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Time to Ditch the NAIRU
American Economic Association, 1997
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Time to Ditch the NAIRU
Abstract: The concept of a natural rate of unemployment, or nonaccelerating inflation rate of unemployment (NAIRU), remains controversial after twenty-five years. This essay presents a brief for no-confidence, in four parts. First, the theoretical case for the natural rate is not compelling. Second, the evidence for a vertical Phillips curve and the associated accelerationist hypothesis that lowering unemployment past the NAIRU leads to unacceptable acceleration of inflation is weak. Third, economists have failed to reach professional consensus on estimating the NAIRU. Fourth, adherence to the concept as a guide to policy has major social costs but negligible benefits.
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Comment from our editors:
Is there something even akin to a 'natural rate of unemployment', the infamous term coined by Milton Friedman? And, more to the point, is the theoretical construct of a labour 'market' even scientifically sound?
In this masterly refutation of one of modern central bankers' (and, indeed, macroeconomic mainstream's) central tenets, the non-accelerating inflation rate of unemployment or "NAIRU", James Galbraith demonstrates that since there is no such thing as a labour market in the sense of other markets for goods and services, the concept of a persisting relationship between unemployment and inflation is a fallacy. But as long as rate setters and politicians believe in this Phillips Curve-inspired thought, employment will be sacrificed time and again to ward off an imaginary lift-off in inflation, effecting huge economic and social cost to no avail. In his train of argument, Galbraith is relentlessly Post-Keynesian, stipulating that aggregate demand determines the rate of employment, while nominal wages are subject to exogenous factors such as the relative bargaining power of trade unions and employers, leaving no place for a deterministic relationship between unemployment and inflation.
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