How is unemployment defined? Well, it depends. A lot of people seem to have their own pet definitions. That's fine. But let's stick to the way it is defined officially, by the people who collect these statistics; see How the Government Measures Unemployment. (For a list of alternative measures, see here).
So this is how it works. You are asked in a survey whether you have done any paid work in the previous four weeks. If you answer yes, then you are counted as employed. If you answer no, then you are nonemployed.
If you are nonemployed, you are asked another question: Have you been doing anything in the past four weeks to find work (and if so, what)? If your job search activity is judged to be sufficiently "active," then you are counted as unemployed; otherwise, you are counted as a nonparticipant.
One thing that should strike you about this procedure is that workers are never asked whether they are unemployed or not. It's not up to them to decide.
Nonemployment consists of both unemployment and nonparticipation. What is the distinguishing characteristic between unemployment and nonparticipation? Clearly, it is not joblessness. The distinguishing characteristic is active job search. (The only exception to this appears to be the small number of workers on temporary layoff).
I think it is important to recognize this distinction and what it might mean for how we go about thinking about unemployment (and what might be done about it). A lot of people (including macroeconomists writing introductory textbooks) are fond of equating unemployment with idleness. But is it right (that is, might it be misleading) to equate active job search with idleness?
One frequently reads that "unemployment represents wasted resources." But if job search is an information-gathering activity, designed to locate a high quality job match, in what sense does such an activity necessarily constitute wasted resources? (Does the existence of single people in the marriage market also represent wasted resources?) If the unemployment rate were to suddenly plummet because a large number of workers aborted their job search activity--accepting crappy jobs, or exiting the labor force--is this a reason to celebrate? Should the Fed, in this event, breathe a sigh of relief?
To the extent that unemployment (as measured in the data) represents job search activity, it seems to me that the fundamental cause of unemployment is a matching friction. Evidently, people do not know the "location" (broadly defined to include, sector, occupation, etc.) of their best job match; and so, it makes sense to go looking for your "soulmate," rather than matching with the first thing that comes along. This suggests that a theory of unemployment should model these matching frictions explicitly. A sticky wage is not going to do the trick. A sticky wage may depress employment; if so, it leads only to nonemployment, not unemployment (there is no reason to search if you know that jobs are not available).
Thinking in this manner is likely to influence our views about policies designed to "cure" unemployment. For example, it suggests that extending UI benefits during a recession may be part of a desirable policy. The idea here is to encourage unemployment (job search activity); that is, to help people find jobs that match their skills (and to smooth their consumption over difficult times). On the other hand, it leads to some scepticism over the idea of the government simply "creating jobs" in a recession. It may not be that easy--we need the "right kind" of jobs--jobs that are well-tailored to individual skills. Perhaps the market is a better judge of which skills are needed and which are not.
Anyway, I could talk a long time about this and related labor market issues. But instead, I think it might be better to point you to a paper that does the talking for me. The article is by Richard Rogerson (recently moved to Princeton) and is called Theory Ahead of Language in the Economics of Unemployment (JEP, 1997). Here is an excerpt, to whet your appetite:
One unemployment concept that macroeconomists have used extensively is the natural rate of unemployment. In a search of the literature, I came across the following uses or definitions of this term. Blanchard and Fischer (1989), in their graduate macroeconomics textbook, first equate the natural rate of unemployment to the average rate of unemployment (p. 349), only to later equate it to the equilibrium rate of unemployment (p. 545). In their chapter of the Handbook of Labor Economics devoted to the natural rate, Johnson and Layard (1986, p. 921) write: ‘‘In this chapter we deal with unemployment in the long run. We do not bother about the movement of unemployment over the cycle, but only with its average level. In other words, we are looking at what we call the equilibrium unemployment rate. . . . This is what Friedman called the ‘natural unemployment rate’. . . .’’ Also in the Handbook of Labor Economics, Hall and Lilien (1986, p. 1021) write: ‘‘The natural rate is the normal unemployment rate that results from this process of labor allocation when workers and firms correctly perceive the levels and rates of change of price and wages.’’ Lilien (1982, p. 777) had earlier written, ‘‘Because it takes time for separated workers to be matched to jobs, some positive level of unemployment will always exist. Economists have long recognized this fact and have labelled this necessary quantity of unemployment the frictional, natural or equilibrium unemployment rate.’’ In his undergraduate textbook, Mankiw (1994) defines the natural rate of unemployment to be the steady state rate of unemployment, whereas in their undergraduate text, Auerbach and Kotlikoff (1995, p. 426) refer to the natural rate of unemployment as the ‘‘lowest sustainable rate of unemployment.’’ Bean (1994) defined the natural rate to be the equilibrium rate, whereas Christiano defines the natural rate to be the trend component of unemployment generated by the Hodrick-Prescott filter. Clark and Summers (1979) suggest that it is the efficient rate of unemployment, and Hahn (1980) defines the natural rate of unemployment to be unemployment at full employment.The full article is available here: Theory Ahead of Language in the Economics of Unemployment.
If transitivity is assumed to hold, then the above list of quotations would tell us something like: long run = frictional = average = equilibrium = normal = full employment = necessary = steady state = lowest sustainable = efficient = Hodrick-Prescott trend = natural. It would seem doubtful that any concept that is sufficiently ambiguous as to promote this many different uses can be helpful in guiding scientific inquiry. I am by no means the first to question the clarity of this concept. Solow (1986, p. S24) has written, ‘‘[I]t is not clear what we are talking about when we talk about the natural rate.’’
In a larger context, the natural rate of unemployment was only one of many terms that were introduced supposedly to clarify key issues and lead the search for a theory of unemployment. Primary among the other terms were several decompositions of measured unemployment; there was equilibrium and disequilibrium unemployment, voluntary and involuntary unemployment, and frictional and cyclical unemployment. There was also the notion of full employment unemployment. Milton Friedman (1968) was adding to this list in his presidential address to the American Economic Association when he introduced the concept of the natural rate of unemployment. Much of this ‘‘language of unemployment’’ continues to be used today. Is this because these terms have turned out to be the precise and powerful concepts that facilitate clear communication and allow issues to be defined sharply? In this essay, I will argue that they are not.