Monday, February 22, 2016

Krugman, the Gang of Four and the NAIRU Straitjacket

G. Friedman v. M. Friedman

Krugman and the CEA Gang of Four former chairs don't come right out and say it but G. Friedman's projections are implausible because... "NAIRU!"

um... um... um...

Two points on that.

First is Dean Baker's post about the latest Economic Report of the President's "insight into the question of how fast the economy can grow, and more importantly how low the unemployment rate can go."
Economists have long held the view that lower rates of unemployment would be associated with rising rates of inflation and vice versa. When the Federal Reserve Board decides to raise interest rates to slow the economy it is based on the belief that unemployment is falling to a level that would be associated with a rising rate of inflation. 
Most economists now put the unemployment rate at which inflation starts to rise somewhere near the current 4.9 percent rate. (This is called the non-accelerating inflation rate of unemployment or NAIRU.) So does the ERP. But its analysis suggests a somewhat different story.
Second is Jamie Galbraith's 1997 -- that's almost 20 years ago -- Journal of Economic Perspectives article, "Time to ditch the NAIRU"
First, the theoretical case for the natural rate is not compelling. Second, the empirical evidence for a vertical Phillips curve and the associated hypothesis that lowering unemployment past the NAIRU leads to unacceptable acceleration of inflation is weak, and has become much weaker in the past decade. Third, viewed collectively, attempts to estimate the location of the NAIRU have become a professional embarrassment; disagreements remain on too many basic issues. Fourth, adherence to the concept as a guide to policy has major costs and negligible benefits. Conversely, the risks of dropping the natural rate hypothesis are minor, while the benefits from a sustained pursuit of full employment could be substantial.
G. Friedman's projections may well be wrong. But the argument that they are "implausible" is based on uncompelling theory, weak empirical evidence, embarrassing estimates and "a guide to policy [that] has major costs and negligible benefits."

But, hey, you can't criticize the top wonks if the they don't come right out and say it.

UPDATE: John T. Harvey writes, at Forbes:
In the words of Christina Romer, former chair of the Council of Economic Advisors under Barack Obama: 
"Just as there is no regularity in the timing of business cycles, there is no reason why cycles have to occur at all. The prevailing view among economists is that there is a level of economic activity, often referred to as full employment*, at which the economy could stay forever."
*Often referred to as full employment? War is Peace. Freedom is Slavery. Ignorance is Strength. NAIRU is full employment.


veteran novice said...

For the Fed to assure that unemployment stays above 4.9 by raising interest rates while at the same time politicians cut welfare and food stamps and children's lunch programs because somehow unemployemt is entirely the unemployed person's fault seems inconsistent and heartless.

ProGrowthLiberal said...

"Often referred to as full employment?"

Herein lies the problem with this outdated concept. We are far from full employment. And NAIRU types say the unemployment has fallen below NAIRU. And yet inflation is still very low.

Sandwichman said...

"Herein lies the problem with this outdated concept."

I agree. But it is Christina Romer, former chair of the Council of Economic Advisers saying this, not some obscure prof from UMass Amherst.

SoJoyouslyWandering said...

Hardly fair to Krugman. He was very explicit about one compelling line of evidence against Friedman's conclusions, namely that there isn't a single 10 year period since WWII when the USA has grown at 4.5%. Best we've done was ~3.5%.

Sandwichman said...

"...there isn't a single 10 year period since WWII..."

That's a fact. It is also a fact that there wasn't a single recession as deep with as anemic a recovery as 2008. There has also never been a woman or a Jewish president of the U.S. so it is implausible to suggest that either Hillary Clinton or Bernie Sanders could win the election.

ProGrowthLiberal said...

"There has also never been a woman or a Jewish president of the U.S."

Maybe we should elect Janet Yellen as our next President!