The NAIRU and Useful Boojums
Solon is fond of the Non-Accelerating Inflation Rate of Unemployment, familiarly known as the NAIRU. It is the only useful boojum he has identified before it ceased to be a snark (1). When Solon first encountered the NAIRU concept, in a fit of accustomed scepticism and unaccustomed energy he fitted the second degree of change in unemployment in the equations for two large developed economies; in place of the first degree. In both the fit was significantly better. Clearly, the NAIRU was not going to be found. However, the NAIRU fitted current macro-economic theory and Solon was content to see what the search for this snark produced.
For a snark of the boojum variety, the NAIRU has had a short life; and it is now time for it itself to “softly and silently vanish away:” It lingers in macro-models which have nowhere else to hang the real as opposed to monetary factors in their price-change equations, but the attempt to identify it in the real world has been largely given up. The theorists are searching for other approaches.
Solon regards the abandonment of the approach underlying the NAIRU as something of a pity. He thinks that there is little reasonable doubt that inflationary pressure or the lack of it in an economy, given open international capital and product markets, depends on three factors:
- The collective propensity to save of the aggregate of economic agents, where a low propensity points to rising inflation,
- The willingness of the workforce to take risks to achieve higher nominal incomes, where greater risk-taking generates inflationary pressure, and
- The perceived willingness of the monetary and fiscal authorities to limit the supply of finance for inflationary price rises.
Observers of <country-region><place>Japan sometimes write, in despair, as though only the first was important. Monetarists used to write as though the third was the only factor of importance; refusing to notice that monetary expansion, in the short to medium term, was much akin to pushing on a piece of string. The original proponents of the NAIRU and its predecessors were fascinated by the second. In Solon’s view, all three should be specified as proper forward looking indicators.
In the case of the second factor, the error in the NAIRU was to assume that the risks of bidding for greater rewards in the coming months were dependent upon the aggregate rate of unemployment in the recent past. The first fault in that assumption was that macro-economic expectations might well be different in the coming months. The second was to assume that all workers faced equal risks. In most modern economies, some workers are much more secure in their jobs than others, and often face much lower risks in bidding up their remuneration.
The proper type of indicator to attempt to develop is, in Solon’s opinion, a sample survey on a rotating panel basis of what workers think are the chances of their securing different degrees of remuneration increase (or decrease) in their current jobs in the forthcoming period. There are options to be explored in how far ahead that survey can usefully look and in the weighting of the results; but Solon expects even the crude first attempts to be roughly right inflationary pressure indicators, as opposed to the exactly wrong (for this purpose) unemployment percentages.
The third factor already seems to have an excellent indicator in the interest futures market.
Solon suspects that the propensity to save in the relatively near future might be fairly well predicted from existing consumer confidence studies; but is too lazy to test the hypothesis (or even to verify the extent to which it has already been tested.)
The attempts to fit the three forward-looking indicators jointly to the data should offer the observer some good statistical fun. The relationship is non-linear ex-hypothesi, and Solon will not be surprised if discontinuities are found.
(1) A snark is an unknown object or concept which is the subject of a fervent and prolonged search. If a snark turns out to lead enquirers to vanish (in a labyrinth?) or not to exist, it is then classified as a boojum. The terms originate in a text by a 19th. Century mathematician – Lewis Caroll, “The Hunting of The Snark”. Natural as that surmise is, this text is much more than a prevision of the search for Iraqi weapons of mass destruction. It has lasting importance in quantum physics; and in the history of science ,the concept of the useful boojum has clarified the nature and utility of a group of past theories. The celestial spheres, phlostogen and the aether all proved to be useful boojums. “Dark matter” and “dark energy” may prove to be snarks approaching useful boojumhood at present.
Should you wish to comment, an email to solon@use-solon.org may draw a response.
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