What’s happened to Nairu?

By Felix Salmon
September 29, 2009
Rich Miller reported yesterday that a number of luminaries have diagnosed a significant upwards move in Nairu, the rate of unemployment below which inflation starts kicking in -- or, to put it another way, the level of unemployment which the Fed should consider to constitute "full employment". They include JP Morgan's chief economist Bruce Kasman; Harvard's Lawrence Katz; and Ned Phelps, who got his Nobel for looking at such things.


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Rich Miller reported yesterday that a number of luminaries have diagnosed a significant upwards move in Nairu, the rate of unemployment below which inflation starts kicking in — or, to put it another way, the level of unemployment which the Fed should consider to constitute “full employment”. They include JP Morgan’s chief economist Bruce Kasman; Harvard’s Lawrence Katz; and Ned Phelps, who got his Nobel for looking at such things.

Against that, notes Miller, the Fed doesn’t seem to think that Nairu has increased at all.

One of the people Miller quotes as believing that Nairu has risen is Pimco CEO Mohamed El-Erian. I asked him for a bit more detail on his thinking, firstly on what causes changes in Nairu. He replied:

A number of factors are contributing to the increase in theNAIRU. They include:

First, lower labor mobility which, in part, is due to the poor state of the housing market where negative equity positions are hindering what has traditionally been a geographically flexible job hunting process.

Second, the elimination of activities that were facilitated by turbo-charged and unsustainable Wall Street credit factories. These activities that can no longer be supported in a de-levering and de-risking world.

Third, industries–such as autos, finance, and real estate–that are experiencing a major size reset after a period of over-expansion

Fourth, an erosion of skills as people are unemployed for longer

Fifth, the ongoing re-alignment of the global economy in the context of overall over-capacity

All this points to a worrisome picture for unemployment. High rates of unemployment will persist for longer; and the reversion will be to a higher NAIRU. As I noted in today’s FT column, this has implications for the sustainability of the growth recovery, the robustness of social safety nets and other aspects of the social contract, and the mobilization of political support for longer-term structural reforms.

El-Erian also confirmed for me that he reckons a 7% Nairu “sounds reasonable” — well above the 4.8%-5% that the Fed seems to be using.

Determinations of Nairu are always more of an art than a science, but it does seem reasonable to assume that the reasons El-Erian outlines would bring it up. In turn, that’s going to raise problems for right-leaning economists and politicians, who are going to find it harder to extol the abilities of the free market to find employment for all, and thereby dismiss claims that we need to provide a robust social safety net for the millions of Americans who can’t find jobs.

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Comments
11 comments so far

http://econospeak.blogspot.com/2009/09/w hy-capitalism-fails-and-minsky-punts.htm l – “have the government act as employer of last resort, guaranteeing a job to anyone who wanted one”

it _is_ part of the fed’s mandate afterall! (…and posner is on board ;) http://www.tnr.com/article/how-i-became- keynesian

Posted by glory | Report as abusive

“…that’s going to raise problems for right-leaning economists and politicians, who are going to find it harder to extol the abilities of the free market to find employment for all…”

Since we don’t actually HAVE a free market, I don’t see how this is relevant. Now, if you meant to say that left-leaning economists and politicians will have problems extolling the abilities of third-way socialism to find employment for all, then you would have a point.

Posted by Noah Yetter | Report as abusive

Really? People still believe in the NAIRU?

Posted by wait...what? | Report as abusive

You see, if it wasn’t for the tech bubble, we wouldn’t have had to spend the surplus on deregulating wallstreet, which led to the collapse because democrats who were never in charge wanted to give mansions to ACORN. Or something.
Smoke a little crack, and it will start to make sense…

Posted by conservarue | Report as abusive

This implies that inflation is driven by wages. Given that wages have essentially been flat for long periods now, it is reasonable to ask whether there are other causes for inflation – such as resource limitations (oil), expansion of the money supply (dollar), and the interaction between the two.

High rates of unemployment will persist for longer – by fiat, not as a consequence of decisions and actions by those in power, not because of redistribution of wealth that is neither reasonable nor decent, not because those that were unable or unwilling to gamble in the casino we call an economy are being burdened with the cost of the catastrophic failure of that pyramid scheme. It is worse than the weather – we cannot even conceive of a “climate change” on Wall Street.

That’s why unemployment will have to remain high – because anything else would require an actual change affecting not only those that are unemployed, but also those who never seem to pay for their greed-induced mistakes.

Posted by b. | Report as abusive

As someone who got his degree in economics this decade… I can only dream about this country having so easy a problem to fix as inflation due to low unemployment and robust wage growth.

In my lifetime I have seen (and expect to see) inflation coming from sources much more difficult to fix. Sources such as global supply and demand (commodities) and bad public policy (government and healthcare stand out). Not to mention that entities seem to be accumulating more and more market power (what this is due to is debatable).

Posted by Basho | Report as abusive

7% as NAIRU, eh? I can still remember an old Isaac Asminov column from around the time Felix was born where he mentions overhearing businessmen talking about whether 5 or 6% was NAIRU.

Nice to see our economy has “evolved” so that there are excess people, especially with all those jobs that were, er, created by Comparative Advantage.

And what exactly would be the dire consequences of inflation above the target rate? (more dire, that is, than the consequences of the Fed trying futilely to stop the inflation) Would it allow workers to get uppity?

Posted by skeptonomist | Report as abusive

Given that inflation in recent years has been driven almost entirely by *oil prices*, which are driven much more by industry fundamentals than by employment or any other general economic feature these days, what does NAIRU have to do with it?

In fact inflation is barely relevant when our economy is so dependent on a single external price.

When we switch to a renewable-energy economy, you can start thinking about NAIRU.

Posted by Anon. | Report as abusive

“First, lower labor mobility which, in part, is due to the poor state of the housing market where negative equity positions are hindering what has traditionally been a geographically flexible job hunting process.”

Interesting. I wonder to what magnitude health insurance tied to an employer affects this.

Posted by Mario | Report as abusive

Possible increase in NAIRU and ‘problems for right-leaning economists and politicians.’ Huh? Is the NAIRU concept part of the ‘vast right-wing conspiracy’?

Posted by Philip Rothman | Report as abusive
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