The Non-Accelerating Inflation Range of Unemployment

Hopefully my last two posts on the subject have made it clear that I am ready, willing, and able to defend the theory of a Non-Accelerating Inflation Rate of Unemployment, not just as “the best of a bad lot” but as a worthwhile theory in and of itself. Having declared victory, I am now getting out. Herewith I renounce the Non-Accelerating Inflation Rate of Unemployment. Le NAIRU est mort.

Vive le NAIRU! As we bury the theory, we need not also bury the acronym. Rather, let me suggest that there is a range of unemployment rates that is compatible with stable inflation: the Non-Accelerating Inflation Range of Unemployment. I’m not sure who coined that phrase, but I associate it with Harvard labor economist James Medoff. (A Google search on the phrase turns up nothing of interest.)

If the unemployment rate goes above the NAIRU range, the inflation rate declines. If it goes below, the inflation rate rises. If it stays within the range, the inflation rate remains the same, except for random changes and responses to external shocks.

It is a theory with which, it seems to me, almost everyone will eventually have to agree. It is proven by thought experiment and historical experience. Even the most ardent “Old Keynesian” or real business cycle advocate will have to acknowledge that, if we push unemployment far enough below the full-employment level, the inflation rate will start to rise fairly rapidly. To put it conversely, an inflationary monetary policy will initially push unemployment below the full-employment level. Some may deny the possibility of pushing unemployment below the full-employment level, but it seems to me that the late 1960s provide an example.

On the other side, even the most ardent Laxtonite advocate of the convex Phillips curve will have to acknowledge that, if we push unemployment high enough, we will get fairly rapid disinflation – or conversely, that there are limits to the unemployment effects of even the most draconian disinflaitonary (or deflationary) policy. The early 1980s would seem to provide an example. I might also cite the rapidity with which deflation materialized during the early 1930s, as well as the relatively small absolute unemployment increase in 1990s Japan.

And there is surely some range of unemployment in the middle that is compatible with stable inflation. Traditional NAIRU people may still claim that the range is degenerate, just a single point, but the experience of the late 1990s makes that claim very difficult to maintain.

What I’m suggesting is a Phillips curve that is convex on the left side and concave on the right side, like the shape depicted below. For extremely low unemployment rates – near zero – we are in hyperinflationary territory. As we consider gradually higher unemployment rates, the inflation rate first falls quickly toward “ordinary high inflation,” then more slowly down to the expected inflation rate, where it essentially remains over a certain range. Subsequently, as we consider gradually higher unemployment rates above the NAIRU, the inflation rate falls slowly, then more quickly, then very quickly into the deflation zone.