s why this choice is best: it correctly states that unemployment gravitates toward its natural rate over the long run, and that only unexpected inflation can influence real variables in the short run. The other statements misstate the relationship by claiming inflation sets the natural rate, or that the natural rate is always zero, or that expectations and monetary policy have no effect at all.