# The Non-existence Of NAIRU In SFC Models

Simon Wren-Lewis has a post on his blog, The NAIRU: A Response To Critics. In that he refers to a blog post from me where I refer to the book Monetary Economics by Wynne Godley and Marc Lavoie. He perhaps doesn’t like me just citing the textbook and needs an explanation. How is that for an argument! Suppose I write a paper on gravitation. Do I always have to derive Einstein’s equations? Can’t I just refer it to the reader?

In other words, how is telling somone that, “SFC models have no NAIRU” not a good argument? Easy to check.

Anyway, an explanation: In stock-flow coherent models, the wage dynamics is given by equations such as these (page 302) :

ωT= (W/p)T = Ω0 + Ω1·pr + Ω2·(N/Nfe)

W = W–1·(1 + Ω3·(ωT−1W-1/p-1))

Here,

is the price level, is the nominal wage rate, ωis the target real wage rate, pr is the labour productivity, is the level of employment, Nfe is the full employment level and the three Ωs are parameters.

Wages change only discretely. Workers have a target wage rate which depends on productivity and the employment level. The actual wage rate is the outcome of bargaining of employees of firms with management. So workers try to catch up to what they consider fair. And their target depends on the level of employment. If unemployment is high, negotiation is more difficult and if unemployment is low, it’s easier as jobs can be switched. So there’s a Phillips curve.

Another important point is that there is no inflation expectations here.

The parameters Ωs used by the authors Godley-Lavoie and Gennaro Zezza are: –0.4, 1, 1.2 and 0.3.

Simulations of such models do not produce a runaway inflation, only higher inflation at full employment.

It’s not difficult to see why. How does the wage dynamics equations imply a runaway inflation? Can you inspect them conclude in a straightforward manner that there’s NAIRU? Anyway, simulations confirm.

That doesn’t mean there can’t be a wage-price spiral. This might happen—as the authors Godley and Lavoie explain—if the parameters Ωs change fast with time or if wage settlement happen more frequently. But as I have mentioned, it’s not necessarily so.

More realistic models have a flatter segment like this (Figure 11.1, page 387 from Monetary Economics, Ed. 1):

snipping via amazon.com

In this model (the “growth model prototype”) with behavioural equations for the government, central bank, firms, banks and households, the wage dynamics are similar to the equations above except that they have a flat segment. Again no accelerating prices!

In the discussion above (with no flat segment), I mention that there’s no NAIRU, but just to confirm I asked Marc Lavoie if this is crucial and he said no. Quoting his email with his permission:

The (unique) NAIRU has to be associated with a relationship that says that any negative discrepancy between the actual rate of unemployment and the NAIRU will lead to an acceleration of the rate of inflation. In terms of the rate of employment, it implies that any positive discrepancy between the actual rate of employment and the NAIRU will lead to an acceleration of the rate of inflation. This means that we can draw an upward-sloping curve relating the rate of employment to the change in the rate of inflation, where the change is zero when the economy is at the NAIRU.

In the case of Godley and Lavoie (2007), whether it is chapter 9 or 11, the equations that define the real wage target are such that they do not lead to such a curve. What we get is an upward-sloping curve that relates the rate of employment to the rate of inflation, and not to its change. When we are in the flat area of Figure 11.1, this means that the rate of inflation remains constant even if the rate of employment is higher. Besides the flat area, we have a kind of old Phillips curve: to a higher rate of employment is associated a higher rate of inflation, but that is all. There is no acceleration. Another way to put it is to say that there is an infinite number of NAIRU or a multiplicity of NAIRU (of rates of employment with steady inflation).

So with explanations about wage dynamics which has a Phillips curve (with or without a flat segment), I show that SFC models have no NAIRU.

The New York Times On Automation

The Editorial Board of The New York Times have written an editorial in “The Opinion Pages” stating that they don’t see automation as something taking away jobs.

The article also rightly says:

Americans should blame policy makers, not robots.

While that’s great—good start—the article errs on trade:

Defenders of globalization are on solid ground when they criticize President Trump’s threats of punitive tariffs and border walls. The economy can’t flourish without trade and immigrants.

It’s a bit of a straw man argument to claim that anyone opposed to free trade is opposed to trade itself. The U.S. trade imbalance is a problem for employment. Globalization has also led to offshoring of jobs. Immigration control can be used for economic migration without discrimination to help workers both in employment and wage bargaining. The principle of non-refoulement should be respected and all refugees should be allowed.

[the header of this post is the link]

# Dean Baker On Economists’ Contradictions On Productivity

Dean Baker has been writing some of the best articles about the U.S. economy in the past few weeks. I have already linked to his articles on this blog. If you have missed them, follow the tag with his name at the end of this post.

His analysis has been about economists’ incorrect narrative about productivity and U.S. trade. This narrative simply is that workers are losing jobs because of automation and not because of U.S. trade and globalization. Dean Baker shows that it’s quite the opposite.

In his latest post, he points out the inconsistency of economists stands. One on the one hand, economists seem to be saying that productivity rises will be large because of automation and on the other hand saying that productivity won’t rise much.

This is the stand of Paul Krugman whom Baker cites. In his column On Economic Arrogance for The New York Times, Krugman argues that it’s impossible for the U.S. to grow at 3-3.5% in the next decade. Krugman says:

The only way we could have a growth miracle now would be a huge takeoff in productivity — output per worker-hour. This could, of course, happen: maybe driverless flying cars will arrive en masse. But it’s hardly something one should assume for a baseline projection.

Now, it’s quite possible that Donald Trump, being the erratic person he is, can mess thinks up. You can’t be sure what he is up to. He may come up with a large fiscal expansion or not. But the more important question is about the possibility. Would Hillary Clinton or Bernie Sanders been able to achieve the growth rate of 3-3.5% had they been the President? According to Krugman it’s simply unlikely because he thinks productivity growth will be low.

The same kind of argument was given by Krugman when Bernie Sanders released his economic plan. See John Cassidy’s article Bernie Sanders And The Case For A New Economic Stimulus Package in The New Yorker from for a good analysis, written February 2016. In the article Cassidy reminds us of the Kaldor-Verdoorn Law according to which faster GDP growth leads to faster productivity rises.

To break out of this low-growth trap, the economy needs policies designed to boost demand and push it onto a higher growth path: one in which rising investment, higher levels of productivity, rising rates of participation in the labor force, and higher wages all reinforce each other. With these conditions in place, companies would have more of an incentive to make capital investments, and as the price of labor rises they would also have an incentive to innovate and move up the value chain. Realistically, we can’t expect 5.3-per-cent G.D.P. growth and 3.3-per-cent productivity growth to persist for a decade. But we don’t necessarily have to settle for the 2.1-per-cent G.D.P. growth we’ve become accustomed to, or even the 2.3-per-cent rate that the Council of Economic Advisers has identified as its long-term potential. The U.S. economy has the resources and the ingenuity to do better than that.

As [Gerald] Friedman points out, the idea that faster G.D.P. growth generates higher productivity growth (and higher wages) has historical support. Back when I was an undergraduate, it was associated with Nicholas Kaldor, the British Keynesian, and with P. J. Verdoorn, a Dutch economist. (In a footnote, Friedman cites both of them.) More recently, in the late nineteen-nineties we saw rapid rates of G.D.P. growth and productivity growth appear in tandem. Some analysts would claim that the latter generated the former, rather than vice versa, but that argument isn’t convincing. In a Kaldorian virtuous cycle, G.D.P. growth spurs productivity growth, which, in turn, spurs G.D.P. growth. Causation goes both ways.

So the U.S. economy has a lot of scope for growth in the next decade. There are ways:

• The U.S. GDP can grow without productivity rising simply because there’s huge unemployment. The U-6 unemployment rate is currently 10.1%. Because of Okun’s law which says that a growth of 1.65% will reduce unemployment by 1% (see estimation of this parameter for the U.S. by Matias Vernengo here.)
• Rise in the workforce. Over time, work force also rises, (depending on demographics), this adds to the capacity of the economy. A notable thing during the crisis is the fall in the workforce in the U.S. Am not sure about details around this. Seems this is not captured in U-6. One would have expected the labour force to have not dropped and unemployed being captured in U-6. In other words, it’s possible that there’s more potential labour available.
• As above, because of Kaldor-Verdoorn law, higher production leads to higher productivity. The Verdoon coefficient is 0.63 as per the paper cited above. So a growth of 1% will lead to a rise in productivity by 0.65%. Higher productivity implies that it takes less labour to produce the same amount of things. This in turn implies that the labour can be employed elsewhere or to produce more of the same stuff. So rise in productivity increases production capacity.

So these three points are enough to prevent the U.S. economy from hitting full capacity for a long time. Scarcity is a thought which needs to go from economics.

At any rate, the main purpose of this post was to point out the contradictory things economists say. Economists seem to be saying that automation will rise, which translates to rise in productivity. At the same time they are also saying that productivity will be low. Further Dean Baker has also pointed out how the Federal Reserve is on the path to raise interest rates. If they are worried about automation killing jobs, why aren’t they worried about the Federal Reserve’s rate hikes destroying jobs?

# Why NAIRU is “zOMG HYPERINFLATION”

Does employment and inflation have a relationship? Yes of course. Can a wage-price spiral happen? Yes it can. A lot of economists exploit this possibility to incorrectly argue for NAIRU.

This post is a continuation of a recent post Simon Wren-Lewis, NAIRU And TINA in which I argued that NAIRU is not a useful concept and is counterproductive.

That wage-price spirals can happen isn’t a proof for NAIRU itself. NAIRU is defined as the unemployment rate Ubelow which prices start accelerating (or inflation starts to rise indefinitely). But the NAIRU hypothesis is a hypothesis of certainty. Economies are complex dynamical systems and just because wage-price spirals may have happened in the past doesn’t imply that it will always happen.

In the last mentioned how stock-flow consistent models, full employment can be achieved with no rising inflation, just higher inflation when parameters about wage-bargaining aren’t changing or if intervals between settlements shorten.

As I said in my previous post, NAIRU advocates think that a fraction of the workforce should be kept unemployed to keep inflation under control. By claiming that there exists a NAIRU or an unemployment rate below which prices necessarily start accelerating, they do a huge disservice to not just Economics but also to the welfare state. Any politician reading about NAIRU is likely to take away the incorrect notion that if unemployment is pushed too low, hyperinflation can happen. Hence the politician responsible for taking decisions is likely to postpone or abandon the pursuit for full employment.

So one can cogently believe all three of the following:

• there is a relationship between employment and inflation
• wage-price spiral can occur
• NAIRU is wrong.

In other words, NAIRU proponents exploit the possibility to claiming a certainty. Wage-price spirals happened in the 70s and Joan Robinson even saw it coming. But wage-spiral is not NAIRU. Conflating the two is vile.

What are the solutions if a wage-price happens? There is a lot of literature for an “incomes policy” from economists such as Nicholas Kaldor. For the purposes of this post, it’s not necessary to go in that direction as it’s not needed in current times at least in the advanced economies.

# The All American iPhone: Bad, Or Good?

The new American President Donald J. Trump is pushing for bringing back jobs to the U.S. as everyone knows. In his inauguration speech he said:

We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs. Protection will lead to great prosperity and strength.

I will fight for you with every breath in my body – and I will never, ever let you down.

America will start winning again, winning like never before.

We will bring back our jobs. We will bring back our borders. We will bring back our wealth. And we will bring back our dreams.

We will build new roads, and highways, and bridges, and airports, and tunnels, and railways all across our wonderful nation.

We will get our people off of welfare and back to work – rebuilding our country with American hands and American labor.

We will follow two simple rules: buy American and hire American.

Now this has led to the repetition of the story that offshoring jobs is beneficial to the U.S. The Apple iPhone is used frequently to tell the story. According to this story, as argued by many such as the MIT Technology Review, the all-American iPhone will be pricier and hence bad for the U.S. One of the arguments is that the iPhone is so complicated that it’s even impossible to make everything in the U.S! While that is certainly true, it doesn’t mean that remaking the iPhone in America, i.e., most of it is not possible or bad.

In fact such denialism has quite contributed to the rise of Trump. People interested in politics and to the left of Trump on the economic left in the “political compass” should have a look into such things.

Let’s say that Apple manufactures most parts of iPhones in the U.S. Since its costs will rise, as it has to pay more labour for example, it will be priced higher if Apple wants to keep the same margin. Now since wages are a source of domestic demand for the U.S. economy, this will lead to higher output and income for U.S. economic units. It will also lead to an improvement in the U.S. balance of payments and international investment position as the U.S. is paying foreigners lesser in the new supply chain than is the case now. Higher U.S. employment would also mean higher wage-bargaining and higher wages. Higher prices won’t hurt iPhone buyers since real incomes would rise.

Needless to say, there’s also an international aspect. That iPhones will be more expensive might mean lower volume of iPhone exports. But price is not the only thing consumers look at. So the fall in exports won’t hurt if that’s the case. Moreover, a rise in U.S. output would be beneficial to the world and iPhone exports needn’t fall. Something has to fall you’ll say. Yes, Apple’s market share will fall, although not the absolute value of its profits.

Donald Trump has to be resisted for his authoritarianism and xenophobic policies. But economic myth-making is not the right way.

# Simon Wren-Lewis, NAIRU And TINA

Last month, Matthew C Klein wrote an article for Financial Times’ blog Alphaville arguing against the concept of NAIRU. Today, Simon Wren-Lewis published a reply to Klein on his blog defending NAIRU. SWL’s argument is essentially that there is no alternative (TINA):

… But here is the rub. If we really think there is no relationship between unemployment and inflation, why on earth are we not trying to get unemployment below 4%? We know that the government could, by spending more, raise demand and reduce unemployment. And why would we ever raise interest rates above their lower bound?

… There is a relationship between inflation and unemployment, but it is just very difficult to pin down. For most macroeconomists, the concept of the NAIRU really just stands for that basic macroeconomic truth.

The sad part of this argument is that NAIRU isn’t the only answer to the relationship between (un)employment and inflation. Both of the following can be true:

• There is a relationship between employment and inflation.
• The concept of NAIRU is false.

What is NAIRU (non-accelerating inflation rate of unemployment)? According to the originators of this incorrect idea, it is the rate of unemployment U* below which inflation starts rising indefinitely. It’s a bit of a misnomer as it’s prices which is accelerating, not inflation. Nonetheless, the extreme nature of this should be clearly stated: NAIRU advocates think that a fraction of the workforce should be kept unemployed to keep inflation under control.

Post-Keynesians have rejected these arguments since the beginning. In their book Monetary Economics, Wynne Godley and Marc Lavoie show that in their model full employment can be achieved without a runaway inflation.

This is not the first time SWL has defended orthodoxy. A few years ago, he called rational expectations “one of economics’ major achievements” and also that:

It is not a debate about rational expectations in the abstract, but about a choice between different ways of modelling expectations, none of which will be ideal. This choice has to involve feasible alternatives, by which I mean theories of expectations that can be practically implemented in usable macroeconomic models.

However for the foreseeable future, rational expectations will remain the starting point for macro analysis, because it is better than the only practical alternative.

Dean Baker — The Trouble With International Trade: People Understand It

Dean Baker:

[these days,] major news outlets have been filled with misleading and dishonest stories claiming that the real cause of manufacturing job loss has been automation and that people are stupid to worry about trade.

From December of 1970 to December of 2000 we lost 130,000 manufacturing jobs, less than one percent of the total. There was plenty of productivity growth in manufacturing over these three decades. While manufacturing employment did fall as a share of total employment, there was little change in the absolute number of manufacturing jobs over this long period.

By contrast, manufacturing employment dropped by more than 3.4 million, or more than 20 percent, in the seven years from 2000 to 2007. This was trade. The trade deficit exploded over this period to almost 6 percent of GDP, which would be more than \$1.1 trillion in today’s economy.

[the title is the link]

# Dean Baker On Automation

In his farewell address, Barack Obama toed the New Consensus’ line (around 12:50 in the video in the link):

… But, for all the real progress that we’ve made, we know it’s not enough. Our economy doesn’t work as well or grow as fast when a few prosper at the expense of a growing middle class, and ladders for folks who want to get into the middle class.

That’s the economic argument. But stark inequality is also corrosive to our democratic idea. While the top 1 percent has amassed a bigger share of wealth and income, too many of our families in inner cities and in rural counties have been left behind.

The laid off factory worker, the waitress or health care worker who’s just barely getting by and struggling to pay the bills. Convinced that the game is fixed against them. That their government only serves the interest of the powerful. That’s a recipe for more cynicism and polarization in our politics.

Now there’re no quick fixes to this long-term trend. I agree, our trade should be fair and not just free. But the next wave of economic dislocations won’t come from overseas. It will come from the relentless pace of automation that makes a lot of good middle class jobs obsolete.

In other words, Obama says that international trade and globalizing production aren’t responsible for weak employment and labour markets, but it’s automation.

Dean Baker has been writing a series of good articles puncturing these arguments. In his latest, titled Badly Confused Economics: The Debate on Automation, he writes that productivity hasn’t been rising much and that if tightness of the labour market is cited as one of the reasons for hikes in interest rates by the Federal Reserve, that’s contradictory. Baker says:

… The other reason why the concern over automation seems misplaced is that it is directly at odds with how we talk about other areas of economy policy. To take an example that has recently been in the news, the Federal Reserve Board raised interest rates in the United States last month. It is widely expected to raise interest rates several more times in 2017.

The reason for raising interest rates is that the Fed is concerned that the economy is creating too many jobs. This will increase workers’ bargaining power, putting upward pressure on wages. A more rapid rate of wage increases will lead to more rapid inflation. To prevent this outcome, the Fed wants the economy to have fewer jobs.

But how can it make sense that, at a time when we are worried that automation is destroying a massive number of jobs, we also need the Federal Reserve Board to add to the job destruction by raising interest rates? If automation is leading to mass job destruction the Fed should not have to be worried about overly tight labor markets.

# Dean Baker On US Manufacturing And International Trade

The U.S. manufacturing deficit was \$831 billion in 2015. The 2016 number might be out in a few days. Dean Baker has an excellent articlePainful Nonsense on Trade on his blog in which he debunks the claims of most economists that the US trade imbalance didn’t lead to job losses. He says:

… Note that the level of manufacturing employment, while it has cyclical ups and downs, is nearly constant from 1970 to 2000 at around 17 million. It plunged in the early years of the last decade as the trade deficit exploded. Most of the fall in employment was before the collapse of the housing bubble in 2008. This is what happens when a trade deficit increases from around 1.5 percent of GDP, the mid-1990s level, to almost 6.0 percent of GDP at its peak in 2005–2006 (over \$1.1 trillion in today’s economy).

and also that the comparison to Germany is misleading:

DeLong also does a bit of sleight of hand in telling us that the loss of manufacturing employment is the same everywhere, pointing out that even Germany, the big success story, saw employment in manufacturing fall from about 40 percent of the labor force in 1971 to 20 percent at present. This is true, and if the United States had the same share of its workforce employed in manufacturing as Germany, we would have another 15 million manufacturing jobs.

A similar point was made by Wynne Godley in 1995! In A Critical Imbalance In U.S. Trade, The U.S. Balance Of Payments, International Indebtedness, And Economic Policy he said:

It is sometimes said that manufacturing has lost its importance and that countries in balance of payments difficulties should look to trade in services to put things right. However, while it is still true that manufacturing output has declined substantially as a share of GDP, the figures quoted above show that the share of manufacturing imports has risen substantially. The importance of manufacturing does not reside in the quantity of domestic output and employment it generates, still less in any intrinsic superiority that production of goods has over provision of services; it resides, rather, in the potential that manufactures have for expansion in international trade.

# Dani Rodrik On Free Trade

In a recent article for Foreign Policy, Dani Rodrik makes this claim:

Meanwhile, economists rightly point out that trade is only weakly implicated in the major economic problems of the day — deindustrialization and income inequality. They are correct that the distributional consequences of trade are better addressed with safety net programs and nontrade remedies. But they have systematically downplayed these consequences — especially when the requisite compensatory programs have remained on paper. And they seem unable to grasp the valid core of the public’s concern about social dumping.

It’s a bit disappointing that Dani Rodrik who presents himself as a dissenter is towing the line of the New Consensus. The new trade theory, which is a part of the new consensus says that free trade is fine as long as losers are compensated. In this article Rodrik states the same but just takes issue on the latter part, i.e., compensation.

This line of argument is deeply flawed. An individual country’s growth has a deflationary bias because free trade puts a rein on fiscal policy to achieve full employment. So who is there to compensate? Moreover, it’s not comparative advantage which governs economic dynamics but absolute advantage via Gunnar Myrdal’s principle of circular and cumulative advantage . As Nicholas Kaldor says, “success breeds further success and failure begets more failure.”

Moreover it’s the the whole world economy which has a deflationary bias because of free trade as pointed out by Nicholas Kaldor in his 1980 article Foundations And Implications Of Free Trade Theory

In a recent article on the ‘Causes of Growth and Recession in World Trade’,1 T. F. Cripps has demonstrated that a country is not ‘balance of payments constrained’ if its full employment imports, M*, are less that its import capacity M̅ (as determined by its earning from exports). Such a country is free to choose the level of domestic demand which it considers optimal for its own circumstances,2 whereas the other countries from whom M* > M̅, must, under conditions of free trade, reduce their output and employment below the full employment level, and import only what they can afford to finance. He then shows that the sum of imports of the ‘unconstrained’ countries determine the attainable level of production and employment of the ‘constrained’ countries, and the remedy for this situation requires measures that increase the level of ‘full-employment’ imports or else reduce the export share of the ‘unconstrained countries’. The ‘rules of the game’ which would be capable of securing growth and stability in international trade, and of restoring the production of the ‘constrained’ countries to full employment levels, may require discriminatory measure of import control, of the type envisaged in the famous ‘scarce currency clause’ of the Bretton Woods agreement.

In the absence of such measures all countries may suffer a slower rate of growth and a lower level of output and employment, and not only the group of countries whose economic activity is ‘balance-of-payments constrained’. This is because the ‘surplus’ countries’ own exports will be lower with the shrinkage of world trade, and they may not offset this (or not adequately) by domestic reflationary measures so that their imports will also be lower. Provided that the import regulations introduced relate to import propensities (i.e. to the relation of imports to domestic output) and not to the absolute level of imports as such, the very fact that such measures will raise the trade, production and employment of the ‘constrained’ countries will mean that the volume of exports and domestic income of the ‘unconstrained’ countries will also be greater, despite the downward change in their share of world exports.3

Footnotes:

1Cambridge Economic Policy Review (March 1978), pp, 37-43.

2Owing to the widespread view according to which a given increase in effective demand is more ‘inflationary’ in its consequences if brought about by budgetary measure than if it is the result of additional investment or exports (irrespective of any limitations of import capacity) the inequality or potential inequality in its payments balance may cause a surplus country to regard a lower level of domestic demand as ‘optimal’ in the first case than in the second case.

3In other words, if countries whose ‘full employment’ balance of payments shows a surplus because M* < α W (where M* is the level of full employment imports, α is the share of a particular country’s exports of in world trade W) after a reduction of α to α̂ (α̂ < α) through the imposition of discriminatory measures, the country will still be better off if α̂ W* > α W where W* is the volume of world trade generated under full employment conditions.

Of course, the solution is hard and in my opinion, international agreements to reach balanced trade is the correct way. Free trade is the most sacred tenet in all of macroeconomics and it’s not going to be easy to get rid of it.