the Fed may no longer view the non-accelerating inflation rate of unemployment (NAIRU) as a useful tool for guiding monetary policy. The problem seems to be that they don’t know where it is and what it means.
Let’s see what the Financial Times had to say:
Economists are chewing over a puzzle that could have profound implications for the future path of US interest rates: has the Federal Reserve changed its thinking about the relationship between unemployment and inflation? To be more precise: does the Fed now think that the US economy can operate with unemployment as low as 4.5 per cent in the long term without generating inflation? Or does it simply think the inflationary effect of unsustainably low unemployment now takes longer to percolate through the economy than it did in the past? This puzzle has preoccupied economists ever since Ben Bernanke presented the Fed’s monetary policy report to Congress earlier this month. The report shows Fed policymakers think unemployment will be between 4.5 and 4.75 per cent this year and next, while inflation will decline from between 2 and 2.25 per cent this year to between 1.75 and 2 per cent in 2008. This is intriguing, because unemployment at 4.5 to 4.75 per cent is lower than most estimates of what economists call the “non-accelerating inflation rate of unemployment” (Nairu) – the rate of unemployment below which inflation picks up.
What does “most estimates of what economists call … “ mean? My estimate of NAIRU is certainly not 5%. Actually, I’m one of those natural rate of the employment-population types, which is why I’ve decided to graph this ratio from January 1997 to January 2007. Notice something – this ratio was at the current rate or higher for most of the late 1990’s. And yet, we did not have hyperinflation. I wonder if the Financial Times is aware of this fact.