"Briefing Room"
"Economic Network""
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Concept of a 'Natural Rate Unemployment' Is Grossly Inflated

Robert Eisner
L.A. Times
March 3, 1994.

Economics long has had a reputation as the dismal science." We economists are full of such aphorisms as "There is no free lunch" and "No gain without pain".

Some of the great classical economists insisted that we could not permanently raise the wages of workers living at the brink of starvation. If we tried to, they argued, we only would permit them to live longer, reproduce and increase the number of mouths to be fed from limited supplies of food. Real wages then would be forced down farther, until enough people died of starvation for the shares of food and real wages of survivors to return to their original levels.

There was a remedy proposed- the 19th-Century original of the "Just Say No" injunction: Just say no, said the eminent Thomas Malthus, to early marriage and sex to hold down the population. No wonder economists were considered a dismal lot.

But all this is not just ancient history. Dear to the hearts of many Economists working today and underlying the decisions of all too many policy makers is the infamous concept of a "natural rate of unemployment" that we cannot over the long run escape.

According to this notion, if we try to get unemployment below the natural rate, we will bring on increased inflation. And worse, as long as we stay below the "natural" unemployment rate, inflation will keep accelerating. Only if unemployment is at the natural rate will inflation, whatever it is, stay constant. The natural rate is thus called the "NAIRU"- the acronym for that mouthful, "nonaccelerating inflation rate of unemployment".

Getting and trying to keep unemployment even one percentage point below NAIRU will presumably give us not just more inflation- say, an increase from 2% to 3%. Rather, proponents of this view contend, it will mean inflation going first to 3% but then to 4% and then 6% and then 10% and so on. Before long we will have hyperinflation, as in Germany between the world wars, with people carrying wagons full of money to the bakery to buy a loaf of bread.

The only way to stop inflation from increasing is to allow unemployment to get back to its natural rate. But by then we will have a high constant rate of inflation. To get inflation down again, the NAIRU theorists say, we require excess unemployment; that is, unemployment higher than the natural rate. Since we presumably will not permit inflation to stay sky-high, accepting more inflation to reduce unemployment now would necessitate more unemployment later.

But this is a doctrine with little or no consistent factual support. Unemployment in the United States has bounced all around its so-called natural rate with no indications of permanently accelerating inflation from, our episodes of low unemployment.

And if unemployment is natural. God has certainly treated his children differently in different times and places. Much of Western Europe used to have unemployment rates well below ours, in the 2% or 3% range. But Europe has been experiencing double-digit rates for years without the accelerating deflation NAIRU doctrine calls for. Japan's rate remains under 3% - with little or no inflation.

None of this seems to phase at least some "natural raters." I have quipped, on the basis of fairly solid observation, that the difference between Conservatives and Liberals is that Conservatives put the natural unemployment rate around 6.5%- some go to the extreme of arguing that the actual unemployment rate, no matter how high is natural- while Liberals put it at 5.5%.

Of course we cannot expect the unemployment rate to be zero. Economists allow for some "frictional" unemployment. Even under conditions that we would call full employment, some people may be briefly unemployed looking for the right new job when they lose their old one.

But we have had unemployment as low as 1.2%, amid the huge government spending of World War II. If business can sell all it can produce, it will try to hire everyone available. During the Vietnam War, from 1966 to 1969, unemployment 'was in the 3% range while inflation "accelerated" over the a years 1968 to 1971 all the way from 5.0% to 5.4%.

From 1988 to 1990, unemployment in the United States remained under 5.5%, again below the presumed NAIRU, and the rate of inflation moved from 3.9% in 1988 to 4.4 % in 1989, remained at 4.4 % in 1990 and came back down to 3.9% in 1991- hardly evidence of dangerously accelerating inflation.

Yet a minority of senators succeeded last year in blocking President Clinton's stimulus plan, which was designed to reduce unemployment. Their underlying objection was that stimulus could not work to reduce unemployment below its natural rate.

And now Alan Greenspan shocks the financial world, and the economy, by moving to raise interest rates in order to combat an inflation that nobody can find. The justification? The economy is doing too well. If we don't slow it down and hence keep unemployment from getting below the current 6.5%- which Martin Feldstein, chairman of President Reagan's Council of Economic Advisers is quoted as calling "essentially full employment"- we shall have that accelerating inflation!

In deference to that dogma, more than 8 million Americans remain totally unemployed, millions more can find only part-time jobs and still more millions are not even counted because they have given up looking for jobs.

There is nothing natural or necessary about all this misery, or the damage to the economy.
Robert Eisner is William R. Kenan professor of economics at Northwestern University. He is the author of "The Misunderstood Economy: What Counts and How to Count it."


1) T/F, Explain:  According to Robert Eisner, many economists and policy makers believe that the Natural Rate of Unemployment is with the problem of accelerating inflation.

2) T/F, Explain:  Robert Eisner agrees with the above view.

3) T/F, Explain:  According to Robert Eisner, history provides ample evidence to support the natural raters' view.

4) T/F, Explain:  According to Robert Eisner, it really doesn't make much difference whether or not policy makers use the "Natural Rate Theory" as a foundation for economic policy

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