Introduction

The natural rate hypothesis (NRH) was introduced by Phelps (1967) and by Milton Friedman in his 1967 Presidential Address to the American Economic Association (1968). Friedman's version of the hypothesis is based on the Wicksellian concept of the ‘natural’ rate, and broadly speaking postulates that it is impossible to permanently reduce (increase) the realised or the ‘market’ rate of unemployment below (or above) its ‘natural’ level. The natural rate of unemployment, which plays a central role in the formulation of the natural rate hypothesis, is denned by Friedman (1968, p. 8) to be

According to this definition the natural rate of unemployment is not a constant or an immutable rate, but is determined by a host of market and non-market factors. It is influenced by government policy towards legal minimum wage rates, costs of searching for new employments, labour mobility, technological innovations and many other factors that have direct bearings on the workings of the labour and capital markets. Friedman's primary reason for introducing this concept, as with Wicksell before him, was an attempt to ‘separate the real forces from the monetary forces’ that impinge on the market rate of unemployment.