by From Lars Syll Even as it became conventional wisdom, the supposed relationship between unemployment and increasing or decreasing rates of inflation was breaking down — notably in the 1990s. Unemployment got below 4 percent in 2000 without inflation taking off. Since the onset of Great Recession, the gap between theory and reality has only grown … Once 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. Indeed, since 2014 we are seeing an increase in the share of the economy that goes to labor. Even better, lower unemployment doesn’t just help workers: It can spur overall growth.
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from Lars Syll
Even as it became conventional wisdom, the supposed relationship between unemployment and increasing or decreasing rates of inflation was breaking down — notably in the 1990s. Unemployment got below 4 percent in 2000 without inflation taking off. Since the onset of Great Recession, the gap between theory and reality has only grown …
Once 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. Indeed, since 2014 we are seeing an increase in the share of the economy that goes to labor.
Even better, lower unemployment doesn’t just help workers: It can spur overall growth. As the economist J.W. Mason argues, as we approach full employment incentives emerge for greater investment in labor-saving productivity, as companies seek to keep labor costs in check as workers demand more. This productivity increase stimulates yet more growth.
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.
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 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.