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Natural rate hypothesis

1. Summary of natural rate hypothesis

Fifty years ago, Milton Friedman articulated the natural rate hypothesis. It was composed of two sub-hypotheses: First, the natural rate of unemployment is independent of monetary policy. Second, there is no long-run trade-off between the deviation of unemployment from the natural rate and inflation. Both propositions have been challenged. The paper reviews the arguments and the macro and micro evidence against each. It concludes that, in each case, the evidence is suggestive, but not conclusive. Policymakers should keep the natural rate hypothesis as their null hypothesis, but keep an open mind and put some weight on the alternatives.

On the basis of “natural unemployment rate”, Lucas proposed a theoretical view that there is a natural level of economic variables such as employment, output and price, which is determined by the actual factors (such as production and Technology) dominated by government policies.

2. The gist of natural rate hypothesis

The gist of the natural rate hypothesis is: the operation of the capitalist market economy has its internal dynamic balance, and external forces can break the balance for a while, but can not make it shake fundamentally; the best thing the government can do is to conform to it as much as possible. This is consistent with monetarism’s firm belief in free economy.