The Myth Of A Natural Jobless RateRobert Kuttner
The Federal Reserve has again voted to leave interest rates alone, despite a continuing recovery and low unemployment. So it's time to bury the idea of a natural rate of unemployment, or NAIRU, nonaccelerating inflation rate of unemployment. The claim, you will recall, is that bringing unemployment below its "natural rate" is both futile and dangerous: futile, because the economy is doing the best it can; dangerous because an overheated economy triggers accelerating inflation that is hard to reverse.
Until recently, most believers in the natural rate hypothesis placed it around 6%. Lately, the jobless rate has hovered close to 5%--and inflation has actually come down. The NAIRU crowd has an explanation: The natural rate of unemployment sometimes moves.
It moves! But if the natural rate moves, then it is not a consistent benchmark--which was the essence of the theory. James K. Galbraith, who teaches economics at the University of Texas, offers a useful metaphor. Natural rate proponents view it as a kind of cliff. If Federal Reserve policy lets the unemployment rate get too low, the economy falls off a cliff--into a torrent of accelerating inflation. But the reality, says Galbraith, is not an abrupt cliff but a gently sloping beach. Policy makers should cut interest rates until they find an inflationary tide line. The worse risk is that monetary policy gets its feet wet and has to back off.
SURPRISING CONVERT. One surprising convert to the "beach" school is none other than Alan Greenspan. On monetary policy, the Fed chairman has turned out to be a relative dove. He has been willing to let economic activity expand and to let jobless rates drop below what his colleagues consider a NAIRU, as long as there are no signs of rising inflation. He has, mercifully, ignored perverse pleadings from the Fed's own senior staff to target zero inflation.
If economic life today is a beach rather than a cliff, we can thank major structural changes in the economy. These changes include greater competition, more flexible labor markets and modes of production, the elimination of cost-of-living allowances, increased global trade, and partial deregulation. All of these shifts work to let markets work better and to discourage price increases.
In the Sept./Oct. issue of American Prospect, the journal that I edit, economist Alan S. Blinder, former vice-chairman of the Fed, debates growth and inflation with fellow economists Barry Bluestone of the University of Massachusetts at Boston, Bennett Harrison of the New School for Social Research, and James Galbraith. Blinder, a former contributor to this column and a relative inflation hawk, contends that the economy is growing about as fast as it prudently can. He extrapolates from the last business cycle and calculates that we are already near the NAIRU point where lower unemployment would trigger accelerating inflation.
TECH PAYOFF. Bluestone and Harrison challenge Blinder's view as too static. The supposed yearly growth limit of 2.3% is derived by adding recent productivity growth rates (1.1%) to labor force growth (1.2%). But Bluestone and Harrison demonstrate that in the new high-flex economy, growth itself can have constructive feedback effects that raise the presumed limit. Higher growth rates signal businesses to invest more, which increases productivity. Faster growth also bolsters wages, which coaxes more people into the labor market, contributing to higher rates of sustainable growth.
Further, Bluestone and Harrison add, the information-technology revolution is at last beginning to pay off in higher productivity. This also allows the economy faster growth and lower unemployment without courting inflation. So the idea of a stable NAIRU, impervious to shifts in the economy, is a myth.
Blinder and the others do agree on one crucial point. Public policy, especially education and training policy, can make a constructive difference. If the bottom 10% of the workforce is effectively unemployable, a 9% unemployment rate means there are more jobs than employable workers--which creates inflationary wage pressures. But if that bottom 10% can get trained and can perform useful work, then the unemployment rate can drop without increasing inflation.
Both the right and the left can take some comfort here. The right can boast that a more flexible and less regulated economy can grow faster. And the left can insist that government education and training interventions are a crucial part of the recipe. The losers are the scholastics of the economics profession who think something as complex and evolving as a modern economy can be reduced to formulas more appropriate to a physics class.