oldfart
Older than dirt
I believe that an understanding of how economists approach economic policy discussions and what they have in the toolbag is useful to the score or so of posters here who want to try a little analysis on their own. For the rest, understanding the terms may make your invective directed at each other at least a bit more entertaining. So....
Back in the old days, discussions of the relationship of unemployment and inflation centered around the "Phillips curve" which showed a trade-off between unemployment and inflation. Originally there was really no theory behind it; "The Phillips curve started as an empirical observation in search of a theoretical explanation." Phillips curve - Wikipedia, the free encyclopedia
The effort to create a theoretical framework to explain the observed results has to center on the role of wages, as this is the main connection between the labor market (where unemployment is observed) and the product market (where inflation is observed). So economists started talking about the "non-accelerating inflation rate of unemployment" (NAIRU). But this concept itself leads to confused thinking, as it is wages that connect inflation to unemployment. So a better concept has been the "non-accelerating wage (increase) rate of unemployment", (NAWRU).
William Phillips published his original paper in 1958 and the analysis caught on in the '60s. By the early '70s a problem arose when it obviously did not do a good job of explaining "stagflation", the period of high unemployment coupled with high rates of inflation. The obvious culprit was that there were non-wage causes of inflation as well, most prominently oil price shocks. This effort led directly to the "rational expectations" models of the '70s and the NAIRU.
By 1988 Robert J. Gordon of Northwestern University had analyzed the Phillips curve to produce what he calls the triangle model, in which the actual inflation rate is determined by the sum of
demand pull or short-term Phillips curve inflation,
cost push or supply shocks, and
built-in inflation.
The last reflects inflationary expectations and the price/wage spiral.
I can testify from personal experience that segmented theories of inflation close to Gordon's "triangle model" were commonplace in economic classrooms of the late '60s and after and were common in graduate schools as well, so I'm not sure why the Wikipedia author gave such credit to Gordon. Anyway, this is the current model in use today with variations. The first component of inflation, the "demand-pull" component describes movement along the short-term Phillips curve while the other two are explanations of what shifts the Phillips curve over time.
So just what is NAWRU supposed to mean? First, it is an observed phenomena which fits into the triangle model of Gordon, but is not itself a theory. There is observed a rate of unemployment consistent with a given rate of inflation that will not increase unless acted upon by some other mechanism than the labor market (like oil shocks or a "Minsky moment" about anticipated rates of inflation being dramatically too low). Sometimes this is called a "natural rate" of unemployment, but this runs the danger of being confused with the Wicksellian "natural rate of interest" which is determined by the "round-aboutness" of the structure of production (You really don't want to get into Swedish capital theory do you? All of you damned Austrians put those hands down!).
At this rate of unemployment, the labor market exhibits sufficient slackness that labor is unable to increase wages (either nominal or real depending on the model) at a rate that would accelerate inflation. Despite the name "demand-pull" inflation, there is a a cost or supply side element to this argument; as long as wage increases are less than the increase in labor productivity, the labor cost per unit of production will stay the same or decrease. In fact, labor costs per unit of production have been decreasing over the past thirty years in real terms, but the lion's share of the benefit has gone to capital and rents, not labor, with the trend accelerating dramatically in the last five or six years.
So reductions in the unit labor cost of production have not resulted in increases in real wages as much of classical economic theory would predict, it has been redistributed to those who receive profits and rents. These people have a lower propensity to consume (a higher propensity to save) and have resulted in a world awash in savings and deficient in demand, causing unemployment to rise. In the model terms, the Phillips curve is shifting so that the NAWRU is steadily increasing. This in a nutshell is the premier economic problem of our time.
It is a vicious cycle. High unemployment weakens labor's bargaining power and results in lower real wages while increased productivity lowers unit labor costs and increases profits to record levels, received by a class that attempts to save most of this increase rather than spend it. The resulting increase in income inequality moves the economy along the Phillips curve to ever higher levels of NAWRU, i.e. higher unemployment with no inflation, setting the cycle to repeat. This cycle is not going to correct itself, without intervention it will only get worse with the standard of living of almost all Americans declining and eventually output suffering as well so that even the wealthy will see profits fall.
With this theoretical structure, there are a couple of possible remedies to break the cycle. The most promising is to increase demand. Investment spending is primarily a function of the demand for the end product (a "derived demand") and will only go up when the cycle is broken. Net exports are problematical to increase. Consumption can be increased if the wealthy can be persuaded to spent extremely lavishly, but there appears to be a limit to how many yachts, airplanes, banana republics, and Congressmen they can be induced to buy; and it will not be enough. That leaves two possibilities, increase consumption by the rest of the population (which will require that they become less income-constrained) and government spending. The first is realistically a reversal of existing trends in income inequality, a government policy to redistribute income away from the top to everyone else. The second is called stimulus. I favor both.
So this is the case presented by "progressive" economists. If you don't agree, feel free to describe your framework and explain the trends of the last forty years. How does your model of the economy show an improvement in economic conditions coming about?
Back in the old days, discussions of the relationship of unemployment and inflation centered around the "Phillips curve" which showed a trade-off between unemployment and inflation. Originally there was really no theory behind it; "The Phillips curve started as an empirical observation in search of a theoretical explanation." Phillips curve - Wikipedia, the free encyclopedia
The effort to create a theoretical framework to explain the observed results has to center on the role of wages, as this is the main connection between the labor market (where unemployment is observed) and the product market (where inflation is observed). So economists started talking about the "non-accelerating inflation rate of unemployment" (NAIRU). But this concept itself leads to confused thinking, as it is wages that connect inflation to unemployment. So a better concept has been the "non-accelerating wage (increase) rate of unemployment", (NAWRU).
William Phillips published his original paper in 1958 and the analysis caught on in the '60s. By the early '70s a problem arose when it obviously did not do a good job of explaining "stagflation", the period of high unemployment coupled with high rates of inflation. The obvious culprit was that there were non-wage causes of inflation as well, most prominently oil price shocks. This effort led directly to the "rational expectations" models of the '70s and the NAIRU.
By 1988 Robert J. Gordon of Northwestern University had analyzed the Phillips curve to produce what he calls the triangle model, in which the actual inflation rate is determined by the sum of
demand pull or short-term Phillips curve inflation,
cost push or supply shocks, and
built-in inflation.
The last reflects inflationary expectations and the price/wage spiral.
I can testify from personal experience that segmented theories of inflation close to Gordon's "triangle model" were commonplace in economic classrooms of the late '60s and after and were common in graduate schools as well, so I'm not sure why the Wikipedia author gave such credit to Gordon. Anyway, this is the current model in use today with variations. The first component of inflation, the "demand-pull" component describes movement along the short-term Phillips curve while the other two are explanations of what shifts the Phillips curve over time.
So just what is NAWRU supposed to mean? First, it is an observed phenomena which fits into the triangle model of Gordon, but is not itself a theory. There is observed a rate of unemployment consistent with a given rate of inflation that will not increase unless acted upon by some other mechanism than the labor market (like oil shocks or a "Minsky moment" about anticipated rates of inflation being dramatically too low). Sometimes this is called a "natural rate" of unemployment, but this runs the danger of being confused with the Wicksellian "natural rate of interest" which is determined by the "round-aboutness" of the structure of production (You really don't want to get into Swedish capital theory do you? All of you damned Austrians put those hands down!).
At this rate of unemployment, the labor market exhibits sufficient slackness that labor is unable to increase wages (either nominal or real depending on the model) at a rate that would accelerate inflation. Despite the name "demand-pull" inflation, there is a a cost or supply side element to this argument; as long as wage increases are less than the increase in labor productivity, the labor cost per unit of production will stay the same or decrease. In fact, labor costs per unit of production have been decreasing over the past thirty years in real terms, but the lion's share of the benefit has gone to capital and rents, not labor, with the trend accelerating dramatically in the last five or six years.
So reductions in the unit labor cost of production have not resulted in increases in real wages as much of classical economic theory would predict, it has been redistributed to those who receive profits and rents. These people have a lower propensity to consume (a higher propensity to save) and have resulted in a world awash in savings and deficient in demand, causing unemployment to rise. In the model terms, the Phillips curve is shifting so that the NAWRU is steadily increasing. This in a nutshell is the premier economic problem of our time.
It is a vicious cycle. High unemployment weakens labor's bargaining power and results in lower real wages while increased productivity lowers unit labor costs and increases profits to record levels, received by a class that attempts to save most of this increase rather than spend it. The resulting increase in income inequality moves the economy along the Phillips curve to ever higher levels of NAWRU, i.e. higher unemployment with no inflation, setting the cycle to repeat. This cycle is not going to correct itself, without intervention it will only get worse with the standard of living of almost all Americans declining and eventually output suffering as well so that even the wealthy will see profits fall.
With this theoretical structure, there are a couple of possible remedies to break the cycle. The most promising is to increase demand. Investment spending is primarily a function of the demand for the end product (a "derived demand") and will only go up when the cycle is broken. Net exports are problematical to increase. Consumption can be increased if the wealthy can be persuaded to spent extremely lavishly, but there appears to be a limit to how many yachts, airplanes, banana republics, and Congressmen they can be induced to buy; and it will not be enough. That leaves two possibilities, increase consumption by the rest of the population (which will require that they become less income-constrained) and government spending. The first is realistically a reversal of existing trends in income inequality, a government policy to redistribute income away from the top to everyone else. The second is called stimulus. I favor both.
So this is the case presented by "progressive" economists. If you don't agree, feel free to describe your framework and explain the trends of the last forty years. How does your model of the economy show an improvement in economic conditions coming about?
Last edited: