NAIRU — a non-existent unicorn

30 Jun, 2020 at 17:27 | Posted in Economics | 8 Comments

powemp3In our extended NAIRU model, labor productivity growth is included in the wage bargaining process … The logical consequence of this broadening of the theoretical canvas has been that the NAIRU becomes endogenous itself and ceases to be an attractor — Milton Friedman’s natural, stable and timeless equilibrium point from which the system cannot permanently deviate. In our model, a deviation from the initial equilibrium affects not only wages and prices (keeping the rest of the system unchanged) but also demand, technology, workers’ motivation, and work intensity; as a result, productivity growth and ultimately equilibrium unemployment will change. There is in other words, nothing natural or inescapable about equilibrium unemployment, as is Friedman’s presumption, following Wicksell; rather, the NAIRU is a social construct, fluctuating in response to fiscal and monetary policies and labor market interventions. Its ephemeral (rather than structural) nature may explain why the best economists working on the NAIRU have persistently failed to agree on how high the NAIRU actually is and how to estimate it.

Servaas Storm & C. W. M. Naastepad

Many politicians and economists subscribe to the NAIRU story and its policy implication that attempts to promote full employment is doomed to fail since governments and central banks can’t push unemployment below the critical NAIRU threshold without causing harmful runaway inflation.

Although this may sound convincing, it’s totally wrong!

One of the main problems with NAIRU is that it essentially is a timeless long-run equilibrium attractor to which actual unemployment (allegedly) has to adjust. But if that equilibrium is itself changing — and in ways that depend on the process of getting to the equilibrium — well, then we can’t really be sure what that equilibrium will be without contextualizing unemployment in real historical time. And when we do, we will — as highlighted by Storm and Naastepad — see how seriously wrong we go if we omit demand from the analysis. Demand policy has long-run effects and matters also for structural unemployment — and governments and central banks can’t just look the other way and legitimize their passivity re unemployment by referring to NAIRU.

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.

This importantly means that long-run equilibrium is an awfully bad guide for macroeconomic policies. In a world full of genuine uncertainty, multiple equilibria, asymmetric information, and market failures, the long-run equilibrium is simply a non-existent unicorn.

NAIRU does not hold water simply because it does not exist — and to base economic policies on such a weak theoretical and empirical construct is nothing short of writing out a prescription for self-inflicted economic havoc.

NAIRU is a useless concept, and the sooner we bury it, the better.

8 Comments

  1. “In the real world, it is the second law of thermodynamics and historical — not logical — time that rules.”
    .
    Thermodynamics assumes no quantum or scale effects, therefore the second law is severely restricted. (Thermodynamics 101 assumptions here: http://subbot.org/edx/thermodynamics/assumptions.png ). Thermodynamic practitioners make no claims about their laws’ applicability beyond, essentially, steam engines.
    .
    NAIRU is wrong because supply chains are payment chains in reverse. Payments create supplies; inflation is a noisy interruption in payment flows, easily dealt with by the Fed supplying as much liquidity as desired. Public policy should treat unemployment with basic income and challenges to advance knowledge in individual or ad hoc group ways …

    • It might help to deal with the complexity of humanity rather than resort to over simplification when setting an imaginary baseline.

      In case you missed it – natural, stable and timeless equilibrium

      • “over simplification when setting an imaginary baseline” came to mind when reading the Vickrey quote in a subsequent blog post. Vickrey said:
        .
        “the function of government debts that is significant for the macroeconomic health of an economy is that they provide the assets into which individuals can put whatever accumulated savings they attempt to set aside in excess of what can be wisely invested in privately owned real assets.”
        .
        But this is not how the real world works. Savers invest in money market funds which return them interest by borrowing in repo using government debt. We have to talk bout today’s finance, rather than over simplify based on imaginary baselines. “Full employment” is another imaginary baseline. When Lars says that mainstream macroeconomics is rigorously irrelevant, he should include the mainstream macroeconomic goals of full employment and price stability.

  2. Unemployment is a way to raise the profits from exploiting labour. That is the reason for the establishing and continuing adherence to the nairu ideology. Full employment on the other hand, was a method to legetimate continued capitalist rule – and colonial warfare – in the face of the progress in the early socialistic Soviet-state, and later the socialist bloc. The dismantlig of full employment policies and establishing of nairu as a part of capitalistic globalization has made that rather evident. http://www.fredtorssander.se/fredpress/2020/02/29/a-non-monetary-graphical-description-of-the-productivity-growth-in-sweden-1870-2017/

    • Unemployment is a way to raise the profits from exploiting labour??? In that case you’d expect to see profits rise when unemployment rises. In fact it doesn’t: it does the REVERSE. That is, during a boom, profits rise and unemployment falls.

      Now all anti-capitalists will be crying their eyes over that akward fact…:-)

      • It can do. For example critics of globalisation argue that associated automation or very large inward labour flows through economic migration suppresses wages, and therefore increase profits accruing to capital. Higher employment and shortages of labour could increase labour costs, therefore reducing profit. Corporations under this line of argument prefer a continual supply of surplus labour.

        As with all these issues (including the one that countries with their own currencies need not worry about government debt accumulation, irrespective of what currency and what country) these issues complex, and require a proper (historically informed and model free) ground up discussion.

      • “In that case you’d expect to see profits rise when unemployment rises.”

        Why? The comment referred to unemployment as a stock. No mention about it rising (a change in flow).

  3. It’s a dangerous concept. It just gives New-Keynesian macroeconomists an excuse to use Model and go on estimating output gaps. But inflation could be caused by specific or sectoral problems within the economy and have nothing to do with the overall level of employment.You could have loose liquidity and unemployment. It is yet another device that stops us finding the real problems for the sake of preserving Model. And it comes at a large social cost.


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