Friday, February 24, 2017

Brian Romanchuk — NAIRU (Again)

SWL: Accepting the concept of the NAIRU does not mean you have to agree with their judgements. But if you want to argue that they could be doing something better, you need to use the language of macroeconomics.
As an applied mathematician, Brian showed how macroeconomists don't know what they are talking about with respect to NAIRU when using the language of macroeconomics because the concept is empty.

And no advanced math required to do it. Just basic logic and philosophy of science.
Philosophy is a battle against the bewitchment of our intelligence by means of our language. — Ludwig Wittgenstein, Philosophical Investigations, § 109
There are many parallels between economics and philosophy, one of the most evident is unfounded assumptions presumed to be self-evident. Scientific method was developed to circumvent this.
BR: The whole point of the standard NAIRU definition is that it is easy to observe: you just need to back out the acceleration of inflation (keeping in mind there may be other variables whose influence needs to be isolated). However, in the real world, the observed unemployment rate is affected by institutional factors -- which do not exist in a NAIRU model. Since the end result is that NAIRU estimates are inherently unreliable, the concept is wrong by definition.

This is why most mainstream macro has retreated to discussing output gaps of various types. Output gaps have to be inferred via various statistical techniques, and they are inherently fuzzier. It may be that Professor Wren-Lewis has some of these more recent models in mind when he is referring to NAIRU; but that makes as much sense as referring to post-1990 Fed Policy as monetary base targeting.
If you want to use standard academic terms, NAIRU is falsifiable, and was in fact falsified. The generalised output gaps that popped up to replace NAIRU are pretty much unfalsifiable.
To a philosopher standing outside economics looking in, it appears that many economists are so intellectually committed to finding a solutions that they convince themselves and each other that they have found one when they have not.
We have got on to slippery ice where there is no friction and so in a certain sense the conditions are ideal, but also, just because of that, we are unable to walk. We want to walk: so we need friction. Back to the rough ground! — Ludwig Wittgenstein, Philosophical Investigations, § 107
Bond Economics
NAIRU (Again)
Brian Romanchuk

19 comments:

Dan Lynch said...

As Bill Mitchell has pointed out many times, Australia maintained 2% unemployment and modest (< 4%) inflation for 30 years after WWII. There was some luck involved, but nonetheless it demonstrates what is possible.

Matt Franko said...

Might have been dissaving War Bonds...

Matt Franko said...

Also in the US during that period the Marshall Plan was implemented without allowing any foreign claims...

AXEC / E.K-H said...

The fatal mistake of the discussion is to accept the NAIRU-Phillips curve (with the well-known disclaimers) and to focus on the economic policy implications with regard to the given situation in the US/UK/etc. But there is NO use to discuss policy if the underlying theory is defective.

Right policy depends on true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

So what FIRST has to be done is to fix the NAIRU-Phillips curve.* The insight that there is NO such thing as a NAIRU then opens up new economic policy perspectives.

The correct theory of the macroeconomic price mechanism tells us that ― for purely SYSTEMIC reasons ― the average wage rate has in the given situation to rise faster than the average price. This opens the way out of mass unemployment, deflation, and stagnation.

If the price mechanism does not spontaneously deliver, as standard economics claims since 200+ years, THIS becomes an issue for economic policy and economics has to figure out the optimal rates of change for wage rate and price.

Egmont Kakarot-Handtke

* For details see ‘NAIRU, wage-led growth, and Samuelson’s Dyscalculia’
http://axecorg.blogspot.de/2015/01/nairu-wage-led-growth-and-samuelsons.html

Ralph Musgrave said...

Dan,

Re Australia's low unemployment in the 1950s and 60s, that low unemployment was common to most of the West. In fact Switzerland's official unemployment figure on two occasions in that period was zero! Though possibly that can be attributed to the fact that Switzerland imported a lot of Italian labour at that time, and forced unemployed Italians to go home!!

Ralph Musgrave said...

I always like the way Bill Mitchell gets furious at the mention of NAIRU. But he finds the "low unemployment causes inflation" idea indispensible. So he gives it a different name, namely "inflation barrier" (IB). Frankly that's just silly.

However, we should always remember that Bill has done a great job combating the debt and deficit phobes like Rogoff and Reinhart.

Bob said...

If NAIRU were equal to frictional unemployment, who would have an issue with it?

Auburn Parks said...

My goodness Ralph,

will you please persist with you're inaccurate representations of MMTers complaints abbout NAIRU?

Nobody is arguing that there is no relationship between employment levels, productive capacity and inflation.

The mainstream claims that this relationship is knowable and as such it is used to set policy.

This is the claim that is wrong, and the one MMTers continue to point out is wrong.

They say that the NAIRU is 5% so if UE gets lower than 5%, CBs want to raise interest rates
to slow down the economy to combat inflation.

This is utter bullshit as there is no reason to think that UE rates lower than 5% generate accelerating inflation.

This is the point of contention. That 5% is the number specifically and that in theory you can estimate this using output gap models.

The point of contention is NOT whether their is a relationship between labor, supply, and inflation.

Please stop misleading the readership community, Thanks

Ralph Musgrave said...

Auburn,

It’s news to me that defenders of NAIRU say it can be measured accurately. Certainly Simon Wren-Lewis, the most recent and vociferous and one of the best qualified defenders of NAIRU says “NAIRU is one of those economic concepts which is essential to understand the economy but is extremely difficult to measure”. See:

https://mainlymacro.blogspot.co.uk/2017/02/nairu-bashing.html

But if there are any NAIRU advocates who do claim it can be accurately measured, I flatly disagree with them and agree with you: it can’t be accurately measured.

It’s also news to me that NAIRU bashers are simply saying it cannot be accurately measured. Certainly Brian Romanchuk recently penned an article entitled “NAIRU should be bashed, smashed and trashed”. That title and indeed the text of his article say pretty clearly that the entire concept behind NAIRU should be abolished.

Auburn Parks said...

Ralph-

I cant tell sometimes whether you are being intentionally or unintentionally disingenuous. This exchange is from last week's original comment thread on Brian's first NAIRU article.

This is how you start:

" Bill Mitchell is positively delusional when it comes to NAIRU. He foams at the mouth at the mention of the acronym, while admitting there is a relationship between inflation and unemployment. He just gives it a different name: the "inflation barrier". All he's doing is playing with words."

Notice how this is almost literally a copy of your first comment in this thread:

"I always like the way Bill Mitchell gets furious at the mention of NAIRU. But he finds the "low unemployment causes inflation" idea indispensible. So he gives it a different name, namely "inflation barrier" (IB). Frankly that's just silly."

Now, here are my responses in the two threads, which are also almost identical given that you are making the same argument twice.

The first one by me from a week ago:

"Ralph-

The concept, analysis and application of NAIRU is totally bogus. Yes, there is a relationship between unemployment, wage growth, productivity and inflation. But we have no idea what that relationship is on a formal mathematical level. This is because of the complexity of instiutional and policital arrangements and their impact on supply, employment, and income distribution. These things vary between countries, within countries and over time. So even if you were able to build a relevant mathematical model that approximated the data for a specific place at a specific moment in time, all the relevant inputs are dynamic and changing meaning the relevance of the model is basically extremely limited and decays over time.

All of this is far different then the Fed announcing that "full employment" is 5% because thats what our NAIRU model says. This is a factually inaccurate statement and not relevant to the underlying economic situation as the UE rates (specifically U3) that is primarily used as measuring sticks is itself misrepresenting the employment situation as the U3 excludes 6 million people who want a job but stopped looking as as such are not counted in the U3 figure.

To say there is a relationship between the employment, productive capacity and inflation is not at all the same thing as saying "unemployment below 5% will lead to accelerating inflation"."

And today's reply is above in the thread and says virtually the same thing.

Your next reply is again the same today as it was a week ago:

"No one has ever claimed, far as I know, that NAIRU can be measured with any great accuracy. Certainly as a supporter of NAIRU I've never claimed it can be accurately measured. But that does not stop it being a useful concept. If you're taking a sailing ship from A to B, the knowledge that there is a relationship between wind speed and the speed of the ship is OF SOME USE, even if you don't know exactly what the relationship is.

Re the Fed’s claim that their NAIRU model says full employment is 5%, I sincerely hope they qualify that by saying something like “This is our best guess”. If you can provide evidence that the Fed thinks it can measure NAIRU to the nearest 0.0001% or thereabouts, then they’re talking complete BS, I agree."

Auburn Parks said...

Continued:

To which I replied a week ago, and I will reply again:
"Ralph that is exactly what CBs say. We are at full employment and so we need to raise interest rates. The full employment figure is based on their NAIRU model estimate. So you are ignoring the explicit stated policy of most CB."

To which you responded a week ago by looking it up for yourself and providing this meaningful comment:

"After a bit of Googling, I see what you mean: the Fed produces this chart which makes it look like NAIRU can be estimated with the same accuracy as the money supply, inflation, etc.

https://fred.stlouisfed.org/series/NROU

That’s silly. The chart should have a “health warning” on it, saying the NAIRU is very much a guess.

But that’s not to say there isn't some level of unemployment below which inflation accelerates, or rises to too high a level: it’s just that economists can’t estimate it very accurately. Also, the following sentence below that chart is garbage far as I can see:

“The natural rate of unemployment (NAIRU) is the rate of unemployment arising from all sources except fluctuations in aggregate demand.” I’ll contact them and ask them to explain that sentence, or delete it, or something. Plus I’ll suggest they put a health warning on that chart."

So thats your comment from last week. You found it ridiculous that the Fed, which actually sets policy that effects 100s of millions of people not one orthodox economist on his blog who's trying to respond directly to cogent criticisms and so mellows his verbal opinion (not that he would change how the thing is used in DSGE models of course) operates using the NAIRU model.

So instead of you recognizng that we had this conversation just last week and that you yourself found the information that proves the claims that I, Bill Mitchell, and many other critics of the official NAIRU model and use (NOT some verbal claim about a relationship but actually plugging figures into a model and then using the results of that model to determine policy) say about NAIRU, here you are repeating your same talking points again.

Auburn Parks said...

Continued:


This type of thing leads me and I hope others here in the MNE community to be suspicious of your intellectual credibility and rigor. When you come face to face with evidence that definitively undermines your claim, you should adjust your claims. This is how science and knowledge advance. We determine things using evidence and then we accept the evidence in our construction and move on. We dont pretend that we didnt just see the evidence 7 days ago and ignore the ramifications that evidence has on our conceptual model of world.

In summary, you made a claim that anybody who criticizes NAIRU is ridiculous because obviously there is a relationship between supply, labor and inflation.

Myself and others pointed out to you that we are not criticizing the notion that there is a relationship between supply, labor, and inflation but that the NAIRU model and estimate that the orthodox and CBs use is wrong and so useless.

You respond that nobody actually uses and constructs NAIRU in the way myself and others describe and so we are essentially arguing against a strawman.

You then discovered yourself that CBs actually do estimate NAIRU and use it in the way that myself and others criticize, and you are rightfully critical.

1 week later you ignore the discovery that you personally made and that the rest of us dissenters already knew and proceed to make the wrong argument again.

Why did you waste your, my and the rest of the communities time repeating the same debunked idea?

Auburn Parks said...
This comment has been removed by the author.
Auburn Parks said...

So yes there is a relationship between supply, labor, and inflation.
But No, the mainstream economics community's model for estimating that relationship and the way they use that estimate to conduct concrete policy is not correct.

So their methodology is wrong, their model is wrong and their policies based on these things are wrong and so hurt millions of people. As such, the current concept of NAIRU and its use should be "Bashed, Trashed, and whatever the rest of Brian's title was"

Dan Lynch said...

@Ralph, the post WWII prosperity was common in the West but Australia did better, unemployment-wise, than the U.S..

Perhaps some luck was involved, but perhaps some policy, too. I would like to see Australia's "golden years" studied more carefully.

The interesting thing to me, in studying that period, is how inflation was, and largely continues to be, a global phenomena. If the price of oil goes up, that affects every country. If the price of wheat goes up, that affects every country. I came away with the impression that inflation is often related to global commodities, and as such, there is little that any one country can do about it.

Banana republics like Venezuela can be exceptions, being particularly sensitive to commodity markets and exchange rates.

Inflation due to a tight labor market has not happened very often, but when it has happened, it was not necessarily a bad thing from the worker's point of view. There was some modest inflation in the U.S. immediately after WWII, as price controls were lifted and the public cashed in their war bonds and went shopping -- yet the working class made real, inflation-adjusted gains in that era.

Of course the last thing the ruling elites want is a strong labor market. The elites will not allow it to happen. NAIRU and fear of inflation are just convenient excuses to maintain slack in the economy.



Neil Wilson said...

Alex sends another logic torpedo suggesting NAIRU is appealing to backward causation

AXEC / E.K-H said...

NAIRU and the scientific incompetence of Orthodoxy and Heterodoxy
Comment on Simon Wren-Lewis on ‘The NAIRU: a response to critics’ and Lars Syll on ‘Simon Wren-Lewis — flimflam defender of economic orthodoxy’

The NAIRU Phillips curve is an explicit formal description of the functioning of the macroeconomic labor market. Formal description means that one has a number of variables and their relationships which summarize the current knowledge of how the economy or some part of it works. Scientific knowledge is embodied in the true theory.

Right policy depends on true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

The two questions that arise with any description are: (i) is it conceptually/logically consistent, and (ii), is it materially consistent? The second question involves the measurability of variables, the practical problem of measurement, data gathering, and statistical methodology. From a description that is either formally inconsistent or materially inconsistent ANY economic policy conclusions can be drawn. Put the other way round, policy proposals that are not based on a materially/formally consistent theory are at the same level as sitcom blather, storytelling, or soap box agenda pushing.

Economic policy guidance that is not based on the true theory is pretty much the same as ancient Roman poultry entrails reading.

The NAIRU Phillips curve is scientifically worthless because it is conceptually inconsistent.#1 So, any discussion about measurement problems or the economic policy implications of a NAIRU is pointless. Needless to emphasize that most of the discussion circles around these distracting side issues.

The NAIRU Phillips curve is integral part of standard economics: “The concept of the NAIRU, or equivalently the Phillips curve, is very basic to macroeconomics. It is hard to teach about inflation, unemployment and demand management without it.”#2

Standard economics is built upon this set of foundational propositions, a.k.a. axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

It should be pretty obvious that the standard axiom set contains THREE NONENTITIES: (i) constrained optimization (HC2), (ii) rational expectations (HC4), (iii) equilibrium (HC5).

See part 2

AXEC / E.K-H said...

Part 2

Methodologically, the neo-Walrasian axioms are forever unacceptable but scientifically incompetent economists from Jevons/Walras/Menger onward accepted them as defining the ‘language of economics’: “Accepting the concept of the NAIRU does not mean you have to agree with their judgements. But if you want to argue that they could be doing something better, you need to use the language of macroeconomics.”#2

Not at all! The neo-Walrasian language of macroeconomics is composed of NONENTITIES and this leads quite naturally to measurements problems, material inconsistency, and vacuous political blather. So Heterodoxy is right in saying that “the NAIRU has to be bashed, smashed, and trashed”.

The problem of traditional Heterodoxy is that it has nothing better to offer.#3 The standard microfoundations HC1/HC5 are false, but Keynesian macrofoundations are also false. So, both orthodox and traditional heterodox labor market theories are proto-scientific rubbish.#4 As an inevitable consequence, the whole discussion about NAIRU has degenerated to the squabble of political sects. Wren-Lewis tries in vain to deny this plain fact: “Economics is certainly not a religion, where all you have to do is choose which sect you belong to and then follow great works.“

What has to be done to get out of confused sectarian squabble is to fix the labour market theory by putting it on consistent macrofoundations.

Two factors determine macroeconomic employment: overall demand and the price mechanism, or more specifically, the actual configuration of average wage rate, price, and productivity. By consequence, economic policy is about private/public demand management AND wage/price management.

The correct theory of the macroeconomic price mechanism tells us that ― for purely SYSTEMIC reasons ― the average wage rate has in the current situation to rise faster than the average price. THIS opens the way out of mass unemployment, deflation, and stagnation and NOT the blather of scientifically incompetent orthodox and heterodox agenda pushers.#4

Egmont Kakarot-Handtke

#1 See ‘NAIRU, wage-led growth, and Samuelson’s Dyscalculia’
http://axecorg.blogspot.de/2015/01/nairu-wage-led-growth-and-samuelsons.html
#2 See SWL ‘The NAIRU: a response to critics’
https://mainlymacro.blogspot.de/2017/02/the-nairu-response-to-critics.html
#3 See LPS ‘Simon Wren-Lewis — flimflam defender of economic orthodoxy’
https://larspsyll.wordpress.com/2017/02/25/simon-wren-lewis-flimflam-defender-of-economic-orthodoxy/
#4 See ‘Mass unemployment: The joint failure of orthodox and heterodox economics’
http://axecorg.blogspot.de/2017/01/mass-unemployment-joint-failure-of.html

Bob said...

If the average wage rate rises above the average price rise...

...labour gains more disposable income
...sales of goods and services increase
...more labour is hired, reducing unemployment
...production rises