NAIRU — a long-run equilibrium slippery eel

14 June, 2016 at 17:09 | Posted in Economics | 1 Comment

The concept of equilibrium, of course, is an indispensable tool of analysis … But to use the equilibrium concept one has to keep it in place, and its place is strictly in the preliminary stages of an analytical argument, not in the framing of hypotheses to be tested against the facts, for we know perfectly well that we shall not find facts in a state of equilibrium. Yet many writers seem to conceive the long-period as a date somewhere in the future that we shall get to some day …

210578Long-run equilibrium is a slippery eel. Marshall evidently intended to mean by the long period a horizon which is always at a certain distance in the future, and this is a useful metaphor; but he slips into discussing a position of equilibrium which is shifted by the very process of approaching it and he got himself into a thorough tangle by drawing three-dimensional positions on a plane diagram.

No one would deny that to speak of a tendency towards equilibrium that itself shifts the position towards which it is tending is a contradiction in terms. And yet it still persists. It is for this reason that we must attribute its survival to some kind of psychological appeal that transcends reason.

 

The existence of long-run equilibrium is a very handy modeling assumption to use. But that does not make it easily applicable to real-world economies. Why? Because it is basically a timeless concept utterly incompatible with real historical events. In the real world it is the second law of thermodynamics and historical — not logical — time that rules.

Is long-run equilibrium really a good guide to macroeconomic policy? Friedman’s NAIRUvian long run and the more strictly classical natural rate, based on rational expectations, are certainly beguiling. But are they relevant? Information may be asymmetric. Competition may be monopolistic. Nonlinearities and even chaos are possible. Equilibria may be multiple or continuous. In such cases, the long-run equilibrium may be undetermined or incalculable or beyond achievement. To put it another way, the future may be inherently unpredictable. Here, the political scientists with their concept of “rational ignorance” may have something to teach economists.

James K. Galbraith

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  1. The subject of equilibrium has been badly treated in regard to macroeconomics. Some wrongly claim that it is not the right way to base ones analytic thoughts.
    In fact a government never achieves it, yet (and this should be the main approach) a government should always be trying to get its social system close to an equilibrium state. So what seems to me to be significant is how close at any moment the system is to achieving a perfect balance, and where the changes best need to be made so that there is a trend away from any current imbalance condition.


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