The NAIRU Delusion

Article excerpt

The hypothesis that there is a natural rate of unemployment (or a nonaccelerating-inflation rate of unemployment) is probably accepted in one form or another by the great majority of professional economists in the United States today and by the politicians, businesspeople, bankers, speculators, and journalists who are influenced by them. The acceptance of the hypothesis is in fact so general that it has become treated almost as an axiom in discussions of national and international policies that adversely affect the lives of millions of men and women throughout the world.

In considering this hypothesis (or any other proposition in economics), the underlying argument may be stated as a disjunction: (1) Either economics is, as used to be said, one of the "moral sciences," that is, a normative discipline, or it is not. (2) If it is not normative--if instead, as many now say, it is actually or analogously a hard science--it has no business dabbling in public policies, because a natural economic system would be as imperivious to criticism as is the solar system. (3) If, however, economics is a normative discipline--if it studies a historical and necessary aspect of the conduct of life--the natural rate hypothesis must be considered ethical doctrine. Thus, this paper is addressed not only to the question of the validity of the hypothesis, but also to the implications of the hypothesis for the moral obligations of economists as individuals and for the morale of the profession as a whole.

Although the search for "natural" processes in society goes back beyond Adam Smith, at least to Hobbes, our particular story begins, as does so much of modern economics, with a perverse reading of Keynes. In contradiction of the "classics," Keynes wrote that "we oscillate, avoiding the gravest extremes of fluctuation in employment and in prices in both directions, round an intermediate position appreciably below full employment and appreciably above the minimum employment a decline below which would endanger life." Keynes emphasized that he was reporting "a fact of observation concerning the world as it is or has been, and not a necessary principle which cannot be changed" [Keynes 1936, 254], but the natural rate theory, as it developed 20 years later, has talked of necessity and discounted or disregarded change.

A Question of Definition

At the outset, let it be recognized that there is no the natural rate hypothesis. There are almost as many hypotheses as there are hypothesizers. For a few examples: The paper that may be said to have been the empirical base of the hypothesis concluded that price stability required a certain level of productivity growth as well as certain levels of wages and unemployment [Phillips 1958, 299]. The paper that first used the term "the natural rate of unemployment" based its analysis on an interplay between real and nominal wages and real and nominal prices but made no mention of productivity [Friedman 1968, 7-11]. An early technical symposium likewise disregarded productivity [Phelps 1970]. In a later prominent graduate-school textbook, the rate of change of productivity is the sole term on the right-hand side of the ultimate equation [Blanchard and Fischer 1989, 544]. An encyclopedia article presents four equations for the natural rate, but there is no term in any of them that concerns productivity or the price level or inflation or the acceleration thereof, instead they concern frictional unemployment, structural unemployment, and what is called contractual unemployment (to explain why insiders with jobs are paid more than outsiders would be willing to work for) [Haltiwanger 1988]. A highly regarded think tank hosted a conference on the natural rate during which inflation was mentioned only in a question from the floor that apparently went unanswered [Juhn, Murphy, and Topel 1991, 138]. An author, who presents himself as spokesperson for mainstream economics praises the natural rate's christener for predicting the long-run Phillips curve (supposed to be vertical) and then reproduces the U. …