NAIRU

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NAIRU is an acronym for non-accelerating inflation rate of unemployment, [1] and refers to a theoretical level of unemployment below which inflation would be expected to rise. [2] It was first introduced as NIRU (non-inflationary rate of unemployment) by Franco Modigliani and Lucas Papademos in 1975, as an improvement over the "natural rate of unemployment" concept, [3] [4] [5] which was proposed earlier by Milton Friedman. [6]

An acronym is a word or name formed as an abbreviation from the initial components of a phrase or a word, usually individual letters, as in NATO or SCUBA and sometimes syllables.

Unemployment People without work and actively seeking work

Unemployment, or joblessness, is a situation in which able-bodied people who are looking for a job cannot find a job.

Inflation increase in the general price level of goods and services in an economy over a period of time

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time. The opposite of inflation is deflation.

Contents

Monetary policy conducted under the assumption of a NAIRU typically involves allowing just enough unemployment in the economy to prevent inflation rising above a given target figure. Prices are allowed to increase gradually and some unemployment is tolerated.

Monetary policy subclass of the economic policy

Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the money supply, often targeting inflation or the interest rate to ensure price stability and general trust in the currency.

Origins

An early form of NAIRU is found in the work of Abba P. Lerner ( Lerner 1951 , Chapter 14), who referred to it as "low full employment" attained via the expansion of aggregate demand, in contrast with the "high full employment" which adds incomes policies (wage and price controls) to demand stimulation. Friedrich von Hayek argued that governments attempting to achieve full employment would accelerate inflation because some people's skills were worthless. [7]

Abba P. Lerner American economist

Abraham "Abba" Ptachya Lerner was a Russian-born British economist.

The concept arose in the wake of the popularity of the Phillips curve which summarized the observed negative correlation between the rate of unemployment and the rate of inflation (measured as annual nominal wage growth of employees) for a number of industrialised countries with more or less mixed economies. This correlation (previously seen for the U.S. by Irving Fisher) persuaded some analysts that it was impossible for governments simultaneously to target both arbitrarily low unemployment and price stability, and that, therefore, it was government's role to seek a point on the trade-off between unemployment and inflation which matched a domestic social consensus.

The Phillips curve is a single-equation economic model, named after William Phillips, describing an inverse relationship between rates of unemployment and corresponding rates of rises in wages that result within an economy. Stated simply, decreased unemployment, in an economy will correlate with higher rates of wage rises. Phillips did not himself state there was any relationship between employment and inflation; this notion was a trivial deduction from his statistical findings. Samuelson and Solow made the connection explicit and subsequently Milton Friedman and Edmund Phelps put the theoretical structure in place. In so doing, Friedman was to successfully predict the imminent collapse of Phillips' a-theoretic correlation.

An industry is the production of goods or related services within an economy. The major source of revenue of a group or company is the indicator of its relevant industry. When a large group has multiple sources of revenue generation, it is considered to be working in different industries. Manufacturing industry became a key sector of production and labour in European and North American countries during the Industrial Revolution, upsetting previous mercantile and feudal economies. This came through many successive rapid advances in technology, such as the production of steel and coal.

A mixed economy is variously defined as an economic system blending elements of market economies with elements of planned economies, free markets with state interventionism, or private enterprise with public enterprise. There is no single definition of a mixed economy, but rather two major definitions. The first of these definitions refers to a mixture of markets with state interventionism, referring to capitalist market economies with strong regulatory oversight, interventionist policies and governmental provision of public services. The second definition is apolitical in nature and strictly refers to an economy containing a mixture of private enterprise with public enterprise.

During the 1970s in the United States and several other industrialized countries, Phillips curve analysis became less popular, because inflation rose at the same time that unemployment rose (see stagflation).

In economics, stagflation, or recession-inflation, is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment, and vice versa.

Worse, as far as many economists were concerned, was that the Phillips curve had little or no theoretical basis. Critics of this analysis (such as Milton Friedman and Edmund Phelps) argued that the Phillips curve could not be a fundamental characteristic of economic general equilibrium because it showed a correlation between a real economic variable (the unemployment rate) and a nominal economic variable (the inflation rate). Their counter-analysis was that government macroeconomic policy (primarily monetary policy) was being driven by a low unemployment target and that this caused expectations of inflation to change, so that steadily accelerating inflation rather than reduced unemployment was the result. The resulting prescription was that government economic policy (or at least monetary policy) should not be influenced by any level of unemployment below a critical level - the "natural rate" or NAIRU. [8]

Milton Friedman American economist, statistician, and writer

Milton Friedman was an American economist who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the complexity of stabilization policy. With George Stigler and others, Friedman was among the intellectual leaders of the second generation of Chicago price theory, a methodological movement at the University of Chicago's Department of Economics, Law School and Graduate School of Business from the 1940s onward. Several students and young professors who were recruited or mentored by Friedman at Chicago went on to become leading economists, including Gary Becker, Robert Fogel, Thomas Sowell and Robert Lucas Jr.

Edmund Phelps American economist

Edmund Strother Phelps is an American economist and the recipient of the 2006 Nobel Memorial Prize in Economic Sciences.

In economics, adaptive expectations is a hypothesized process by which people form their expectations about what will happen in the future based on what has happened in the past. For example, if inflation has been higher than expected in the past, people would revise expectations for the future.

The natural rate hypothesis

The idea behind the natural rate hypothesis put forward by Friedman was that any given labor market structure must involve a certain amount of unemployment, including frictional unemployment associated with individuals changing jobs and possibly classical unemployment arising from real wages being held above the market-clearing level by minimum wage laws, trade unions or other labour market institutions. Unexpected inflation might allow unemployment to fall below the natural rate by temporarily depressing real wages, but this effect would dissipate once expectations about inflation were corrected. Only with continuously accelerating inflation could rates of unemployment below the natural rate be maintained.

The NAIRU

The "natural rate" terminology was largely supplanted by that of the NAIRU, which referred to a rate of unemployment below which inflation would accelerate, but did not imply a commitment to any particular theoretical explanation, any particular preferred policy remedy or a prediction that the rate would be stable over time. Franco Modigliani and Lucas Papademos defined the noninflationary rate of employment (NIRU) as the rate of employment above which inflation could be expected to decline, and attempted to estimate it from empirical data [9] James Tobin suggested the reason for them choosing a different term was to avoid the "normative implications" of the concept of a 'natural' rate. [10] He also argued that the idea of a 'natural' rate of unemployment should be viewed as closely linked to Friedman's description of it as the unemployment rate emerging in general equilibrium, when all other parts of the economy clear, whereas the notion of a NAIRU was compatible with an economy in which other markets need not be in equilibrium. [10] In practice the terms can be viewed as approximately synonymous. [11]

Properties

If is the NAIRU and is the actual unemployment rate, the theory says that:

if for a few years, inflationary expectations rise, so that the inflation rate tends to increase;
if for a few years, inflationary expectations fall, so that the inflation rate tends to slow (there is disinflation); and
if , the inflation rate tends to stay the same, unless there is an exogenous shock.

Okun's law can be stated as saying that for every one percentage point by which the actual unemployment rate exceeds the so-called "natural" rate of unemployment, real gross domestic product is reduced by 2% to 3%.

The level of the NAIRU itself is assumed to fluctuate over time as the relationship between unemployment level and pressure on wage levels is affected by productivity, demographics and public policies [11] In Australia, for example, the NAIRU is estimated to have fallen from around 6% in the late 1990s to closer to 4% twenty years later in 2018. [12]

Relationship to other economic theories

Most economists do not see the NAIRU theory as explaining all inflation. Instead, it is possible to move along a short run Phillips Curve (even though the NAIRU theory says that this curve shifts in the longer run) so that unemployment can rise or fall due to changes in inflation. Exogenous supply-shock inflation is also possible, as with the "energy crises" of the 1970s or the credit crunch of the early 21st century.

The NAIRU theory was mainly intended as an argument against active Keynesian demand management and in favor of free markets (at least on the macroeconomic level). Monetarists instead support the generalized assertion that the correct approach to unemployment is through microeconomic measures (to lower the NAIRU whatever its exact level), rather than macroeconomic activity based on an estimate of the NAIRU in relation to the actual level of unemployment. Monetary policy, they maintain, should aim instead at stabilizing the inflation rate.

Criticism

Since NAIRU can vary over time, any estimates of the NAIRU at any point in time have a relatively wide margin for error, which limits its practical value as a policymaking tool. [11] As the NAIRU is inferred from levels of inflation and unemployment and the relationship between those variables is acknowledged to vary over time, some economists have questioned whether there is any real empirical evidence for it at all. [13]

The NAIRU analysis is especially problematic if the Phillips curve displays hysteresis, that is, if episodes of high unemployment raise the NAIRU. [14] This could happen, for example, if unemployed workers lose skills so that employers prefer to bid up of the wages of existing workers when demand increases, rather than hiring the unemployed.

Some economists who favour the provision of a state job guarantee, such as Bill Mitchell, have argued that a certain level of state-provided "buffer" employment for people unable to find private sector jobs, which they refer to as a NAIBER (non-accelerating inflation buffer employment ratio), [15] is also consistent with price stability.

Naming

The NAIRU, non-accelerating inflation rate of unemployment, is actually misnamed. It is the price level that is accelerating (or decelerating), not the inflation rate. The inflation rate is just changing, not accelerating. [16]

See also

Related Research Articles

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study aggregated indicators such as GDP, unemployment rates, national income, price indices, and the interrelations among the different sectors of the economy to better understand how the whole economy functions. They also develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, saving, investment, energy, international trade, and international finance.

Full employment is a situation in which everyone who wants a job can have work hours they need on "fair wages". Because people switch jobs, full employment involves a positive stable rate of unemployment. An economy with full employment might still have underemployment where part-time workers cannot find jobs appropriate to their skill level. In macroeconomics, full employment is sometimes defined as the level of employment at which there is no cyclical or deficient-demand unemployment.

Franco Modigliani Italian-American economist

Franco Modigliani was an Italian-American economist and the recipient of the 1985 Nobel Memorial Prize in Economics. He was a professor at UIUC, Carnegie Mellon University, and MIT.

New Keynesian economics is a school of contemporary macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.

This aims to be a complete article list of economics topics:

The natural rate of unemployment is the name that was given to a key concept in the study of economic activity. Milton Friedman and Edmund Phelps, tackling this 'human' problem in the 1960s, both received the Nobel Prize in economics for their work, and the development of the concept is cited as a main motivation behind the prize. A simplistic summary of the concept is: 'The natural rate of unemployment, when an economy is in a steady state of "full employment", is the proportion of the workforce who are unemployed'. Put another way, this concept clarifies that the economic term "full employment" does not mean "zero unemployment". It represents the hypothetical unemployment rate consistent with aggregate production being at the "long-run" level. This level is consistent with aggregate production in the absence of various temporary frictions such as incomplete price adjustment in labor and goods markets. The natural rate of unemployment therefore corresponds to the unemployment rate prevailing under a classical view of determination of activity.

Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists, attempted to interpret and formalize Keynes' writings and to synthesize it with the neo-classical models of economics. Their work has become known as the neo-classical synthesis and created the models that formed the core ideas of neo-Keynesian economics. These ideas dominated mainstream economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 1960s and 1970s.

Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption. Neutrality of money is an important idea in classical economics and is related to the classical dichotomy. It implies that the central bank does not affect the real economy by creating money. Instead, any increase in the supply of money would be offset by a proportional rise in prices and wages. This assumption underlies some mainstream macroeconomic models. Others like monetarism view money as being neutral only in the long-run.

A job guarantee (JG) is an economic policy proposal aimed at providing a sustainable solution to the dual problems of inflation and unemployment. Its aim is to create full employment and price stability, by having the state promise to hire unemployed workers as an employer of last resort (ELR).

History of macroeconomic thought

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

Inflationism is a heterodox economic, fiscal, or monetary policy, that predicts that a substantial level of inflation is harmless, desirable or even advantageous. Similarly, inflationist economists advocate for an inflationist policy.

In economics, hysteresis refers to effects that persist after the initial causes giving rise to the effects are removed. Two of the main areas in economics where hysteresis effects are invoked to explain economic phenomena are unemployment and international trade.

The Lucas aggregate supply function or Lucas "surprise" supply function, based on the Lucas imperfect information model, is a representation of aggregate supply based on the work of new classical economist Robert Lucas. The model states that economic output is a function of money or price "surprise". The model accounts for the empirically based trade off between output and prices represented by the Phillips curve, but the function breaks from the Phillips curve since only unanticipated price level changes lead to changes in output. The model accounts for empirically observed short-run correlations between output and prices, but maintains the neutrality of money in the long-run. The policy ineffectiveness proposition extends the model by arguing that, since people with rational expectations cannot be systematically surprised by monetary policy, monetary policy cannot be used to systematically influence the economy.

<i>Full Employment Abandoned</i> 2008 book by William Mitchell & Joan Muysken

Full Employment Abandoned: Shifting Sands and Policy Failures is a book on macroeconomic issues, written by economists William Mitchell & Joan Muysken and first published in 2008.

NAIBER is an acronym for non-accelerating inflation buffer employment ratio and refers to a systemic proposal for an in-built inflation control mechanism devised by economists Bill Mitchell and Warren Mosler, and advocated by Modern Money Theory as replacement for NAIRU. The concept of NAIBER is related to the idea of a Job Guarantee aimed to create full employment and price stability, by having the state promise to hire unemployed workers as an employer of last resort (ELR).

References

  1. Coe, David T, Nominal Wages. The NAIRU and Wage Flexibility. (PDF), Organisation for Economic Co-operation and Development
  2. https://www.vox.com/2014/11/14/7027823/nairu-natural-rate-unemployment
  3. Modigliani, Franco; Papademos, Lucas (1975). "Targets for Monetary Policy in the Coming Year". Brookings Papers on Economic Activity . The Brookings Institution. 1975 (1): 141–165. doi:10.2307/2534063. JSTOR   2534063.
  4. Robert M. Solow, Modigliani and Monetarism, p. 6.
  5. Snowdon, Brian; Vane, Howard R. (2005). Modern Macroeconomics: Its Origins, Development and Current State. Cheltenham: E. Elgar. p. 187. ISBN   1-84376-394-X.
  6. Friedman, Milton (1968). "The Role of Monetary Policy". American Economic Review . 58 (1): 1–17. JSTOR   1831652.
  7. FA Hayek, ‘Full Employment, Planning and Inflation’ (1950) 4(6) Institute of Public Affairs Review 174. E McGaughey, 'Will Robots Automate Your Job Away? Full Employment, Basic Income, and Economic Democracy' (2018) SSRN, part 2(1), 5
  8. Hoover, Kevin D, "Phillips Curve", The Concise Encyclopedia of Economics, The Library of Economics and Liberty, retrieved 16 July 2007
  9. Modigliani, Franco; Papademos, Lucas (1975). "Targets for Monetary Policy in the Coming Year". Brookings Papers on Economic Activity . The Brookings Institution. 1975 (1): 141–165. doi:10.2307/2534063. JSTOR   2534063.
  10. 1 2 Tobin, James (April 1997). "SUPPLY CONSTRAINTS ON EMPLOYMENT AND OUTPUT: NAIRU VERSUS NATURAL RATE" (PDF). Cowles Foundation Discussion Paper. Retrieved 8 June 2018.
  11. 1 2 3 "The NAIRU in Theory and Practice" (PDF). Journal of Economic Perspectives. 16 (4): 115-136. 2002. Retrieved 8 June 2018.
  12. See the discussion about problems of estimating the NAIRU in Australia in Luci Ellis, 'Watching the invisibles: The 2019 Freebairn Lecture in Public Policy', Reserve Bank of Australia, 12 June 2019.
  13. E McGaughey, 'Will Robots Automate Your Job Away? Full Employment, Basic Income, and Economic Democracy' (2018) SSRN, part 2(1). SP Hargreaves Heap, ‘Choosing the Wrong ‘Natural’ Rate: Accelerating Inflation or Decelerating Employment and Growth?’ (1980) 90(359) Economic Journal 611. K Clark and L Summers, ‘Labour Force Participation: Timing and Persistence’ (1982) 49(5) Review of Economic Studies 825.
  14. Ball, Laurence (2009), Hysteresis in Unemployment: Old and New Evidence (PDF)
  15. William Mitchell, J. Muysken (2008), Full employment abandoned: shifting sands and policy failures, Edward Elgar Publishing, ISBN   1-85898-507-2
  16. Case, K.E. and Fair, R.C. and Oster, S.M. (2016). Principles of Macroeconomics. Pearson. ISBN   9780133023671.CS1 maint: Multiple names: authors list (link)

Further reading