Long-Run Monetary Shadows: Can Policy Shocks Affect the Natural Rate of Unemployment?

The natural rate hypothesis, proposed by Friedman and Phelps, posits that monetary policy does not influence the natural rate of unemployment, which can only be maintained below its natural level through accelerating inflation or above it through accelerating deflation. This thesis challenges this view by investigating the impact of monetary policy on the natural rate of unemployment. We employ a refined method for calculating the natural rate of unemployment, developed by Michaillat and Saez (2022, 2024). Using an internal instrument SVAR approach, we estimate the dynamic response of the natural rate of unemployment to both a pure monetary policy shock and an information shock. To identify these shocks, we leverage instruments constructed by Miranda-Agrippino and Ricco (2021). Our findings indicate that a pure monetary policy shock does not affect the natural rate of unemployment, supporting the natural rate hypothesis. However, an information shock leads to a decrease in the natural rate of unemployment, which we interpret in line with Nakamura and Steinsson (2018). This suggests that central bank announcements prompt the private sector to revise its expectations regarding not only the future trajectory of monetary policy but also other economic fundamentals, such as the unemployment rate.