The Rise of the Natural-Rate of Unemployment Model

This essay examines Milton Friedman influence as a political economist, focusing attention on his successful prediction that inflation would be associated with increasing rates of unemployment. As a consequence of this predictive success, it became widely accepted that policy-induced unemployment would produce long term benefits as unemployment gravitated back towards its Natural-Rate (a magnitude influenced by frictional and structural factors) at a lower level of inflation. This article presents an alternative view of this policy-revolution by suggesting that the magnetic pull of the Natural-Rate of unemployment is not required to explain the stagflation which ended the Old Keynesian era. As inflation was increasing in the 1960s, several economists argued that rates of unemployment were also increasing. These perceptions were clearly at variance with the prevailing trade-off interpretation of the Phillips curve, which suggested that the rise in inflation would be accompanied by a reduction in rates of unemployment. This article, therefore, attempts to describe the largely forgotten, dissenting pre-history of Friedman’s successful assault on the trade-off orthodoxy of the 1960s. These dissenting perceptions were mostly based on factors other than expectational considerations. They consisted of insights based on observations of labour market behaviour. In contrast, Friedman’s insight was couched in macroeconomic terms, with strong microeconomic foundations. This episode may shed some light on the nature of influence in the economics profession in the 1960s. It may abo serve to question the validity of the Natural-Rate Expectations Augmented Phillips (N-RFAP) curve model.