Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 17 February 2017

NAIRU bashing

The NAIRU is the level of unemployment at which inflation is stable. Ever since economists invented the concept people have poked fun at how difficult to measure and elusive the NAIRU appears to be, and these articles often end with the proclamation that it is time we ditched the concept. Even good journalists can do it. But few of these attempts to trash the NAIRU answer a very simple and obvious question - how else do we link the real economy to inflation?

One exception are those that attempt to suggest that all we need to effectively control the economy is a nominal anchor, like the money supply or the exchange rate. But to cut a long story short, attempts to put this into practice have never worked out too well. The most recent attempt has been the Euro: just adopt a common currency, and inflation in individual countries will be forced to follow the average. This didn’t prove to be true for either Germany or the periphery, with disastrous results.

The NAIRU is one of those economic concepts which is essential to understand the economy but is extremely difficult to measure. Let’s start with the reasons for difficulty. First, unemployment is not perfectly measured (with people giving up looking for work who start looking again when the economy grows strongly), and may not capture the idea it is meant to represent, which is excess supply or demand in the labour market. Second, it looks at only the labour market, whereas inflation may also have something to do with excess demand in the goods market. Third, even if neither of these problems existed, the way unemployment interacts with inflation is still not clear.

The way economists have thought about the relationship between unemployment and inflation over the last 50 years is the Phillips curve. That says that inflation depends on expected inflation and unemployment. The importance of expected inflation means that simply drawing unemployment against inflation will always produce a mess. I remember from one of the earlier editions of Mankiw’s textbook he had a lovely plot of this for the US, that contradicted what I just said: it displayed clear ‘Phillips curve loops’. But it was always messier for other countries and it got messier for the US once we had inflation targeting (as it should with rational expectations). See this post for details.

The ubiquity of the New Keynesian Phillips Curve (NKPC) in current macroeconomics should not fool anyone that we finally have the true model of inflation. Its frequency of use reflects the obsession with microfoundations methodology and the consequent downgrading of empirical analysis. We know that workers and employers don’t like nominal wage cuts, but that aversion is not in the NKPC. If monetary policy is stuck at the Zero Lower Bound the NKPC says that inflation should become rather volatile, but that did not appear to happen, a point John Cochrane has stressed.

I could go on and on, and write my own NAIRU bashing piece. But here is the rub. If we really think there is no relationship between unemployment and inflation, why on earth are we not trying to get unemployment below 4%? We know that the government could, by spending more, raise demand and reduce unemployment. And why would we ever raise interest rates above their lower bound?

I’ve been there, done that. While we should not be obsessed by the 1970s, we should not wipe it from our minds either. Then policy makers did in effect ditch the NAIRU, and we got uncomfortably high inflation. In 1980 in the US and UK policy changed and increased unemployment, and inflation fell. There is a relationship between inflation and unemployment, but it is just very difficult to pin down. For most macroeconomists, the concept of the NAIRU really just stands for that basic macroeconomic truth.

A more subtle critique of the NAIRU would be to acknowledge that truth, but say that because the relationship is difficult to measure, we should stop using unemployment as a guide to setting monetary policy. Let’s just focus on the objective, inflation, and move rates according to what actually happens to inflation. In other words forget forecasting, and let monetary policy operate like a thermostat, raising rates when inflation is above target and vice versa.

That could lead to large oscillations in inflation, but there is a more serious problem. This tends to be forgotten, but inflation is not the only goal of monetary policy. Take what is currently happening in the UK. Inflation is rising, and is expected to soon exceed its target, but the central bank has cut interest rates because it is more concerned about the impact of Brexit on the real economy. That shows quite clearly that policy makers in reality target some measure of the output gap as well as inflation. And they are quite right to, because why create a recession just to smooth inflation.

OK, so just target some weighted average of inflation and unemployment like a thermostat. But what level of unemployment? There is a danger that would always mean we would tolerate high inflation if unemployment is low. We know that is not a good idea, because inflation would just go on rising. So why not target the difference between unemployment and some level which is consistent with stable inflation. We could call that level X, but we should try to be more descriptive. Any suggestions?


  1. So according to you a fraction of the workforce needs to be kept unemployed.

    1. What a stupid statement. It tells you the level of unemployment consistent with stable inflation. If you think that is too high, take measures to reduce the NAIRU. But pumping up demand will only reduce unemployment below the NAIRU by increasing inflation.

    2. Well yes stupid statement in the sense that it's a stand of economists.

      So now you are saying that if some "reforms" are not undertaken, people are to kept unemployed.

      You can't escape the extrapolation of your economics which is a political stand really.

    3. What it tells you is that if you try and get very low unemployment, you will find inflation rising with no end. That is very clear and simple. If you can do anything to reduce the NAIRU that is obviously good, but to wish it away is irresponsible.

    4. You are just repeating "zOMG HYPERINFLATION" with some academic coating.

      When a politician listens to you, he'll stop short of reaching full employment.

      That's irresponsible of you, not me.

    5. Do you think a politician should keep on reducing unemployment even if inflation is rising?

  2. Quite agree with the above article: NAIRU bashers are a waste of space (to use technically correct economics jargon).

  3. Set a nominal gdp target growth path (for instance a yearly 4% nominal growth) and each year target the nominal gdp that follows that path. After a boom the actual nominal growth target would be lower and after a slump the actual nominal growth target would be higher. Otherwise use prime age participation rate rather than unemployment rate to set the target (or even more specific:participation age for prime age skilled men). These alternative measures of underemployment are to the unemployment rate what the core inflation is to inflation: it allows to filter out exogenous factors or factors less relevant to monetary policy.

  4. Simon, there is a clear and important difference between a short-term and a long-term NAIRU. Very few people would disagree that there is always a short-term capacity utilization constraint on the economy, above which inflationary pressures would increase.

    But that does not mean that a long-run NAIRU based only on labor market frictions exists and is independent of the state of the economy. Something like that assumes perfect substitution between labor and capital, meaning that a shortfall of investment will not affect the NAIRU. Nor does it take into account concepts such as hysterisis regarding the labor market.

    What most people have trouble with is the second concept which is used to introduce "money neutrality" in the long-run, in the sense that we can use stabilizing policy only in the short-run and worry about labor market "reform" in order to lower the long-run NAIRU. If economists paid much more attention on hysterisis, investment, real interest rates as drivers of the long-run NAIRU apart from labor market frictions and flexibility I think that a lot more people would be much happier with the concept.

    1. Oh and recent research by Blanchard, the Fed, CEA (to name a few) points to the fact that the Phillips curve is now a level level relationship rather than Friedman's accelerationist type. In such a context the A in NAIRU does not make that much sense.

    2. «clear and important difference between a short-term and a long-term NAIRU. Very few people would disagree that there is always a short-term capacity utilization constraint on the economy, above which inflationary pressures would increase.»

      Sure, but that "short-term" is pretty short given the typical multi-year lags expected of policy, so the "short-term" NAIRU, in the cases where it does exist, is rarely of interest.

      «If economists paid much more attention on hysterisis, investment, real interest rates as drivers of the long-run NAIRU apart from labor market frictions and flexibility»

      Then those would not be Economists, but political economists, relegated to working at the margins of the academe and outside policy circles, and make a meager living on mere upper-middle class professorial salaries.
      There is no market demand for definitions of "inflation" that are not proxies for wages, and for explanations of inflation that are not limited to "unaffordable" wages.

      «I think that a lot more people would be much happier with the concept»

      Your thinking seems to me realistic, but «drivers of the long-run NAIRU apart from labor market frictions and flexibility» is quite a limiting concept: because it gives for granted that "inflation" really means just "wage rises" and that there is a hard tradeoff between only "inflation" and unemployment, while instead "inflation" could be well (and statistical studies indeed support that) the result of several factors, some more important than others at different times.

    3. «drivers of the long-run NAIRU apart from labor market frictions and flexibility»

      Put another way, the whole framing of the "inflation" discussion in terms of the prices of wage-intensive goods and their relationship to unemployment is a very political way to ensure that the discussion in essence is about the thesis "wages rises are caused by employment", with the natural policy conclusion that unemployment must be the "cure" for wage rises, which is what "aligned" central banks fervently work to achieve.
      Quite a few people outside the "magic circle" of Economists would object to that framing as a whole, not just to parts of it.

    4. Kostas: I do not have any objection to what you say in the first comment. But for the 2nd, you have to ask why the PC might have become a levels relationship. The obvious explanation is that people are confident that the central bank will meet its inflation target, so they do not need to form inflation expectations. If that was true, the relationship would not survive a prolonged departure from that target.

  5. I cannot believe what I am reading here, how many people should be excluded from a proper place in their community in order to control inflation, a "tax" rich people hate because they can't avoid it? The link between unemployment and inflation is tenuous at best, indeed without full employment inflation cannot be properly measured.

    I am not academic as such but from my reading a far better predictor of inflation is the oil price, obviously with various lags and other variables to be taken into account. Why millions of people wordlwide should be kept unemployed by design is such a sick proposition it shouldn't ever have been contemplated. bill40

    1. This seems like wishing away a real world problem. Are you prepared for ever increasing inflation to get unemployment lower? Wouldn't it be better to look at ways of reducing the NAIRU?

  6. “There is a danger that would always mean we would tolerate high inflation if unemployment is low. We know that is not a good idea, because inflation would just go on rising.”
    This might be an obvious question, but why would low unemployment inevitably mean constantly rising inflation as opposed to a rise in inflation that could be stemmed by tighter monetary policy? Can’t inflation be stabilised at a higher level by the central bank adopting higher interest rates, perhaps the 4% many economists suggested in the aftermath of the Great Recession when the very real risk of the economy hitting the ZLB became apparent?
    And isn’t the experience of the 1970’s misleading in this regard? That decade saw the collapse of the Keynesian orthodoxy that prevailed during the 50’s and 60’s that held there was a simple trade off between inflation and unemployment, but it was exceptional in that the 70s saw the oil price shocks that were the biggest supply-side recession of modern history (perhaps since famine was a significant risk in the early 1800s) - a macroeconomic shock that because of inappropriate policy it took Western economies a long time to recover from.

    1. The way monetary policy reduces inflation is by reducing aggregate demand which increases unemployment.

    2. The full statement should go: The way monetary policy reduces inflation is by... making burden of debt more costly, reducing disposable income, by making new projects less profitable and by making indebted corporations less profitable leading them to closing.... which reduces agregate demannd which increases unemployment.

      Countereffect of such monetary policy is that interest income grows countering reduction in demand from wages and employment. Employing such policy over long term favors redistribution of income from workers to capital.

      Hmmm i wonder how many economists really think this policy through and its implications? And when it is crucial to recall such desicions from before do they remember it? By not giving full explanation, by skipping over the mechanisms of money and credit and debt, it is easy to forget why we are in Secular Stagnation

  7. If I recall correctly Hyman Minsky assumes that stagflation cannot be sustained for a long period of time without a government transfer of purchasing power to the unemployed who otherwise would not have money to buy goods at inflated prices. The other "finance" component of aggregate demand is the pace of credit formation. The unemployed are a poor credit risk so a rise in unemployment should couple to a reduced pace of credit formation. If inflation is generated by a fiscal position and private credit formation with any level of employment whatsoever, and if Congress does not provide automatic stabilizers in the fiscal mix, then the central bank must operate on the pace of credit formation in the financial system to break excessive inflation or deflation. When short term interest rates rise rapidly it should cause cash flow problems in the income statement for financial intermediaries and their customers who must rollover short term liabilities at higher cost. This is the mechanism that induces recession to break inflation. The question is how an economy transitions to a threat of deflation versus a threat of excessive inflation? The balance sheets and income statements of working class households appear to be the signal for inflation or deflation with a little bit of group-think or so-called "animal spirits" since the exact timing of the group-think cannot be predicted with any certainty. Feedbacks in the economy are caused by convergence of sentiment based on the financial position and income forecast combined with government fiscal commitments.

  8. "why on earth are we not trying to get unemployment below 4%?"

    That's very simple Simon. People like you believe we need a reserve army of the unemployed to keep inflation under control. Your models requires millions of people in destitution and excluded from contributing usefully to society.

    We don't have to put up with such waste.

    Actually it is very easy to eliminate unemployment completely. You give people a job working for the public good at the living wage. And you just pay them. Using the Ways and Means account that is now completely freed up thanks to Brexit.

    Then everybody that wants a job has a job, and everybody that is short of work can get enough work, and the private sector has to compete for labour - ending the race to the bottom, eliminating the parasite economy at a stroke and forcing businesses to invest and automate. Which we can let them do because we always have enough jobs at the living wage. The more jobs the private sector automates and eliminates the more productive we are and the higher standard of living we enjoy.

    You turn NAIRU into a NAIBER with a Job Guarantee.

    1. You are talking about a policy to reduce the NAIRU, which I'm all for if it works. Why not talk about it like that?

      Instead you say utterly stupid things like 'your models require millions of people in destitution'. My models tell you that, with current policies and institutional arrangements, what the relationship between unemployment and inflation is. Nothing more than that.

      By attacking these models, which are simply designed to explain the world as it is, you seem to want to defy reality. Just as those who used prices and incomes policies did in the 70s. If that is not your intention, why make it appear as if it is.

      What you do seems to be the same as condemning the models used by weather forecasters because they force us to have rainy days.

    2. Prices and incomes policies were inadequate social responses to this howling flaw in present job market and product market systems

      Yes you are a realist ala Malthus

      But surely you have considered social remedies
      Thru other institutional arrangements

      It's not utopia anymore then pollution controls or congestion contrails
      Or panic controls

    3. «these models, which are simply designed to explain the world as it is,»

      I do understand that is the attempt, and I may even believe that it is the result of "deformation professionelle", but simply *assuming* both that "inflation" is the change in prices of only wage-intensive goods and services (and the use of "core inflation" makes it very clear) and *assuming* that there is a tradeoff *only* between wages/unemployment and "inflation", that is that "inflation" in practice means "wage inflation", is a very political act. It voids the claim that the attempt is to «explain the world as it is».

      If the attempt was indeed to «explain the world as it is» then *all* prices would be included in "inflation" and "inflation" would be explained as the result of several factors, including credit policy and regulatory policy.
      "Inflation", as that old fraud M Friedman did not write, is always and everywhere a *political* phenomenon, and "just like that" assumptions that end up blaming it all on wages as if it was just a simple economic relationship between wages and prices seem obfuscatory to me.

    4. I agree with points from both you and Neil here. Neil is advocating going out and giving the unemployed a coat cut to the person, using that analogy, which is *going off on a tangent* of this post, and advocating economists support coat-wearing. If we cannot force the private sector to hire everyone (matching problem) provide the unemployed with public sector jobs fitted to the person at minimum wage.

      To put it another, JG makes it easier to hire off the bottom and allows more private sector employment for a given level of inflation (assuming NAIRU) but its *main* purpose is to create a relationship between *employment* and inflation.

      "what the relationship between unemployment and inflation is."

      Let's get back to this, assuming "current policies and institutional arrangements." Now I'm not sure whether this is true, the NAIRU seems much more like linear increases until about 3% unemployment in inflation, not acceleration as NAIRU predicts. I remember Bill Mitchell says in one of his blogs (I will try to find.) Also consider the commentator "Blissex" points. There is not much statistical evidence of NAIRU.

  9. A Job Guarantee, Simon.

    Surely you know of it?

    1. Why is this any different from telling people on the dole that they have to work to get it?

    2. I think to challenge to job guarantee advocates
      Is to show how it avoids become a humanist open air gulag

      The history of the works project administration here is sobering

    3. If you dont understand the social, economic and political difference between having a job on a living wage and a dole payment handed out, then I can't help you.

    4. How is it different from telling people in the private sector they have to work to get it? Why advocate forcing a certain % of population on the dole?

      This seems to see JG jobs are 'proper jobs' but they are.

    5. Oh nooo
      Why is that any different? Thats really dissapointing. The worst ever yet of dissapointments i read on your blog.
      Without JG you tell them that they have to work for really meager wage-dole which is under minimum wage. With living wage JG you offer them a job, you do not tell them you have to work to be on the dole.
      With JG you have both JG and on the dole that are different pay.

      Your question really tells that you never paid any interest in JG.
      Another important aspect of JG is inflation control through constant total wage so there is less variations in agregate demand.
      Also there is financial stability from having full employment and with it ability to keep paying debt servicing. It is like automatic stabiliser for loan repayments.

    6. "I think to challenge to job guarantee advocates
      Is to show how it avoids become a humanist open air gulag"

      You could say that about all forms of employment. The JG is libertarian. Nobody is forcing anyone to take a JG job. It is the ultimate auto stabiliser and ultimate social security system.

    7. Suppose we are at the NAIRU: inflation is stable. You introduce a JG to people who have been unemployed for more than a certain amount of time. Surely it would be better to retrain those people in the skills for jobs where there are vacancies, or help them to move to where there were vacancies, or give incentives to firms with vacancies to move to where the unemployed were.


  10. Measuring, or at least nowing how to measure, variables is the hall mark of science. In the case of NAIRU, economists do make a mess of it, in fact taking a kind of (complicated) running average of actual unemployment data to estimate it. Which, in the case of Spain, led to official EC estimates of over 20% (because, as Spain is in the Eurozone, it is hard to get inflation a lot lower than the Eurozone average and 26% Spanish unemployment did not lead to 10% deflation). This does not pass the laugh test. At least taking some kind of kinked curve would be more serious science.

    This is, turning attention to policy, made worse by capital flows. In the end, the ECB targets Eurozone variables (less so than in the times of Trichet, but eventually it does). And it really seems to have been the case that capital flows between Spain and Germany led to a situation where high inflation/low eunemployment in Spain coincided with low inflatin/high unemployment in Germany which, when you take the average...

    Writing from a eurozone country I have do have to admit that, though the treaty's say otherwise, many state, again and again, that the only purpose of monetary economy is getting inflation down to a little below 2%. And in true rational expectations style Trichet did have the idea that he only had to be 'credible'(i.e. wanting to crash the economy) and state that this was his goal to obtain it... No NAIRU there. In true Robert Lucas style: n unemployment there! Which is the real problem. If NAIRU is the price we have to pay to make central bankers take unemployment serious: let it be! But even then they should not make a fool of themselves by messing up with, among others, data about Spain. When my normal temperature is 36,5 degrees Celsius we should not change this to 39 degrees after two days of fever - which is what the EC economists de facto do.

  11. I think Dr. Wren-Lewis had a typo regarding NAIRU:

    "how else do we link the real economy to inflation?"

    Changed to:

    "how else do we link the real economy to our models that repeatedly fail to predict the real economy?"

    1. Please read my post on conditional and unconditional forecasts.

  12. «inflation depends on expected inflation and unemployment»

    That depends on a very political assumption that our blogger seems to me comfortable with: that "inflation" is largely synonymous with "wage inflation", while big increases in profits or rents should not be called "inflation". In practice this means rewriting the statement above as "wage inflation depends on expected wage inflation and unemployment of workers", and rewritten like that it sounds a lot clearer.

    Then it follows that only "unaffordable" worker incomes are "inflationary", and that the incomes of "wealth creating" business and property workers are "not inflationary", and that "competitiveness" means pushing down the "inflationary" incomes of workers.

    «The importance of expected inflation means that simply drawing unemployment against inflation will always produce a mess. I remember from one of the earlier editions of Mankiw’s textbook he had a lovely plot of this for the US, that contradicted what I just said: it displayed clear ‘Phillips curve loops’»

    NAIRU and/or most variants of the Phillips curve are fiendishly difficult to support with statistical evidence; the best paper I read concluded that they seem to a relationship to the price of wage-intensive goods in some periods, but not in others, and there is no way of telling in advance; put another way, the influence of wages and unemployment on the price of wage-intensive goods is only partial, and other factors must be surely in play.

    That to me suggests that NAIRU and/or most variants of the Phillips curve are fundamentally political tools, to support the assumption that not only "inflation" means "wage inflation", but a political reading of the 1970s that there was a "wage to prices spiral" triggered by the "unaffordable" demands of wage earners.

    A more realistic view of the 1970s is that there was a "commodity prices to prices" push and then a huge three-way fight among business owners, property owners and workers as to the distributional impact of that commodity price push. First property owners lost (all those bonds vaporized by rising interest rates), then business and property owners, aided very enthusiastically by central banks, pushed the whole (and then some) distributional cost onto workers, to this day.

    1. So you skipped the bit in the post about inflation generated outside the labour market!

  13. I would also like to point out that the risks of doing the wrong thing are extremely asymmetric: if monetary policy is too tight when we are near the zero lower bound, we risk long-term stagnation. If monetary policy is too loose, at most we risk a little bit of overheating and a short-term recession to bring inflation back under control.

    To me, these argue strongly that what we really should be doing most is increasing the inflation target substantially above 2% (maybe 4-5%?). This would push our economies further from the zero lower bound, providing more leeway for future monetary policy and reducing the danger of deflationary shocks (such as accidentally setting the interest rates too high).

  14. Dear Prof Wren-Lewis,

    You ask: “... why create a recession just to smooth inflation?”

    Why indeed? How about trying to minimize Arthur Okun's Misery Index = Unemployment Rate + Inflation Rate, giving equal weight to each?

    Currently in the U.S., MI = 4.7 + 2.1 (CPI) = 6.8. Historically, this is very good although it has been a bit lower. You worry: “There is a danger that [an average] would always mean we would tolerate high inflation if unemployment is low.”

    Due to frictional unemployment, the lower bound is probably 3.0. So, an MI of 6.8 would produce an inflation rate of 3.8. Why is that intolerable?

    [From a Non-Economist]

  15. I am curious how total disposable income relates to inflation, particularly for the middle n% to eliminate edge effects. I believe, but do not have historical data to demonstrate, that the number of unemployed is irrelevant to inflation if there is no excess income to drive prices up. For instance, if wages grow rapidly while unemployment goes up slightly, it is easy to imagine that there could still be inflation. It is also easy to imagine scenarios where inflation in a core need like housing or energy saps typical money supply growth from wage inflation or higher employment.

    Factors such as above long term trend housing prices inflation (, higher wealth disparity, slowly growing incomes, and lower mandated debt loads all seem to be conspiring to keep disposable income in check. Consequently low unemployment seems to have less impact than it might have in the past.

    I would greatly appreciate any insight you could provide either suporting or refuting my assertion...

    1. «total disposable income relates to inflation»

      That depends on defining "inflation" in a certain way or another, and then violating the assumption that "inflation" is caused only by wage earners, and therefore that only wage repression (achieved by imports of good and services from low wage economies, of immigration of workers from low wage economies, or by unemployment) can tame inflation by making "unaffordable" wages more "competitive".

      There is little space in public debate for alternative definitions of "inflation" or for investigating alternative possible factors for "inflation".

      There was for example an interesting paper that showed that in the USA in areas where property prices were rising fast retail prices were also rising rather faster than others; but that is one against dozens of papers going through extreme sophistry trying to find a *systematic* medium-term or long-term tradeoff between CPI and wages.
      Just as there are legions of researchers trying to estimate the thoroughly imaginary "natural rate of interest" or straining to find "hedonic" sophistry to argue that "inflation" has been overestimated for decades. It is all about politics.

  16. As I understand it what you propose is that to control inflation 5% or so of the working age population should be unemployed. Two questions do they have to be those on the lowest income or can they be the rich? If they are on the lowest income what level of unemployment benefit do you propose they receive?

    1. "what level of unemployment benefit do you propose they receive?"

      It doesn't really matter. People will resent others who are getting "something for nothing" and then politically agitate to get the programme shut down. Also because it is not seen as a systemic problem (the poor are blamed.)

      If people simply haven’t earned their monetary earnings, then to solve the problem you need have more capacity to earn, an ability to sell Labour Hours for a wage.

    2. Seriously, do you not understand the difference between describing the way the economy works and describing what you would like to happen. I'm saying there is some level of unemployment, the NAIRU, at which inflation will be stable. A doctor does not propose your body works in a particular way.

    3. Of course I understand the difference but you are still looking for some number X which will allow policy makers to decide how much unemployment to have in order to have stable inflation so my questions still remain valid.

    4. You are content with blind surgeons ?

      If we can 't establish where the NAIRU zone lies at any particular juncture
      And if we are inflation acceleration phobic
      We will chronically miss to the side of caution
      And in the long run wage class types
      will suffer as well as actual production

    5. "some level of unemployment, the NAIRU, at which inflation will be stable."

      I fully agree with that. The (un)employment level at which "inflation is stable" is going to be difficult to ever find though. Why? The concept, analysis and application of NAIRU is totally bogus. Yes, there is a relationship between unemployment, wage growth, productivity and inflation. But we have no idea what that relationship is on a formal mathematical level. This is because of the complexity of instiutional and policital arrangements and their impact on supply, employment, and income distribution. These things vary between countries, within countries and over time. So even if you were able to build a relevant mathematical model that approximated the data for a specific place at a specific moment in time, all the relevant inputs are dynamic and changing meaning the relevance of the model is basically extremely limited and decays over time.

      All of this is far different then the Fed or BoE announcing that "full employment" is 5% because thats what our NAIRU model says. This is a factually inaccurate statement and not relevant to the underlying economic situation as the UE rates (specifically U3) that is primarily used as measuring sticks is itself misrepresenting the employment situation as the U3 excludes 6 million people who want a job but stopped looking as as such are not counted in the U3 figure.

      In summary, to say there is a relationship between the employment, productive capacity and inflation is not at all the same thing as saying "unemployment below 5% will lead to accelerating inflation".

  17. You say in your piece "we should not be obsessed by the 1970s." but what strikes me most about significant parts of economics is how fashions seem to change and you acknowledge this: "Then policy makers did in effect ditch the NAIRU" but that "For most macroeconomists, the concept of the NAIRU really just stands for that basic macroeconomic truth.".

    Surely this begs the question: are there basic macroeconomic truths like the NAIRU? After all this assertion seems inconsistent with the fact that there are fashions which I assume you would acknowledge as fact. In this context does that not question whether such ideas as the NAIRU have any long term validity in explaining economic phenomena?

    I'm sorry I can't think of anything positive in this respect but I'm sure you'll see that I'm saying: what's the point?

    1. There are fashions of sorts in economics but it is also a progressive science. The NAIRU story was about discovering something that was politically difficult, so some economists did not want to accept it, but since the 1980s it has become received wisdom.

      That is among mainstream economist that it. It seems from comments both here and on twitter that some heterodox economists are still living in that pre-1980s wish fulfillment world.

  18. "few of these attempts to trash the NAIRU answer a very simple and obvious question - how else do we link the real economy to inflation?"
    Why SHOULD there be a mechanical link between the 'real economy' and inflation?!?
    Both unemployment and inflation are high-level abstractions of social reality, not parts of the same machine that must, somehow be linked.
    The economy (the way in which we organize that people get what they need) is the sum total of largely subconscious collective behaviour (that can be modelled).
    Its proper micro-foundation is in our subconscious reflexes as social animal: follow the flock, do what you're told when in doubt, look for what you lack & look for clear symbols and ideas.
    Individual human agency, choice behaviour, comprises less than 10% of our behaviour, so can't be the basis of economic models.
    That makes 'demand & supply' into a wrong starting point for analysis of economies.
    Human agency IS essential for economies of homo sapiens, because even less than 10% of our behaviour can seriously disrupt any mechanical link between abstractions describing it.
    That conscious part of our behaviour is guided by performative language coined by economists (among others) and employed in the political arena, by the 'parables' (Coen Teulings, 2016) that help us understand the world around us.
    If you want to know why unemployment and inflation do not correlate nicely, you have to engage in analysis of economic discourse in schools and public debate, of the drivers of trust and anxiety, of what look like 'animal spirits' if as economist you are raised in the homo economicus paradigm.
    Actually correlations in economics are based on 'social animal spirits' and they are fucked up by homo sapiens acting as conscious humans, intentionally, letting her/himself be convinced by this or that story told by people she/he trusts.
    Can economists be trusted to tell the right stories?

  19. Simon, you dismiss the idea of a nominal anchor based on past attempts at monetary supply targeting and exchange rate targeting. Both are obviously flawed (in hindsight anyway) because they effectively let monetary policy be controlled by changes in velocity, for supply, or outside forces in the case of exchange rate (or not mentioned, commodity) targeting.

    But there have been proposals to use nominal income or nominal GDP as a target instead of inflation, and it seems that with a high enough target, they should fairly naturally keep us from zero bound problems as well as a higher inflation target would.

    I'd of course agree in principle that there's such a thing as a NAIRU, but in practice, it's very difficult to know exactly where it is until you experience the beginning of an actual inflation spiral, and it's sometimes difficult to pick out exactly wage-based inflation vs. supply shock inflation. Part of the problem in 2008 with central bank response is that we had some supply shocks (peak oil among them) that temporarily spiked inflation despite a weak and slipping nominal economy across NA and Europe, and banks focused on the inflation numbers while velocity was tanking because we didn't yet have good nominal income/GDP numbers.

    1. How would you set the initial level of the NGDP target? My guess is you would use some form of NAIRU estimate.

  20. With an adequate model of job markets we can avoid this woeful short cut

  21. We need to socialize the price setting mechanism
    Along the lines suggested by weintraub Lerner et al

    It's essentially an externalities problem
    A simple market failure

  22. You make a good case for targeting NAIRU. However, that brings us back to the original problem. We don't know how to calculate NAIRU to the required accuracy.

    1. I hope I do not make a good case for targeting the NAIRU, for the reason you state. At no point do I suggest this.

  23. To summerise Neil's point, with a job guarantee, we could have 0% involuntary unemployment with stable inflation. Contradicts NAIRU even if the relatio ship (unemployment/inflation) is correct. Can you add a correction in the piece assuming current institional arrangements!

    1. Would inflation be independent of the number of people in the JG scheme?

    2. "Would inflation be independent of the number of people in the JG scheme?"

      Perhaps not, but hiring someone for £10/hour from £9/hour generates far less inflation than hiring from unemployment benefit. It is fair to say the less people in the JG the greater inflation (although we don't know how much and I don't claim to know.) Plus the pool of JG workers will take longer to move to exhaustion. Which is why I am defending you on NAIRU.

      In addition normal businesses can be allowed to go bust, not pay redundancy, etc because the JG will catch people who lose their jobs during a retrenchment. That disciplines the spending and wage channels since there need be no bailouts or the 'special industries' that pump-priming requires. Overpaid workers get an imposed wage cut when they are forced to move to the JG as do greedy bosses. 'Corporate confidence' is no longer of overriding concern. And people can take wage cuts below the minimum wage in a recession - they have two choice of job not zero.

      I remember in 2013 UK 1.5 billion days of output were lost to the economy per year for no reason at all.

      Very large number – immediately relatable by anybody to their personal experience.

      To put it another way, that's why there isn't a 'Phillips curve' or NAIRU in MMT. Because both of those rely upon the traditional notion of 'unemployment' and there is none in MMT. Therefore they can't apply as standard. The 'trade off' changes to reference those on the Job Guarantee scheme instead.

      There may be some one off inflation implementing the JG scheme.

    3. My main point is JG is a powerful and useful tool for economists: with correct demand management, we can help prevent recessions and rein in inflation. The workers on the JG are a much more credible threat to taking positions of currently employed than the unemployed.

      I accept this is a fringe position but it is helpful in maintaining 'order' and a swipe at crime at the very least, that could appeal to 'establishment' type people.

    4. No the price anchor is the wage itself.

  24. Also as to JG not being 'real jobs' private sector jobs especially at the low end are rubbish and JG jobs are awesome, so that will not apply :-)

  25. NAIRU is the economic equivalent of "Muslim ban".

  26. How do we relate the real economy to inflation? For over 30 years from 1941 to 1974 unemployment averaged around 2% and inflation was at acceptable levels typically less that 5%. Why not return to the policy descriptions of that time?

    If we were still using these policies which I understand were aimed at full employment what would the consequences be for the real economy now?

    The excessive inflation in the 1970s was anomalous in the UK context and surely was an input price shock and nothing to do with excess aggregate demand. Therefore to dismiss 30 years of a successful policy because of this seems short sighted.

  27. What is "inflation"?

    Economic definition: Continuous rise in the price level.

    How is it observed?

    There there a standard for correlating interest rate changes with changes in the inflation rate that is medically established?

    Is there a correlation of change in the interest rate and employment rate empirically?

    How tight is it?

    What is the time frame?

    As far as I can see there is little empirical evidence involved. It's based on theory.

    There is a correlate in medicine. Some causation is educed theoretically involving either cause or cure of disease. Empirical testing often shows that there is no close correlation that can be detected. Often single studies are contradicted by subsequent studies that are either fail to replicate the initial study or are more tightly formulated to eliminate confounding variables.

    Nothing like this in NAIRU. It's basically theory that is reducible to ideology. Claiming any relationship means NAIRU true.

    1. The NAIRU is simply the implication of an empirically estimated Phillips curve. It always has been! When you say 'as far as I can see there is little empirical evidence involved' who on earth have you been reading?

  28. SW-L
    The post is showing fine reasoning and argumentation. I respect the all of it except the explanation of stagflation (OPEC had no influence on inflation????)

    But then how do you explain the real world observation that NAIRU was raised in time of falling or low inflation? By all logic NAIRU should fall in times of low inflation yet the observation of official NAIRU showes that officials raised NAIRU level in times of ZLB. How is that calculated?

    Or is it that raising animal spirits is more important then some theory of NAIRU and officials completely discard mathematics of NAIRU just to raise animal spirits?

    So, all of your attack on NAIRU bashers is trown away when you look at real world. You defend theory (and so eloquently) while bashers watch real world. Who should have more sway on policy?

    1. The NAIRU is not constant. Its a function of various variables like union power or the degree of monopoly in the goods market, the degree of mismatch etc. I did not mention it above because it is so obvious in the data. But it is not a function of short run changes in aggregate demand, so it puts a limit on demand policy.

  29. Hey Prof,

    You've missed a label off this post.
    Please add under 'masochism'.

  30. Simon,

    Here is a recent economic paper

    ‘Maximizing Currency Stability in a Market Economy’ that Warren co authored with Professor Damiano Silipo

    It uses the job guarantee wage as the price anchor.

    Please read then provide a critque.


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