Is 6.2% the NAIRU?
News was released today that unemployment was 6.2% in July. How close are we to the natural rate of unemployment, or as some might say the NAIRU.
In my research into effective demand, I track the natural rate of unemployment. How do I determine the natural rate of unemployment? … By comparing unemployment to the UT index, which measures spare capacity of labor and capital up to the effective demand limit. The unemployment rate when spare capacity goes to 0% is the natural rate of unemployment.
The graph shows data from 1967 to the 2nd quarter 2014. (quarterly data) The red dots represent recent data… The blue dots show past data… The yellow dots show the very slow return of employment during the recovery.
The graph shows that the natural rate of unemployment was roughly 4.75% in the past (y-intercept of the equation for the lower trend line). The recent data is moving in a polynomial path whose trend line is showing a natural rate of unemployment of 6.2%. So according to this graph, the unemployment rate of 6.2% is near a new natural rate which is higher than in the past.
At the natural rate, we would normally see a slowdown in output and a rise in inflation. We are seeing a slowdown in output, but inflation is muted because wage growth is still low.
Josh Zumbrun at the WSJ’s Real Time Economics wrote about the unemployment forecasts of the Brookings Institute. Here is a graph posted with that article.
Economists on average were expecting a continued fall in the unemployment rate. The Brookings Institute is seeing the unemployment rate tick back up to 6.2% for many months more. The Brookings Institute was spot on for July’s 6.2% released today. But the broader picture is that the Brookings Institute is seeing unemployment stall around 6.2% for many months more, which agrees with my model given above.
The Brookings Institute is not saying that 6.2% is the natural rate however. I am saying that the natural rate is close to 6.2%. Now unemployment can still go below 6.2%, but when unemployment pushes below its natural level, the economy tends to overheat and become unstable. At which point, the economy would like to return to the natural level. The path of that process can involve inflation, reduced output, falling capacity utilization and even tighter monetary policy.
It seems I need an index to your work. How do you determine UT index? Would not most people think that unemplyment is a measure of the unused capaciity of labor?
Hi Arne,
UT index = effective labor share – capacity utilization * (1 – unemployment rate)
effective labor share = Non-farm business sector labor share * 0.762
Effective labor share is used to determine the effective demand limit upon the utilization of labor and capital.
The model in the post shows how unemployment moves within the UT index.
I’m going to play devil’s advocate. Greenspan allowed unemployment to drift down to 4 percent. I’m guessing that there wont’ be a recession until a major asset bubble bursts (notwithstanding an error by the Fed). So not until 2015 at least.
Hi Peter,
I too don’t expect an official recession until some time in 2015. Yet some variables need to show beforehand that we are moving in that direction.
And let me put that 4.0% unemployment under Greenspan into perspective.
The effective labor share at that point was 82% to 83%… it is now 74% to 75%. Effective demand allowed for greater utilization of labor and capital back then. On the graph above, that time period is seen by the dots around 2% to 3% on the x-axis and 4% on the y-axis. Unemployment was very low in historical perspective but there was even some spare capacity. Actually, at that point, the economy was building toward a recession.
Lambert
I suspect you are saying something more subtle, but I think there is danger in the concept of the NAIRU.
I learned to have contempt for this concept when I read about it in Paul Samuelson’s basic economics text back in about 1980 or so. He seemed to think that when unemployment was less than “NAIRU” unemployed workers were just sitting around waiting until someone offered them a job for more than they were worth. This did not correspond to my experience of unemployment or that of anyone I knew.
I believe that the rate of unemployment is subject to many variables, and that as some of those variables change you get a different “NAIRU.” By talking about it as if it were a magic number you lend aid and comfort to those who would do nothing about unemployment because “it’s good for the economy”… to maintain a reserve army of the unemployed.
based on wage growth, nope it isn’t. Probably more in the mid-5’s, but people forget the low 5’s weren’t that the last expansion, likely due to Real Estate’s low wages.
If by December, we are at 5.5-5.7 and wage inflation has not surged yet, than nope, that isn’t either. Look at wage inflation, beginning to trickle up telling me, it is closer, but it did the same thing in the 90’s as well.
From: http://www.politico.com/magazine/story/2014/07/the-new-normal-109616_full.html#.U9vsflZ0Vz8
“Why We Won’t Get to Normal
Don’t kid yourself. We’ll never have a pre-2008 economy again.
By JAMES K. GALBRAITH
July 31, 2014”
The problem with this take is that the years leading up to 2008 were not ‘normal’ either. Total Household Debt had been rapidly increasing. Much of it was withdrawal of equity from consumers’ homes but it was debt. Debt which masked the problems in the economy. That masking was going on to some extent after 1991.
He believes that we are living in rougher times after 2008 and misses the fact that we were already in deep trouble long before that year. If you believe that the world got rougher after 2008 you may well miss the importance of labor share.
Instead he lists the problems as energy costs after 2000, global loss of confidence in the system, the digital revolution, and the financial system.
Consumers can not spend what they do not have, and producers will not produce what they cannot sell.
Or as your work shows, our problems are due to low labor share.
Coberly,
Do you have a definition of the NAIRU?
I simply see it as the point for the natural level of gdp. Beyond this point, gdp will not want to rise, so inflation would rise instead.
But if inflation cannot rise due to suppression of wages, would output slow down more? Is that what is happening in Japan at the moment?
Edward
I am not an economist. Merely a worker with worries about economists being too sure of themselves.
I understood NAIRU to be the “non accelerating inflation rate of unemployment” and the way i read Paul Samuelson it was something like a law of nature based on the laziness and greed of workers.
I think I understand that you are saying something more subtle… but i think there is danger you will not realize that as conditions change so will the relationship between unemplyment and inflation. and worse, any “hard” number will be an excuse for policy makers to do nothing about rates of inflation that are real hardship for workers.
Coberly —
I have the same concern. The concept seems to be a recipe for resignation and stagnation. Are we supposed to accept a 59% employment-to-population ratio when the rest of the world has long passed that by? (Among 25-54 year olds — who really need to work, and where, therefore, the alleged structural factors have no place — France’s employment — yes, that’s France — is about four percentage points higher than in the U.S.)
How can you break out of this and raise labor’s share without deliberately improving labor’s bargaining power by creating millions of new jobs?
In a similar vein, what was the “NAIRU” on December 7, 1941?
It is also my recollection that in 2000 we went way, way past the then-expected NAIRU, with unemployment breaking the 4.0% barrier, with barely a whiff of inflation.
Urban L,
According to my model of effective demand, the NAIRU back in 2000 was like 3,6% to 4,0%. So we actually did not go past the natural rate. So little inflation was no surprise from my point of view.
Edward —
Can you provide a non-mathematical way of describing how that is so, and how 2000 differed so much from now in your model?
This answer still suggests that the NAIRU should be considered sacrosanct. Is there any public policy action that can change it, or do we just have to suffer until natural economic forces change it (if ever)?
Why cannot deliberate government policies to create jobs directly and absorb the unemployed change it? Isn’t that what WWII did?
Urban L,
non-mathematical?
Labor was higher but capacity utilization did not go very high. So there was room to employ more workers instead of capital.
Machines began to be cheap, and firms needed people to run the machines and computers. So a new wave of workers were being trained and brought into the economy.
Actually unemployment could have gone down to 3.0% without too much effect on inflation… why? Because productivity was rising so fast. And when wages rise with productivity, you will see more employment and less use of capital because people are needed to run the more productive machines.
Since 2000, many of those jobs created in the late 2000s have gone overseas. Labor hours have not been growing since then. Productivity is now blocked by effective demand. And instead of labor share rising like it did around 2000, labor share has been falling.
Edward —
I don’t see my questions about what to do being addressed. Why can’t a sudden increase in demand from increased government spending — a societal decision to fight unemployment due to insufficient demand mainly by fixing and building things we need anyway — immediately increase effective demand?
Moreover, the whole idea of the NAIRU seems highly questionable. As I understand it, Milton Friedman played the most important role in developing and popularizing it, and the basic premise for predicting inflation was that wages would start to grow (and reach a self-reinforcing cycle that would cause wage growth to start accelerating). But the 1970s was a different era. Labor was far more powerful than it is today, and manufacturing was a much bigger part of the economy. It seems to me that labor has been so beaten down for so long that it’s going to require a long, long time of low unemployment (really, a high employment rate) and growing union representation before unions really feel confident enough to start making hard demands.
So if wages will only grow based on the influence of public policy (higher minimum wage, higher infrastructure spending, support for states rehiring public employees) and not so much by strong unions in collective bargaining, and if such growth accordingly will stay moderate, what is the theoretical mechanism that would lead to generalized inflation? I don’t see how we can just assume a relationship when its empirical support is pretty weak and there isn’t clear theoretical support to fill that gap.
It also seems problematic to focus very much at all on the official unemployment rate. We have seen the employment/population ratio drop by seven percentage points, and it’s only gained back one point since the recession officially ended. (It’s still below where it was 36 years ago, in the second quarter of 1978, before the full impact of feminism had occurred.) There has also been a growing disconnect between official unemployment and the employment rate, as the close inverse relationship one would expect and that we used to see has weakened. Based on earlier years, a drop from over 10% to 6.2% unemployment should have been accompanied by a significantly higher increase in the employment rate.
The arguments that it’s some structural shift in the population are belied by the nearly equal weakness compared to other wealthy countries of the employment rate among 25-54 year olds, where delayed entry into the workforce and baby boomer retirements are not factors.
The U-6, which seems to come closer to reflecting the lower employment rate, also seems to come a lot closer to measuring the “real” unemployment rate than the U-3.
urban legend wrote: “Why cannot deliberate government policies to create jobs directly and absorb the unemployed change it? Isn’t that what WWII did?”
The end of the Great Depression seems to be wrapped in myth. Spending on building tanks and planes only to have them destroyed is not a formula for sustained recovery. Sooner or later the war would have ended and 13+ million men would have come home to unemployment and as war production ceased, their future wives would have been unemployed too.
The true cause for the end of the depression was a multi step proposition. During the war, 13+ million men were in the military, most in war zones where spending was at least reduced. The war brought on full employment and brought many young women into war production plants. Personal incomes were quickly raised which caused inflation which inspired wage and price controls. Next came rationing, it was a key component of the very large increase in personal saving, and as a bonus, rationing created pent up demand. Personal savings was between about 25% for three years and not much less for another year. That accumulated savings was the key to recovery. The war ended in 1945, young men came home and married young women and during 1946 they used their personal savings for personal consumption expenditures. Inflation in 1946 was 18.1% as pent up demand emptied the shelves and caused manufacturers to quickly convert back to a consumer based economy. That was the end of the Great Depression and it came when consumers had pent up demands and money to spend.
WWII did not end the Great Depression but some economists came to believe that it did. Never mind the full employment, the high wages, the rationing, or the high personal savings.
We can have all of those without another war. Just impose rationing to force personal savings, have the federal government build and repair so many roads and bridges that we have full employment, and pay high wages. Have the federal government impose very high taxes and take on huge amounts of debt. Continue all those actions for 4 or 5 years.
But the federal government is already too deep in debt to fund those actions. If the highest tax rates were returned to 92% as they were during the war and until about 1965, then maybe there would be adequate funding. The Republicans would fight such a tax increase to the bitter end. So we are stuck.
We could liberalize access to bankruptcy. And we could change the federal law on loans with collateral so that the only recourse available to lenders would be to seize the collateral. Reducing the maximum allowed interest rates would also help. The intent of these actions would be to reduce personal debt. Lenders would be forced to be more careful. We have too many debt slaves.
But haven’t you restated my point that government policy responding to the war “created jobs directly and absorbed the unemployed”? To most people, the level of employment and unemployment is what defines a recession or depression. In the popular mind, which is the only one that really counts, we did not leave recession when the NBER says we did.
Urban Legend wrote: “But haven’t you restated my point that government policy responding to the war “created jobs directly and absorbed the unemployed?”
No, what you are proposing does not provide a self sustaining recovery. They tried that from 1933 and in 1936 the statistics said that there had been a recovery. So they raised taxes a little and cut some deficit spending and the result was the recession of 1937. There had not been a self sustaining recovery, only government spending. Wages had not been high enough and there was no rationing so workers could spend almost all their pay. So there was no large increase in personal savings. The American consumers were not in much better shape than they had been in 1933.
Inflation was held down during the war by WAGE AND PRICE CONTROLS. So workers received HIGH WAGES and they were not reduced by inflation. RATIONING kept workers from spending about 25% of their pay per year. The combination of these two policies caused large amounts of PERSONAL SAVINGS. At the end of the war workers had large amounts of savings and pent up demand. After the war government spending was reduced, but the economy had converted over to a consumer goods economy in 1946.
Reread my last comment and note this sentence in the 5th paragraph. “Just impose rationing to force personal savings, have the federal government build and repair so many roads and bridges that we have full employment, and pay high wages.”
To that I would add that wage and price controls would have to be used to control inflation after a year or two. The intent is to dramatically improve the economic health of American consumers. Thus policies to reduce consumer debt would also be a great help.
Edward,
I accept that it may be meaningful at any given point in time to define a “natural rate of unemployment” (or probably it should be done the other way around and be a “natureal rate of employment” to account for labor force participation, which is low right now). I think that what may be lying behind it sneaking up on people, as it were, is that we have had low capital investment in the last several years, the supply-side negative effect of long-term low aggregate demand, and so the capital stock capacity utilization rate figure is kicking in.
That said, I think you commit a fundamental error that some others, such as coberly have poked at, although one that is widespread and deeply entrenched in many textbooks. This is to identify the natural rate with NAIRU. There is not and never has been a shred of evidence connecting those two, even though many, including yourself, identify them.
This goes back, I think, to Milton Friedman who first defined the natural rate and then suggested it might be related to NAIRU. Many decided that the inflation, atlhough it was actually stagflation and not a situation of overly high employmnet when inflation really took off, somehow proved this connection. It did not.
As noted above by others, the experience of Greenspan pushing the UR down to 4% or so in the mid-90s without any acceleration of inflation pretty much proves that this identification is utter garbage. You may be right that the lowering was tied to setting us up for the next recession. But this was by encouraging the dot,com stock market bubble (arguably a form of inflation), but standard inflation never did appear, and the next recession was not due as they had been so often previously to a Fed tightening to offset surging inflation. There was none. NAIRU is basically a giant crock, and to the extent it exists, it is not at all tied to the natural rate in any way.
The best case you can make would be that somehow running up against capital stock constraints raises costs of productiong because we are using bad old obsolete and unproductive capital stock, or that higher prices are needed to draw forth more capital investment. Maybe. Of course, the usual story is on the labor market side, but given that this UR is associated with a much lower employment rate due to reduced labor force participation, I think any story coming from that side through upward pressure on wages simply is not there, and I think you know it, Edward.
So, bottom line: maybe we are approaching the current natural rate of unemployment, but it does not mean we are approachign the current NAIRU, if that even clearly exists.
JimH
I have no idea how much truth there is in what you say. But when you write
“nflation was held down during the war by WAGE AND PRICE CONTROLS. So workers received HIGH WAGES and they were not reduced by inflation.”
you should hear a “logic” alarm go off.
WAGE CONTROLS….HIGH WAGES ding ding ding ding.
Coberly wrote: WAGE CONTROLS….HIGH WAGES ding ding ding ding.”
Just look at the stats, sometimes logic fails. There is no way to explain it except that there was a war on and they wanted the production, the costs be damned. The Personal Savings Rate tells the tale here.
I looked at Personal Income Table 2.1 at this website: http://www.bea.gov/
I set the MODIFY ‘Options’ for Annual and Select All Years which got me the years 1929 to 2012.
It appears that Personal Income rose at very high rates from 1940 to 1944(BEA).
WARNING this table has been adjusted since I extracted this data but the percentages should be the same.
Year —–1940—–1941——1942—–1943—–1944—–1945—–1946
Income—78.4 ——96——-123.4—-152.1—-166——-171.6—–178.6
Increase–0.075—-0.224——0.285—-0.233—-0.091—-0.034—–0.041
Note: Increase is my calculation.
Personal savings as a percentage of disposable income is also in the table above.
WARNING this table has been adjusted, this is the adjusted data.
Year —–1940—–1941——1942—–1943—–1944—–1945—–1946
Savings—6.8——13.9——-26.2——27.7——27.9——22.5——11.8
Note: Savings are Personal savings as a percentage of disposable income and they are higher than I have been quoting.
Here is the CPI for those years.
From: http://www.bls.gov/cpi/cpifiles/cpiai.txt
Year ——–1940—-1941—–1942—–1943—–1944—–1945—–1946
CPI———-14.0—–14.7——16.3—–17.3——17.6—–18.0——19.5
% Increase–0.7—— 9.9——-9.0——3.0——-2.3——-2.2——18.1
Note: % Increase is Dec-Dec from the table.
Summary:
In 1941 the CPI went up by 9.9% but personal income went up by 22.4%.
In 1942 the CPI went up by 9.0% but personal income went up by 28.5%.
In 1943 the CPI went up by 3.0% but personal income went up by 23.3%.
In 1944 the CPI went up by 2.3% but personal income went up by 9.1%.
In 1945 the CPI went up by 2.2% but personal income went up by 3.5%.
In 1946 the CPI went up by 18.1% but personal income only went up by 4.1%.
So in spite of wage and price controls, wages were increasing faster than inflation during the war but not in 1946 after the war ended. And personal savings were outrageously high for 1942, 1943, 1944, and 1945. Hell even 1946 had 11.8% savings.
Jim H —
My point is not that war is a good way out of depression or recession, nor am I claiming that it was sustainable. My point is a simple one: government took action that ended high unemployment: (1) the draft pulling some 10 million or so men out of the non-institutional population by, in effect, giving them a job; and (2) several million men and women were put to work by government’s demand for war materials. From the public’s standpoint, ending high unemployment (and creating an extremely high employment rate) ended the Depression because that is what matters to them.
re: Barkley R,
Once I understood effective demand, I saw the connection between the natural rate and the NAIRU.
Effective demand changes from business cycle to cycle, but the changes follow the natural rate and the NAIRU.
So the natural rate that effective demand determines turns out to be the NAIRU in that business cycle.
The main hole in macroeconomics is effective demand. I have filled that hole… at least with a model of effective demand that is working so far.
And in your second to last paragraph, you mention low labor force participation…
The labor force participation rate is the rate consistent with the dynamics of supply and demand in terms of wages paid. Once wages (labor share) slumped after the crisis, many people dropped out. You might say it was people close to retirement, but if wages (labor share) had been better, I think many of them would have stayed. So the 6.2% is the real unemployment rate for the dynamics of the labor market.
If wages rise, we will see more people coming back into the labor force. Yet the unemployment would tend to stay around the natural level at the same time… namely around 6.2%.
In other words, the unemployment rate was destined to decline back to a natural rate as real GDP reaches its natural rate, which I determine as $16.1 trillion (2009 $$). We are close now. At this point, 6.2% is corresponding to the natural level of real GDP. 6.2% corresponds to the NAIRU now.
Real GDP will hit a wall around $16.1 trillion. The momentum of the economy most likely will create some inflation and rising wages. There will be some momentum to hire workers to raise profit rates, but then more people will return to the labor force. I suspect that the unemployment rate will not go down much at that point.
Urban L,
The U3 represents the dynamics of supply and demand in the labor market. You might say that workers are underemployed, but what makes a business hire another worker? … another worker will raise profits.
Productivity is now constrained by effective demand, but more workers will put upward pressure on profits. There are other forces putting downward pressure on profits now however,
And one comment about the effect of WWII to end the depression…
labor share grew tremendously during the war. There is your effective demand stimulus.
We can imagine a scenario where everyone got employed but labor share did not rise. What happens? Labor income makes no headway against increases in production. Effective demand does not change.
Urban Legend wrote: “From the public’s standpoint, ending high unemployment (and creating an extremely high employment rate) ended the Depression because that is what matters to them.”
You seem determined to miss my most important point.
What would have happened when the war ended and 13million+ men came home UNEMPLOYED and WITHOUT savings and their future wives were LAID OFF and WITHOUT savings? What could they purchase? NOTHING, it would be back to the Great Depression.
The same is true of any and all government stimulus. It lowers unemployment BUT ONLY UNTIL the government stimulus ends. Then unemployment goes back to just about what it was before the stimulus. (Excluding growth in the economy and there is always some growth.)
If you don’t improve the long term economic health of the workers/consumers then there is no self sustaining recovery.
But if there are large accumulated personal savings then they spend the savings into the economy not to buy tanks but to buy automobiles, refrigerators, and other consumer goods. Factories have to hire people to make those goods and those employees can then buy consumer goods which they need. Self sustaining!
Increasing personal savings or decreasing personal debt both improve the consumers long term economic health.
Please reread my previous two comments directed to you. Carefully.
Or just go back to your old comfortable beliefs and wonder why we haven’t recovered after all the government stimulus already spent during this Great Recession! (Too little, Too soon, Too Late, Too, Too, Too….)
Edward Lambert wrote: “labor share grew tremendously during the war.”
Everything that I have seen says that labor share was low during the war. Wages were high but so were profits. This MAY point to a possible flaw in your formulas. Probably not, this is just be a special case because of artificial and temporary demand not created by consumers.
I think I need to add some miscellaneous economic data for WWII to complete the story.
Germany invaded Poland in September 1939 and England and France declared war on Germany because of it. This set off alarm bells in the US. The planning of the modernization and equipping of the US military began in earnest. In addition the Lend Lease Act in May 1941 allowed the US to supply arms to England. When Pearl Harbor was attacked, war materials production went into high gear.
Almost immediately war materials plant had to start raising pay to meet production goals and they began to compete with each other for labor. And various shortages developed. The result was that in less than 1 year wage and price controls had to be enacted.
Rationing was put in place starting in May 1942:
http://www.ameshistory.org/exhibits/ration_items.htm
“The Emergency Stabilization Act was passed in October 1942, which placed wages and agricultural prices under control”:
http://www.u-s-history.com/pages/h1689.html
After October 1942, employers started to use fringe benefits to attract labor. Probably some employees continued to get promised wage raises because of union contracts and that would have delayed the effect of wage controls.
Jim H —
We are probably talking past each other, and the personal insults are unnecessary. I don’t disagree with anything you said about how the effects of the stimulus survived the war. My point is simply that government decisions ended unemployment at the time, and by getting everyone employed it “ended” the depression.
What is the empirical support for the apparent premise that there is a one-to-one relationship between government introducing stimulus and causing growth and government withdrawing stimulus and all that growth? It seems to me we had a pretty good test of that recently with the beginning and end of the partial payroll tax holiday, and while growth slowed for awhile when it ended, it did not hit the brakes. I’ve always understood that well-designed stimulus is supposed to function as a “jump-start” that will get the entire economy functioning more effectively and ready to carry forward when the stimulus ends. Lower unemployment puts upward pressure on wages, and that will tend to be continue even when the cycle heads back down again.
Of course, if infrastructure spending is called for based on genuine need, then it should function as an increase in demand for labor over a longer term and be withdrawn very gradually.
Edward,
You should know that I have provided a more extensive commentary on this on Econospeak.
That said, let me returrn to challenging you here on the most fundamental point, which you do not even attempt to defend, but merely reassert as obviously true, that the natural rate equals NAIRU. there is not now and never has been a shred of econometric evidence showing that there is any link between these two.
I remind you that the period when we did see accelerating inflation, the 1970s, was also a period of rising unemployment. This does not fit with the natural rate/NAIRU story at all. Certainly if one believes in vertical Phillips curves, as Friedman did, one can argue that inflation can rise sharply once one tryies to go below the natural rate, but there is no mechanism why this increase should result in a full-bore acceleration beyond a one-round or two increase as one moves somewhat up the curve.
Let me also note here that it has been argued from the beginning that the natural rate is endogenous to the actual rate, this involving both labor skills and participation issues. This might support your contention that we are approaching the natural rate now. But this does not remotely support any sort of idea that the natural rate equals the NAIRU, if this latter even exists. What happened in the 90s simply blows this whole story out of the water.
How can you continue to assert such total nonsense, that the natural rate equals NAIRU, and please do not tell us that it is in many textbooks, which it is. That does not justify you repeating utter nonsense that has been shoved down peoples’s throats for blatant ideological reasons. It is and has been from Day One total garbage.
Hello Barkley,
Yes, I actually read your article before I made my reply above.
I realize that there has not been a good connection between the natural level of real GDP and the NAIRU, but there should be. They should share the same moment in the business cycle.
My work is bringing them together…
Let me start at the 70’s… unemployment rose during recessions in the 70’s. Here is a graph.
http://research.stlouisfed.org/fred2/graph/?g=H6R
So saying that unemployment rose with inflation is not helpful. Unemployment rose because of a recession. It just so happened that inflation rose during the recessions of the 70’s. That is a different issue.
However, if you plot unemployment against the effective demand limit, you get a 71% correlation since 1967. You can look at this graph and see that unemployment tends to bottom out when the UT index for the effective demand limit goes to zero. The period at the end of the 90’s was a special case where unemployment kept falling because labor share kept shifting up at the end of the business cycle. That was very unusual, but explainable.
http://research.stlouisfed.org/fred2/graph/?g=H6U
What does the graph show? Unemployment hits its natural rate when the UT index goes to zero.
Now comes the question… Does real GDP hits its natural level when the UT index goes to zero?
http://research.stlouisfed.org/fred2/graph/?g=H6V
First, you will see that in the 70’s, real GDP growth hit its limit as the UT index went to zero, well before the recessions started. After the 70’s, the relationship showed a plateauing of real GDP or even a dropping of real GDP growth at the UT index zero%.
Like you say, what happened in the 90’s was unusual, yet in 1997, real GDP hit the effective demand limit. Real GDP growth was topping out. But then an unusual thing happened… labor share started to grow. This gave room for productivity growth. But also real wages were rising faster than productivity. That is the key and it is unusual at that point in a business cycle. The result was that the business cycle kept expanding upon increased effective demand.
As effective labor share rose 1% point, the NAIRU dropped one percent. Along with that, capacity utilization was falling at the same time, which allowed unemployment more space to fall within the effective demand limit. It was all the result of the pressures to increase productivity with the new technology.
So none of my model is blown out of the water. My model captures the various expressions of unemployment, productivity, real GDP growth and capacity utilization around the natural level.
So I am not asserting nonsense. I am seeing patterns, and I have a model to describe the patterns.
The key is to understand how the natural level shifts according to changes in effective demand. The missing link is effective demand. Once you understand how effective demand puts limits on real GDP growth, and then see those limits as the natural level, and understand how those limits change with changes in effective demand, then you will see how the NAIRU is the natural limit.
The mistake being made is trying to see a constant NAIRU based on previous business cycles. The key is to be able to determine the NAIRU in real time. I have found a way that is working so far. And the NAIRU is matching up to the natural level of real GDP.
Edward,
The problem here is NAIRU, and you have not remotely addressed it. You have only one episode in the US of noticeably accelerating inflation, and that is the 70s. One has to argue that it came out of the economy banging against its limits in the 60s and early 70s, so with some lag, but it is a weak story. After then, we never see any substantially, or barely evenly noticeable, accelerations of inflation, quite aside from the spectacle of the rate of inflation declining in the late 90s as the unemployment rate plunged below its supposed natural/NAIRU rate.
You have barely any evidence of any NAIRU even existing, and certainly not at all since the 70s, none. That anybody should believe that we are near some NAIRU limit now? You have provided zero evidence of this, zero. Maybe 6.2% is the natural rate, but you have completely avoided the fundamental issue: there is no reason for these two to coincide despite your wishful thinking on the matter.
BTW, this is an important issue. If Greenspan had paid attention to you in the mid-90s, we would have had a whole lot less growth and employment, all to prevent an acceleration of inflation that did not occur. And as for now, suggesting that we are on the verge of some acceleration of inflation puts you into the same camp as looney bins like Peter Schiff. Sorry to be so blunt.
Hi Barkley,
NAIRU is a non-accelerating inflation. Only if you go past the natural level will you see much inflation. My data shows that real GDP went beyond the effective demand limit a lot back then. Inflation tendencies were different.
We did some inflation before the crisis (even less gas and food). Real GDP was peeking over the effective demand limit a couple times. And the low inflation over the decades is related to declining labor hours, increased productivity and slow growing wages.
So we have not seen a lot of inflation for many reasons, including monetary policy beating inflation over its head at every turn. But the point at which unemployment reaches its natural level is the point of the NAIRU. It is just that there are many reasons for subdued inflation.
I am not seeing a boom in inflation occurring if unemployment drops much lower. I am rather seeing a slow down in output instead. Inflation would allow output to rise a bit more. Without inflation, output will be cut short. That is what I am seeing. But if you allow a condition for inflation, then you will see the NAIRU produce inflation. We just don’t have that type of economy at the moment.
Mid-90’s? Do you remember that the Fed funds rate rose through 1994 until it reached 6% in early 1995. That is why inflation did not occur. Greenspan hit inflation over the head in the mid 90’s. But Greenspan was not reacting to inflation. He was reacting to the signals of what I see the economy reaching the effective demand limit.
http://research.stlouisfed.org/fred2/graph/?g=H7O
I am not offended by your comment of looney bins… Like I said, I do not see a boom in inflation for many reasons. Partly because the Fed is sticking to their plan of keeping the nominal rate low for a long period to come. I see the Fisher effect. I also think that the economy will start to decay before they start to tighten nominal rates. Thus keeping nominal rates near the zero lower bound as the next recession forms. The Fed may try to raise the nominal rate really fast to react, but they are limited. They plan to only raise the nominal rate no more than 25 basis points per quarter. That is way too slow to react to the dynamics of the natural level of output.
Urban Legend,
I never meant to be insulting but it has been my experience that sometimes you reach a difference of opinion and nothing is gained by repeating one point or another. You should understand that I am not interested in temporary economic improvements made at huge government expense.
You wrote: “I don’t disagree with anything you said about how the effects of the stimulus survived the war.“ The operative phrase is ‘survived the war’. If nothing survives the stimulus then you have solved nothing!
You wrote: “My point is simply that government decisions ended unemployment at the time, and by getting everyone employed it “ended” the depression. “ THIS IS UNTRUE. If nothing survived the stimulus then as soon as the war ended you would have had 13million+ unemployed ex military men and a very large number of unemployed women who had been employed during the war. (Most anyway.)
I agree with you that the conventional wisdom is that “well-designed stimulus is supposed to function as a “jump-start” that will get the entire economy functioning more effectively and ready to carry forward when the stimulus ends.” But that is just plain wrong, it doesn’t work that way. And some observed small temporary improvement is nothing. If we did absolutely nothing there would be some small growth in GDP because of an increase in population or other factors.
I began looking at the Great Depression because of the similarities it had with our Great Recession. Both brought on by debt and both lasting much longer than ordinary recessions. So the question is when did it end and why?
If the period from 1933 to 1937 teaches anything, it is that artificially creating large numbers of jobs for 3 or 4 years was not enough to end the depression. The economic stats started to look better but they included huge sums of government money. The federal government removed some of the money in 1937-1938 and there was an almost immediate downturn in the economy. GDP had been steadily rising from 1933 but it fell in 1938 before continuing its rise(BEA stat). Unemployment had been steadily decreasing from 1934 but it increased in 1938 before continuing its rise. (Employment and Unemployment in the 1930s by Robert A. Margo
Page 43 Table 1 From:http://fraser.stlouisfed.org/docs/meltzer/maremp93.pdf)
Also see “Interpretations” section of this:
http://en.wikipedia.org/wiki/Recession_of_1937–38
So we shouldn’t be fooled by stats that include temporary government spending. (Temporary government intervention allows for a temporary improvement.) That also applies to the about $800Billion from the American Recovery and Reinvestment Act of 2009. And it apples to the 2% payroll tax holiday. None of those, in and of themselves, caused a LASTING recovery. At best they had the potential to aid in a LASTING recovery if the stimulus was large enough and if consumers’ economic health was improved.
The increased government spending during the war did aid in a LASTING recovery but why?
The accumulated savings during the 1940s would be more than a year’s disposable income! (See stats in comment to Coberly) This was an improvement in the economic health of consumers. And those consumers had pent up demands when the war and rationing ended.
The 2% payroll tax holiday is as nothing compared to this. And the holiday accomplished almost nothing. Logically all it could do was temporarily lift Personal Consumption Expenditures by a small amount. And the perceived lasting improvement would be the continual small improvement which I discussed above.
Does this help?
Oops.
“Unemployment had been steadily decreasing from 1934 but it increased in 1938 before continuing its rise.”
Should have been.
Unemployment had been steadily decreasing from 1934 but it increased in 1938 before continuing its fall.