32 AEA PA PERS AND PROCEEDINGS MAY 1987 ingly the competitive contract equilibrium to clear the labor market in a world of approach in which workers have 100 percent imperfect information--not even in the long unemployment insurance and, because of in run. Of course, that efficiency wage models divisibilities, are chosen randomly to work can be built does not imply that they de ing, of course, that unemployed workers have clearing models have no particular claim to higher utility than employed ones. In Lucas's the theoretical high ground opinion, there is“ no reason to believe”that In sum, the scientific basis for modeling competitive models of labor markets that labor markets-or goods markets for that treat unemployment like leisure commit matter-as continuously clearing escapes me. serious strategic error. To reason? I think the preponderance of IV. Is the Natural Rate of Unemploymer the evidence says otherwise. Unemployment a Strong Attractor for the insurance replaces only about 40 percent of Actual Rate of Unemployment? lost earnings. Lately, only about one-third of the unemployed collect it. Where is the Keynes thought not. Indeed, in his revolu evidence that the unem ployed are happier tionary zeal, Keynes spoke loosely (loose than the employed? Most economists think talk was a problem for Keynes) of an Lucass distinguished predecessor at the unemployment equilibrium"which would University of Chicago had it right when he seem to deny the natural rate any attractive wrote,"Under any conceivable institutional force at all. Lucas answers in the affirmativ arrangements, and certainly those that now Modern Keynesians have long had trouble prevail in the United States, there is only a with the master's notion that the econom limited amount of flexibility in prices and ould equilibrate below full employment; wages. And it is hard, for me at least, to they prefer to think of unemployment as a look at what has gone on in this country long-lasting disequilibrium. In the United not to mention in Europe-since 1974 and States at least, the validity of the natural rate see clearing labor markets. That the market- hypothesis has not been at issue for a long clearing approach caught on in this environ- time. The argument, instead, is over whether ment is testimony to Lucas's keen intellect the speed of convergence to the natural rate and profound influence, not to economists' is rapid or glacial espect for facts. On this. the American evidence is un- More than just casual empiricism supports equivocal and the European evidence is this view: numerous formal econometric overwhelming. The U.S. civilian unemploy studies reject the market-clearing hypothesis ment rate peaked at 8.9 percent in May I against some sort of disequilibrium alterna- and then took almost three years to get back tive. Unfortunately, it is usually spot-market down to 6 percent. It then peaked again at clearing that is rejected. Equilibrium con- 10.7 percent in November-December 1982 tracting models in which the wage plays little now, four years later, it has yet to fall below or no short-run allocative role are difficult to 6.7 percent for even a single month. Some formulate econometrically, much less to re- will argue that 7 percent is now the natural ject. Indeed, it is hard to know what ob- rate, without worrying much about how it servations could contradict such models; grew so high. My view is that a theory that theory just leaves too many open possibil- allows the natural rate to trundle along after the actual rate is not a natural rate theory Nonetheless, certain observations are at all worth making. For one, several authors have In Europe, the evidence is far more com- pointed to interindustry wage differentials pelling. Unemployment rates rose more or that are persistent across both time and less steadily from 1974 to 1985-from 3 to space-differentials which are not easily over 13 percent in Britain, from 2.8 to 10.5 quared with market clearing. Theoretically, percent in France, and from 1.6 to 8 percent we know that the wage rate may not be able in Germany. Some young men in these coun