Academic journal article
By Tootell, Geoffrey M. B.
New England Economic Review
Recent news stories about corporate downsizing have increased concerns that the labor market is being permanently restructured. The press implicitly, and some economists explicitly, have concluded that this "restructuring" in the labor market has increased the rate of unemployment that is consistent with stable inflation. (This rate is known as the NAIRU, the non-accelerating-inflation rate of unemployment, the unemployment rate below which inflation tends to rise, and above which inflation tends to fall.) This article examines both macroeconomic data and more disaggregated data in search of evidence for such a conclusion. It finds that neither type of data supports a conclusion that the NAIRU has risen in the past few years.
The policy implications of this debate are significant. Knowledge of the level of the NAIRU is important to monetary policy formation; it helps define the short-run trade-off between unemployment and inflation. If unemployment is below the NAIRU, eventually, inflation will increase; if it is above the NAIRU, inflation will eventually decline. Unless the actual level of inflation is above the desired level, any unemployment above the NAIRU is a waste of resources; the lost output associated with the higher level of unemployment will not move inflation toward its desired level. On the other hand, if inflation is higher than its desired level, unemployment must rise above the NAIRU if the level of inflation is to decline. Thus, knowledge of the level of the NAIRU increases the Federal Reserve's ability to reach its inflation target.(1)
Recent articles by Motley (1990) and Weiner (1993) have suggested that the NAIRU is currently higher than traditional estimates. These studies draw this conclusion by examining macro data in a Phillips curve framework. Neither the approach nor the debate is particularly new; in the late 1970s and early 1980s instability in the Phillips curve was used as evidence for an increase in the NAIRU.(2) However, this study's examination of the Phillips curve provides little support for the conclusion that the NAIRU has increased. Phillips curve estimates of the NAIRU are found to hover around the historical estimate of 5.7 percent.(3)
Even if the historical macro evidence does not show that the NAIRU has increased, a structural break in the relationship between unemployment and inflation may still have occurred recently; insufficient time may have elapsed for this structural break to reveal itself in the macro data. Consequently, this study examines several hypotheses offered to explain why the NAIRU may have changed recently.
One such hypothesis suggests that defense downsizing, along with its postulated increase in interindustry employment variance, has increased the mismatch between the skills demanded and the skills possessed in the labor market--the skills mismatch theory. Alternatively, it has been suggested that the variation in economic activity between regions of the United States has risen; thus, increased interregional variation has increased the geographical mismatch between the unemployed and the vacant jobs. Either of these two occurrences could raise structural unemployment and the NAIRU. However, recent movements in both the interregional and intersectoral variances provide little support for the hypothesis that the NAIRU has increased.
The remainder of this article presents the relevant data in this debate. The first section examines the evidence contained in the macro data. The second section examines some of the more frequently cited reasons for a recent structural shift in the labor market. Neither type of data supports the hypothesis that the NAIRU has risen. The third section concludes with a brief assessment of the difficulties of estimating the NAIRU.
I. The Macro Evidence
In two recent articles, Motley (1990) and Weiner (1993) resurrected a debate that occurred in the 1970s, finding instability over time in the Phillips curve relationship. …