Home > Uncategorized > NAIRU — closer to religion than science

NAIRU — closer to religion than science

from Lars Syll

phillips-curve-lr-1Once we see how weak the foundations for the natural rate of unemployment are, other arguments for pursuing rates of unemployment economists once thought impossible become more clear. Wages can increase at the expense of corporate profits without causing inflation …

The harder we push on improving output and employment, the more we learn how much we can achieve on those two fronts. That hopeful idea is the polar opposite of a natural, unalterable rate of unemployment. And it’s an idea and attitude that we need to embrace if we’re to have a shot at fully recovering from the wreckage of the Great Recession.

Mike Konczal / Vox

NAIRU does not hold water simply because it has not existed for the last 50 years. But still today ‘New Keynesian’ macroeconomists use it — and its cousin the Phillips curve — as a fundamental building block in their models. Why? Because without it ‘New Keynesians’ have to give up their — again and again empirically falsified — neoclassical view of the long-run neutrality of money and the simplistic idea of inflation as an excess-demand phenomenon.

The NAIRU approach is not only of theoretical interest. Far from it.

The real damage done is that policymakers that take decisions based on NAIRU models systematically tend to implement austerity measures and kill off economic expansion. Peddling this flawed illusion only gives rise to unnecessary and costly stagnation and unemployment.

Defenders of the [NAIRU theory] might choose to respond to these empirical findings by arguing that the natural rate of unemployment is time varying. But I am unaware of any theory which provides us, in advance, with an explanation of how the natural rate of unemployment varies over time. In the absence of such a theory the [NAIRU theory] has no predictive content. A theory like this, which cannot be falsified by any set of observations, is closer to religion than science.

Roger Farmer

  1. January 6, 2021 at 12:32 am

    NAIRU is a blatant fudge.

    Unemployment in Australia through the 1950s and 1960s averaged 1.3%. Inflation averaged around 3%. Other OECD countries were not much higher. Impossible according to NAIRU.

    Profound ignorance, wilful ignorance, whatever, it should have been laughed out of contention before it ever got published or used.

    As usual there are beneficiaries – 5% or more unemployment tips the power balance to bosses, who naively think their best interest is served by an insecure, underpaid workforce. All it does is keep the economy stuttering.

  2. Alexander
    January 6, 2021 at 7:54 pm

    I’m an undergraduate student in the process of learning about the shortcomings of neoclassical economics, which has brought me to this blog. Could you recommend some readings that would help me gain a more sophisticated understanding of what drives inflation?

    Thank you very much,
    Alex

    • January 7, 2021 at 11:52 pm

      Hi Alexander, my book Economy, Society, Nature (see right-hand column) was written for you. It’s about economies in general, not just inflation.

    • Meta Capitalism
      January 9, 2021 at 7:22 am

      2 THE ANTI-TEXT

      2.1 The inherent tension with macroeconomics

      As we mentioned the first seminal book in economics, Adam Smith’s The Wealth of Nations, it behoves us to mention another, John Maynard Keynes’s The General Theory of Employment, Interest and Money. Published in 1936 during the Great Depression, it attempted to explain how unemployment could persist, and what ameliorating actions governments could take. In the process of doing this, Keynes became the founding father of macroeconomics. This is the study of large aggregates, and explains such things as unemployment, inflation, exchange rates and interest rates; whereas microeconomics deals with smaller chunks of reality, such as individual markets.

      Keynes’s message is the opposite of Smith’s. Whereas Smith emphasized that a capitalist market economy can be self-regulating and efficient, Keynes emphasized that it was inherently prone to cycles of boom and bust and those periods of bust are terribly inefficient. Whereas Smith emphasized that rational decision-making leads to an efficient outcome, Keynes emphasized that people’s ‘animal spirits’ are driven by waves of spontaneous optimism and pessimism and (implicitly) fuelled by greed, fear and the herd instinct.

      When it comes to macroeconomics, Keynes’s thinking still dominates. It is generally accepted that the government must intervene in the economy to prevent both recessions and overblown expansions, and that it must regulate some sectors. Yet, when it comes to microeconomics, the thinking of Adam Smith dominates. It’s an uneasy coexistence.

      Question for your professor: Keynes emphasized the importance of animal spirits waves of optimism and pessimism. If the economic actors in microeconomics were as Keynes envisaged them, would competitive markets still be efficient? (Hill, Rod; Myatt, Professor Tony. The Economics Anti-Textbook: A Critical Thinker’s Guide to Microeconomics (p. 15). Zed Books. Kindle Edition. https://a.co/3m3czax )

      .
      Great resource Alexander.

      • January 9, 2021 at 9:49 am

        Great comment, Meta. I would like to add that Keynes’s governments-eye focus on the money side of economics and Smith’s on making money by mass-production both take the eye off the physical aspect of human life. What we see if we look is that we always need to consume and care for each other, but we don’t always need to produce, unless the aim of production is taken to be “making money”. This, I suggest, is at the root of Keynes’s waves of optimism and pessimism.

        I use the example of farming. Pastoral care – like human care – has to be on-going, but agriculture tends to be seasonal, with times for planting, nurturing and harvesting but a “winter” season when farmers have time to care for their fencing, drainage and machinery. Why do we not take the same attitude to employment in industry? If we have already produced all the cars we need, why produce more? Wouldn’t it make more sense to take time out to take care of the wealth we have already produced, and the infrastructure and natural environment which enable us to produce and distribute it? Interestingly, this already happens in the holiday and sports industries, which use profits to sustain them through the winter, but why not just give everyone an adequate income and organise the doing of the work as and when it needs doing?

      • Meta Capitalism
        January 9, 2021 at 10:04 am

        What we see if we look is that we always need to consume and care for each other, but we don’t always need to produce, unless the aim of production is taken to be “making money”. ~ Dave Taylor

        .
        Agreed. The rest of my life will dedicated to creating co-op business models that build social capital into the new business models. I gave you a link to great work on that topic about creating a civil economy. I got it from A.J. Sutter.
        .
        You are right. We must take a pastoral care attitude towards employment and industry. This can be expressed through many viewpoints both religious and non-religious, Buddhist and Christian, Jewish, Islamic, and other.[1] They should not be viewed as mutually exclusive but pluralistically.
        .
        I have already said, this is a crisis in meaning and values not science and technology (although I recognize they have a role). One can look at America today and see a microcosm of what is coming soon the entire world.
        .
        You say, “If we have already produced all the cars we need, why produce more?” Ironic. I am currently living in Japan because my wife is employed by one of the world’s largest (and most capitalised auto companies) and she is working on that very idea: we are entering an age when people (especially the younger generation) don’t want to own cars! They are creating entire new visions and business divisions aimed at creating a new vision of mobility as a service and making it possible to own and hence put less cars on the road. Including transportation (air, land, water) that doesn’t run on fossil fuels. So creative things are happening.

        You say, “Wouldn’t it make more sense to take time out to take care of the wealth we have already produced, and the infrastructure and natural environment which enable us to produce and distribute it?” That is exactly what we need to do. To ask “What should we preserve? (Thanks A.J.!) and build upon that.

        Your mind and heart and soul are in the right place Dave.

        https://motanomics.com/2019/06/05/golden-rule-and-business-ethics/

  3. January 7, 2021 at 5:21 pm

    Good for you, Alexander, but the shortcomings of neoclassical economics are very much the shortcomings of neoclassical economists and indeed those blogging here, and of mankind in general: having a split brain and tending to use only half of it, finding it easier to manipulate words (or money) than observe, study and evaluate reality for themselves.

    This physiology I first heard from artist-turned-writer G K Chesterton (1904), and had it reaffirmed in a university course in 1980 on Human Motivation; but it has since become almost commonplace since a medical condition first led to separation of the two sides of a brain. I found the details spelled out in “Drawing on the Right Side of the Brain” by artist Betty Edwards, 1989, BCA. They are related to Right and Left handedness and politics.

    Jungian psychologists have mapped the effects of this on personality, my recommendation here being “Gifts Differing” by Isobel Briggs Myers, 1980, Consulting Psychologists Press. Left-brained people are here termed Thinkers, right-brained ones Intuitives, with just a few of us using both sides. (SensoryThinkers, better with language, tend to become Intuitive in today’s specialisms, with less articulate Intuitive Thinkers like myself tending to have historical and wider interests. That is easier in the UK than in the US, with archeological evidence everywhere stretching our awareness of history back to the pre-Roman Iron Age rather than 1492, when “Columbus sailed the ocean blue”).

    The bias in today’s society is illustrated on this blog by Roger Farmer’s final comment: ” A theory like [NAIRU] … is closer to religion than science”. On the whole, the critics of religion echo a fashion started by Machiavelli and spelled out by Adam Smith (“The Theory of Moral Sentiments”, Part VII Section IV), of telling the powerful what they wish to hear: that their sins are now virtue, and compassion a sin. The likeness to science of its enemy’s version of religion stems from Smith’s mentor David Hume redefining both social science and democratic government as majority opinion, both using ambiguous everyday language rather than stable scientific definitions. So your “more sophisticated understanding” – be it of religion or economics – begins with ‘why’ rather than ‘what’ is being said. On this blog the most popular book is probably Karl Polanyi’s “The Great Transformation”, 2001, Beacon Books, the ‘why’ being indexed under Townsend (p.116ff) and Speenhamland.

    What drives inflation, then? According to Samuelson’s “Economics” (6th edition, Chapter 10, Figure 1), there is no inflation. “With profit properly reckoned as a residual [in a simple circulation of goods and money between business and the public], the two measures of Net National Product must always be identical”. So where does the “residual” go? The argument no-one wishes to publish or even discuss is that there are actually two circuits, both of which are complex: the economy comprising consumers, distributors, producers and developers, with banking being both a development and the consumer in the money-making (chrematic) circuit of money supply, shareholdings, insurance and derivatives. Shortages of money or surpluses of goods can be engineered by banks raising the price of credit or lowering it to increase the sale of goods and development of new ones, increasing profits being “stored” by raising the price of shareholdings. Foreknowledge of a local switch from scarcity to glut enables the prices of particular shareholdings to be collapsed by cash-starving them, allowing banks and wealthy borrowers to buy them up at deflated prices. That’s the ‘what’, but what about the ‘why’ of inflation? Because share prices are just words signalling a quantity of profit, and most people see an unending number series in which ‘bigger’ is better, and not the complex circular continuity of consumption, usage monitoring, replanting and reprovisioning.

    To understand the logic of this you need to study not economics but how electrical circulation involves just four types of component: resistors, capacitors, inductors and transducers (‘developments’ interfacing something else with any of the original three); how economics as a control system uses three (PID) types of information feedback to pursue its aims; how linguistic grammar uses four types of word (nouns, adjectives, adverbs and verbs) to produce another type of thing: a message. Try writing computer programs in Algol68.
    [https://www.eah-jena.de/~kleine/history/languages/Algol68R-UserGuide.pdf].

    The readings I would recommend are therefore not those of US/UK economists. The first is by a Nobel Prize-winning pioneer of chemical physics, the second a bishop and the third a German economist. The fourth is a first-hand observation of the creation of money.

    Frederick Soddy: “Wealth, Virtual Wealth and Debt”, 1926, 1981, George Allen and Unwin.

    Peter Selby: “Grace and Mortgage” [A study of debt from Biblical times], 1997, Darton, Longman and Todd.

    Margrit Kennedy: “Interest and Inflation Free Money”, 1995, New Society Publishers.

    Richard A. Werner: “Can banks individually create money out of nothing? The theories and
    the empirical evidence”, 2014. International Review of Financial Analysis 36 (2014) 1-19.
    [Access from https://www.kreditopferhilfe.net/archiv/%5D.

    • bruceolsen
      January 7, 2021 at 8:31 pm

      Using the validity of Myers–Briggs as a proof point discredits the argument. Jung’s theory of personality was not developed empirically (though in his defense psychology was not an empirical science at the time), and the Myers–Briggs Type Indicator (MBTI) loosely based on Jung has never been rigorously tested. It has poor repeatability and no predictive power. Vox has a summary entitled “Why the Myers-Briggs test is totally meaningless” and there are others with less-clickbaity titles.

      Additionally, I assume you’re using Algol 68 to make a point about simplicity, but Algol 68 failed for a number of reasons (not merely complexity). In that failure it inspired various other languages–some as bulky, some not, some successful, some not–so the actual message is unclear. Atoms are made up of a dozen or more subatomic particles, depending on the theory, and biological systems have orders of magnitude more complexity. Occam and all that.

      • January 7, 2021 at 11:48 pm

        Jung’s theory was based on his own personal observations and Myers-Briggs research continues to demonstrate the truth of it. Though ignoramuses continue to assume its result is a set of constants, it is actually a set of variable preferences which have explanatory power as well as predictive power in the sense of observable behavioural tendencies. Sarcastically, your own assertions must of course be true: you saw them in Vox !

        Its history seems to show Algol68 failed to sell in an America stricken with the “not invented here” syndrome, ge’ed up by a Dutch theorist, Dijkstra, who didn’t understand its philosophic import and the error preventing reason for its complexity. It didn’t fail to WORK, and what it simplified was the automation of operating systems and multi-user, multi-purpose programs. Here I have likened it to making car driving simpler by adding computers to them, but when I was trying it out the aim was more like turning the old “birds-nest” electronics into printed circuits. The “actual message” is obvious and demonstrable once you have seen it: that a reality including language needs four distinct levels of language rather than two, and evolves systematically like an arabic (algorithmic) number counting up to four (as against ten or two). That happens to be true of money: once seen as coins, then notes, then bank accounts and today as virtually costless signalling in and by a computer.

      • bruceolsen
        January 8, 2021 at 3:23 am

        davetaylor1 – In my experience, convoluted verbosity correlates negatively with understanding. Or sometimes it’s just a failure to edit for clarity. Either way, the Vox reference was for you, both for content and as an example of clear, well-structured writing style.

        I thought Dijkstra was rather a pompous ass when I met him at the Wang Institute near Boston in the early 1970s, but to claim, as you do, that he torpedoed Algol 68 because he didn’t understand that its complexity would (supposedly) prevent errors is both counterfactual and rather silly. He helped design the language, and knew the issues intimately, and further he was a pioneer in formal methods for proving program correctness. Complexity does not lead to robustness; simplicity does.

        Don’t waste your time responding.

      • January 8, 2021 at 9:37 am

        For the benefit of other readers, “Vox is an American news website owned by Vox Media”. My judgement of Dijkstra was formed from a history of Algol68 written by another member of the team; my mentor John Morison’s first-hand account of how three people in RRE wrote a compiler for it while its European developers (including Dijkstra) were still arguing about whether that was possible; and the subsequent relatively vigorous marketing of America’s ‘C’. I apologise for having a lot to say and not being able to fit a quart into a pint pot, but it is easy to be intelligible if one cuts out anything demanding thought.

      • January 8, 2021 at 11:46 am

        Bruce Olsen: “In my experience, convoluted verbosity correlates negatively with understanding”.

        Ikonoclast (Jan 8th on Corporate Power): “I didn’t want to and don’t want to turn this into an argument about Ulf Martin’s writing style. The idea content is what is important. I refer to the idea content of both the original post, Bichler and Nitzan’s work in general and Ulf Martin’s paper. When difficult, newly synthesized ideas are first worked out by thinkers there is a whole process often taking years: research, notes, jottings, disjointed pieces, free association screeds, unfinished essays, arguments, counter-arguments, theses, antitheses, syntheses and so on until later finished essays, treatises and perhaps even books are produced”.

  4. Yoshinori Shiozawa
    January 7, 2021 at 6:18 pm

    Alexander,

    I would recommend
    (1) Steve Keen 2011 Debunking Economics – Revised and Expanded Edition: The Naked Emperor Dethroned? 2nd Edition, Zed Books.
    (2) Eric O. Beinhocker 2006 The Origin of Wealth*Evolution, Complexity and the Radical Remaking of Economics. Harvard Business School Press.
    (3) Alan Kirman 2011 Complex Economics: Individual and Collective Rationality. Routledge.
    (4) R.E. Mantegna and H. E. Stanley 1999 An Introduction to Econophysics: Correlations and Complexity in Finance. Cambridge University Press.

    Although they are not books on inflation, these books helps you to reconsider neoclassical economics and you will get new eyes on economics. It is hard to say that there is one good book on inflation (even a good theory of inflation). You can read some parts of above four books. You may think that now popular Randall Wray’s Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems (The second edition 2012) may be a good text on inflation, but in reality it does not contain a theory of inflation except a brief history of hyperinflation. It is also necessary to note that money supply is not so closely related to inflation as many economist claimed in the past.

    • January 8, 2021 at 12:34 pm

      “It is also necessary to note that money supply is not so closely related to inflation as many economist claimed in the past.”

      Yes, this is very much to the point. What money physically is has evolved over the years from coins, notes and bank accounts to virtually costless electronic signals, which can easily be reproduced, transmitted and written off. With rare metals producing insufficient coins for the trade offering, prices had to deflate; the substitution of promissory notes allowed trade to expand but led to goods price inflation and banks failing; double entry accounting permitted goods price manipulation to inflate share prices. The new option is to create our own money electronically as credit and destroy it when the credit is used to make purchases, so profit (money not spent) indebts the system and (figuratively speaking) the credit available is limited by the produce of last year’s work.

  5. ghholtham
    January 8, 2021 at 2:12 pm

    The Nairu had no scientific basis. Its popularity rested on the fact that policy-makers need some simple guides when trying to manage the economy. They know if their policies are too contractionary there can be unnecessary unemployment and if too expansionary they get external deficits, inflation and eventually currency depreciation. Where is the goldilocks point? It is not manifest; the economy is in flux and it changes all the time (the economy is hysteretic and outcomes are path dependent). They know that but it doesn’t help them answer the question. If you tell them it is all too difficult they are tempted to abandon macro management altogether and just balance the budget, leaving interest rates to the central bank. Sometimes we are condemned to do the best we can.
    The trouble with a lot of economics is it supposes people are optimising when in fact they are just doing the best they can without really knowing what’s going on. The trouble with a lot of critics of economics is they suppose there is some clever way of really knowing what’s going on and only perversity (or corruption) stops us finding it. They seldom, however, tell us where to look.

    • January 9, 2021 at 10:34 am

      “[P]olicy-makers need some simple guides when trying to manage the economy. … [Critics] seldom, however, tell us where to look”.

      True. The guide still being used is the idea of a budget: “What you haven’t got, you can’t spend” – the problem being that sometimes one needs to. A guide which is just as simple is to provide credit as needed, and translate what needs doing into an infrastructure which makes it easier to do what needs doing than not, credit normally being justifiable by what it is used for. The big sellers and party politicians have long known about fashion. It is easier to follow the crowd than to think for oneself, especially while getting to know oneself or caring for kids.

    • Meta Capitalism
      January 9, 2021 at 10:52 am

      The trouble with a lot of economics is it supposes people are optimising when in fact they are just doing the best they can without really knowing what’s going on. The trouble with a lot of critics of economics is they suppose there is some clever way of really knowing what’s going on and only perversity (or corruption) stops us finding it. They seldom, however, tell us where to look. ~ Gerald Holtham

      .
      The problem Gerald is that simple answers seldom solve complex problems in context. But for the sake of argument let’s take the Enron fiasco as an exemplar. The regulators knew were to look; in fact they had been looking and had already gathered the data and applied the statistics and reached correct conclusions about the reason for an exponential curve of increasing audit failures by the Big Five. But politics prevented them from implementing policies to that would correct such conflicts of interest. It seems we must take these on a case by case basis. So when we think we can find some social mathematics that will give us access to some secret laws of nature that seems misleading. But perhaps we can, ala Keen, use some mathematical patterns to observe certain phenomena that indicated potential crisis (debt load for example). Again, no simple answers. But I would suggest we start thinking in wider terms; like the role of regulation, transparency, etc.

  6. ghholtham
    January 10, 2021 at 6:07 pm

    I don’t disagree at all. Simple slogans work in politics but practical problems are generally much more complicated. Action is sometimes required even though you don’t know enough to be sure it’s right.

    • Meta Capitalism
      January 10, 2021 at 11:41 pm

      You also once said, Gerald, revolutions seldom work out the way those launching them expect. Case in point in the demagogue President Trump and his attempted coup to overthrown the legitimately elected government of the United States. That is unraveling as we speak, albeit the radicalism he fermented is not going away soon and may well cause more violence. The core of this crisis seems to be one of cultural meanings and values. Much of economics has proven itself to be mere ideology and pseudo-science (despite dogmatic claims of some to the contrary). Once we sort those out we might then be in a better position to reimagine an economics and form of capitalism that can serve our human needs by functioning as a civil economy in the fullness and richness of the term as spoken to in those works that illumination such a wider context.
      .
      But no amount of big data and statistical collectives can answer the question “Which fundamental meanings and which fundamental values should guide us in this endeavour?” At best such methods can only poll our current reference frame.

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