Higher NAIRU doesn’t equal higher interest rates
Goldman Sachs analyst Peter Berezin is jumping into the debate about the impact of a rising NAIRU – a measure of unemployment equilibrium. Felix Salmon posted on it here back on Sept. 29 and quoted PIMCO’s Mohamed El-Erian saying that 7% seems “reasonable.”
Berezin notes that the CBO estimates NAIRU at 4.8%. If it increases to the 5.8% used in the early 1990s, it still wouldn’t have a meaningful impact on the Fed’s monetary policy, which is why people care about NAIRU in the first place. Berein says a 1 percentage point jump in NAIRU should lead to a corresponding 2 percentage point increase in the Fed funds rate. That would take the so-called optimal fed funds rate (which takes into consideration the extraordinary measures like quantitative easing) to -3.5% from -5.5%. Even using El-Erian’s “reasonable” 7% level would still keep the optimal fed funds in the negative.
Given the significant amount of excessive capacity in the economy, both in the labour market and in the utilization of productive capital, an increase in the NAIRU – provided that it is temporary – is unlikely to have a bearing on the outlook for Fed policy over the coming several quarters. In other words, when the unemployment rate is heading to 10% even a sizable increase in NAIRU is unlikely to imply a positive optimal Fed Funds Rate. This supports our view that the Fed is likely to keep rates on hold at least through to 2011.
Berezin figures inflated NAIRU will prove temporary in the long run as those who lost their jobs after the housing market imploded will eventually find employment elsewhere.