NAIRU — a harmful fairy tale

2 Jan, 2021 at 10:24 | Posted in Economics | 19 Comments

The NAIRU story has always had a very clear policy implication — 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.

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Althouigh a lot of mainstream economists and politicians have a touching faith in the NAIRU fairy tale, it doesn’t hold water when scrutinized.

One of the main problems with NAIRU is that it is essentially a timeless long-run equilibrium attractor to which actual unemployment (allegedly) has to adjust. 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 equlibrium will be without contextualizing unemployment in real historical time. And when we do, we will 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 refering to NAIRU.

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

NAIRU wisdom holds that a rise in the (real) interest rate will only affect inflation, not structural unemployment. We argue instead that higher interest rates slow down technological progress – directly by depressing demand growth and indirectly by creating additional unemployment and depressing wage growth.

As a result, productivity growth will fall, and the NAIRU must increase. In other words, macroeconomic policy has permanent effects on structural unemployment and growth – the NAIRU as a constant “natural” rate of unemployment does not exist.

This means we cannot absolve central bankers from charges that their anti-inflation policies contribute to higher unemployment. They have already done so. Our estimates suggest that overly restrictive macro policies in the OECD countries have actually and unnecessarily thrown millions of workers into unemployment by a policy-induced decline in productivity and output growth. This self-inflicted damage must rest on the conscience of the economics profession.

19 Comments

  1. Full employment can create growing producttivity, by technological progress under certain cicumstances. The development of Sweden from (at least) 1870 up to GLOBCAP, the globalization of capitalism, is a very good example, as the curve isn’t complicated by war. But growing producttivity is not in the interest of capital in the long run. One of the effects of growing productivity is diminishing need for investment and diminishing returns from investment. http://www.fredtorssander.se/fredpress/2020/02/29/a-non-monetary-graphical-description-of-the-productivity-growth-in-sweden-1870-2017/

  2. I’m confused about this labour market vs labour pool thingy … is it just me.

  3. NAIRU is debunked at least 100 times, but still seam to live on in at least some circles!It´s a scam! Dust in your rust Milton Friedman!

    • NAIRU is a useful lie. The truth in the matter is not quite as useful for orthodox economics. “Taking them as a whole, the general movements of wages are exclusively regulated by the expansion and contraction of the industrial reserve army, and these again correspond to the periodic changes of the industrial cycle. They are, therefore, not determined by the variations of the absolute number of the working population, but by the varying proportions in which the working class is divided into active and reserve army, by the increase or diminution in the relative amount of the surplus population, by the extent to which it is now absorbed, now set free.”
      NAIRU is amainly a method to use macro economic engineering that together with migration hinders labor from regaining some of their losses when the market gets “overheated”.

    • And the idea that the Earth is round rather than flat has doubtless been debunked at least a hundred times.

      • not by any credible debunking

  4. So there’s no NAIRU – i.e. no relationship between inflation and unemployment?? This is truely wondrous news: it means we can bump up demand to sky high levels and reduce unemployment to near zero and apparently there’ll be no increase in inflation as a result. Whoever though up this amazing idea deserves a Nobel prize (I don’t think).

    • Certainly there is a relationship between inflaion an unemployment. It is placed on the level that that governementt and the market decides to place it. https://ekonomistas.files.wordpress.com/2014/05/figure-10-unemployment-inflation-phillips-curve.png

      • All your chart shows is that there is a lot of background noise, and that a clear relationship between inflation and unemployment is not easy to discern. Doubtless there’s a relationship between how long peoples’ finger nails are and how fast they can run because long finger nails add weight to a human body and offer more air resistance when someone is running. But I suspect it would be very hard to prove a relationship between the length of peoples’ finger nails and how fast they can run.

        • The curve shows how changed market and governemetal policies can transport the area of variation from under 4 percent unemployment and about 3 to 15 percent inflation before 1990 to above 5,5 percent unemployment therafter, and then inflation in the region of +5 to – 2 percent. But of cause one could claim that not only the cange of area of variation but also the relationship between inflation and unemployment is a result of market and governement agreements and regulation? In which case NAIRU may only be about combatting the tendencie of rate of profit to fall. Something I find quite probable.

        • It would not be too hard to determine both those relationships in running. The keys would be maintaining muscle mass and running shape while changing the weight. Both of these could also be modeled using analytical or finite element models. The fingernail one is probably pretty small, as batons do not cause much difference in runners speed. Weight would depend on how the weight is added. Muscle mass added to the key groups of muscles that move the arms and legs would help the runner, fat probably would hurt depending on what type of eating led to the fat

    • NAIRU is a particular postulated relationship between unemployment and inflation. That it doesn’t exist does not imply that there is no relationship. MMT suggests that full employment is a threshold, below it demand-pull inflation is unlikely, above it more demand will cause inflation.

      • So you’re agreeing with the BASIC idea behind NAIRU, i.e. that there’s a relationship between inflation and unemployment, but not with some more narrow definition of NAIRU (e.g. that it includes the “acceleration” concept – as per the “A” in NAIRU). Well that’s quite possibly correct, but the trouble is you don’t tell us what your narrow definition is, and nor does the above article. Plus a large majority of criticisms of NAIRU do not specify a narrow definiton either, i.e. (by implication) they criticise the BASIC idea, i.e. that there’s a relationship between inflation and unemployment.

  5. NAIRU is just another made-up theory of mainstream economics that does not comport with reality. Time for something better.

  6. Someone tell us what nairu stands for?

    • Non-accelerating inflation rate of unemployment

      • Thank you

  7. Read The Deficit Myth by Stephanie Kelton. It gives a brilliant new perspective on our bumbling attempts at practicing ‘Economics’ in this world

  8. I’m much amused by Storm and Naastepad’s claim that slower “technological progress” creates “additional unemployment”. Perhaps they can explain why when technology was no near as advanced as it is today (e.g. 100 or 200 years ago) unemployment levels were very similar to those we see today.


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