NAIRU — closer to religion than science

5 Jan, 2021 at 10:55 | Posted in Economics | 5 Comments

phillips-curve-lr-1Once we see how weak the foundations for the natural rate of unemployment are, other arguments for pursuing rates of unemployment economists once thought impossible become more clear. Wages can increase at the expense of corporate profits without causing inflation …

The harder we push on improving output and employment, the more we learn how much we can achieve on those two fronts. That hopeful idea is the polar opposite of a natural, unalterable rate of unemployment. And it’s an idea and attitude that we need to embrace if we’re to have a shot at fully recovering from the wreckage of the Great Recession.

Mike Konczal / Vox

NAIRU does not hold water simply because it has not existed for the last 50 years. But still today ‘New Keynesian’ macroeconomists use it — and its cousin the Phillips curve — as a fundamental building block in their models. Why? Because without it ‘New Keynesians’ have to give up their — again and again empirically falsified — neoclassical view of the long-run neutrality of money and the simplistic idea of inflation as an excess-demand phenomenon.

The NAIRU approach is not only of theoretical interest. Far from it.

The real damage done is that policymakers that take decisions based on NAIRU models systematically tend to implement austerity measures and kill off economic expansion. Peddling this flawed illusion only gives rise to unnecessary and costly stagnation and unemployment.

Defenders of the [NAIRU theory] might choose to respond to these empirical findings by arguing that the natural rate of unemployment is time varying. But I am unaware of any theory which provides us, in advance, with an explanation of how the natural rate of unemployment varies over time. In the absence of such a theory the [NAIRU theory] has no predictive content. A theory like this, which cannot be falsified by any set of observations, is closer to religion than science.

Roger Farmer

5 Comments

  1. The Swedish Riksbank admitted in 2012 that NAIRU-level can’t even be calculated afterwards with any precision. And Riksbanken is the institution that decides the level in Sweden. Quis custodiet ipsos custodes? The market? The politicians have accepted the EU gag.
    “… går det alltså inte att ens i efterhand bestämma jämviktsarbetslöshetens nivå…” http://archive.riksbank.se/Documents/Tal/Wickman_Parak/2012/tal_120124_sve.pdf

  2. Both Roger Farmer and fredtorssander (above) make the common accusation against NAIRU, namely that it is devoid of predictive power, or any sort of ACCURATE predictive power.

    The fact that an idea cannot be use to make accurate predictions does not invalidate the basic idea. Herd immunity, or if you like “survival of the fittest” is a device that has been used by mother nature for millions of years to enable species to deal with viruses and bacteria. The fact that it is not possible to predict with any accuracy just what proportion of a species has to be wiped out before the species gains effective immunity to a bacteria or virus does not invalidate the basic herd immunity idea.

    • Best argument against NAIRU:
      .
      Inflation does not matter. The Fed can use open market operations to buy and sell inflation swaps, and Treasury Inflation Protected Securities, so as to manipulate inflation expectations (i.e. inflation swap breakeven rates) to whatever they wish. Cost Of Living Adjustments guarantee real income purchasing power stability no matter how high or how fast inflation rises. TIPS protect savings. Inflation is a solved problem and need be no constraint on public policy.

    • I am certain that the NAIRU-motivated decisions that the Swedish Riksbank makes has a predictive power. Actually I think they should be seen as decisions – period. And that the real motivation for those decisions can only be found by the classic question: Cui Bono. But it might be interesting to learn if and how the calculated NAIRU also makes some difference. It would be hard to prove though.

    • You can however, relatively easily show that herd immunity exists after the fact, and you can show what proportion of a population needs to be immune for herd immunity to occur, epidemiologists have been doing that recently for Covid. You can’t do similar very well, if at all with NAIRU.

      Also, lack of accurate predictive power does mean you shouldn’t use any of the predictions made using that model


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