Milton Friedman Prize Lecture

M. Friedman

273

of unemployment” (U

N

 

), which is consistent with the real forces and with

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accurate perceptions; unemployment can be kept below that level only by an

accelerating inflation; or above it, only by accelerating deflation.

The “natural rate of unemployment”, a term I introduced to parallel Knut

Wicksell’s “natural rate of interest”, is not a numerical constant but depends

on “real” as opposed to monetary factors - the effectiveness of the labor market,

the extent of competition or monopoly, the barriers or encouragements to

working in various occupations, and so on.

For example, the natural rate has clearly been rising in the United States

for two major reasons. First, women, teenagers, and part-time workers have

been constituting a growing fraction of the labor force. These groups are more

mobile in employment than other workers, entering and leaving the labor

market, shifting more frequently between jobs. As a result, they tend 

t o

experience higher average rates of unemployment. Second, unemployment

insurance and other forms of assistance to unemployed persons have been

made available to more categories of workers, and have become more generous

in 

duration and amount. Workers who lose their jobs are under less pressure to

look for other work, will tend to wait longer in the hope, generally fulfilled,

of being recalled to their former employment, and can be more selective in the

alternatives they consider. Further, the availability of unemployment insurance

makes it more attractive to enter the labor force in the first place, and so may

itself have stimulated the growth that has occurred in the labor force as a

percentage of the population and also its changing composition.

The determinants of the natural rate of unemployment deserve much fuller

analysis for both the United States and other countries. So also do the meaning

of the recorded unemployment figures and the relation between the recorded

figures and the natural rate. These issues are all of the utmost importance for

public policy. However, they are side issues for my present limited purpose.

The connection between the state of employment and the level of efficiency

or productivity of an economy is another topic that is of fundamental im-

portance for public policy but is a side issue for my present purpose. There

is a tendency to take it for granted that a high level of recorded unemployment

is evidence of inefficient use of resources and conversely. This view is seriousIy

in error. A low level of unemployment may be a sign of a forced-draft economy

that is using its resources inefficiently and is inducing workers to sacrifice

leisure for goods that they value less highly than the leisure under the mistaken

belief that their real wages will be higher than they prove to be. Or a low

natural rate of unemployment may reflect institutional arrangements that

inhibit change. A highly static rigid economy may have a fixed place for every-

one whereas a dynamic, highly progressive economy, which offers ever-

changing opportunities and fosters flexibility, may have a high natural rate

of unemployment. To illustrate how the same rate may correspond to very

different conditions: both Japan and the United Kingdom had low average

rates of unemployment from, say, 1950 to 1970, but Japan experienced rapid

growth, the U.K., stagnation.

The “natural-rate” or “accelerationist” or “expectations-adjusted Phillips

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Economic Sciences 1976

curve” hypothesis - as it has been  variously designated - is by now widely

accepted by economists, though by no means universally. A few still cling to

the original Phillips curve; more recognize the difference between short-run

and long-run curves but regard even the long-run curve as negatively sloped,

though more steeply so than the short-run curves; some substitute a stable

relation between the acceleration of inflation and unemployment for a stable

relation between inflation and unemployment - aware of but not concerned

about the possibility that the same logic that drove them to a second derivative

will drive them to ever higher derivatives.

Much current economic research is devoted to exploring various aspects of

this second stage - the dynamics  of the process, the formation of expectations,

and the kind of systematic policy, if any, that can have a predictable effect

on real magnitudes. We can expect rapid progress on these issues, (Special

mention should be made of the work on “rational expectations”, especially

the seminal contributions of John Muth, Robert Lucas, and Thomas Sargent.)

[Gordon (9).]

4. STAGE 3: A POSITIVELY SLOPED PHILLIPS CURVE?

Although the second stage is far from having been fully explored, let alone

fully absorbed into the economic literature, the course of events is already

producing a move to a third stage. In recent years, higher inflation has often

been accompanied by higher not lower unemployment, especially for periods of

several years in length. A simple statistical Phillips curve for such periods

seems to be positively sloped, not vertical. The third stage is directed at ac-

commodating this apparent empirical phenomenon. To do so, I suspect that

it will have to include in the analysis the interdependence of economic ex-

perience and political developments. It will have to treat at least some political

phenomena not as independent variables - as exogenous  variables in econ-

ometric jargon - but as themselves  determined by economic events - as

endogenous variables [Gordon (8)]. T he second stage was greatly influenced

by two major developments in economic theory of the past few decades - one,

the analysis of imperfect information and of the cost of acquiring information,

pioneered by George Stigler; the other, the role of human capital in determining

the form of labor contracts, pioneered by Gary Becker. The third stage will,

I believe, be greatly influenced by a third major development - the application

of economic analysis to political behavior, a field in which pioneering work

has also been done by Stigler and Becker as well as by Kenneth Arrow, Duncan

Black, Anthony Downs, James Buchanan, Gordon Tullock, and others.

The apparent positive relation between inflation and unemployment has

been a source of great concern to government policy makers. Let me quote

from a recent speech by Prime Minister Callaghan of Great Britain:

“We used to think that you could just spend your way out of a recession and

increase employment by cutting taxes and boosting Government spending.

I tell you, in all candour, that that option no longer exists, and that insofar as

it ever did exist, it only worked by injecting bigger doses of inflation into the

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