## Sunday, November 19, 2017

### On Using NAIRU To Analyse A Job Guarantee

Professor Simon Wren-Lewis wrote "Some thoughts about the Job Guarantee," in which he makes an attempt to analyse a Job Guarantee using the NAIRU concept. The analysis suffers from the well-known defects of NAIRU.

In the article, he argues that a Job Guarantee implementation would cause a one-time upward shock to wages. He argues that this is not "acknowledged" by MMT authors, even though it appears this effect is common knowledge to anyone who has read the MMT literature. As a result, that is a curious argument. However, he then flips to an analysis where the Job Guarantee has no effect on inflation.

However, the situation gets more interesting. He writes (note JG = Job Guarantee, IU = involuntary unemployment, and NAIRU = NAIRU):
Suppose we start with an economy with stable inflation, implying unemployment was at the NAIRU, and introduce JG. As this puts upward pressure on inflation because the costs of losing a job are reduced. the only way of keeping inflation stable is to deflate demand, which of course would reduce output, labour demand and therefore increase the number of people on JG jobs. So if we were to compare two economies where inflation was stable, one with IU and one with JG, the number of JG jobs would exceed IU in the other economy.
This passage would be helped by a clearer mathematical exposition; as it stands, I have to make some guesses as to what he means.

My interpretation of his argument is as follows.

• Let the percentage of the people in the workforce not employed in "regular employment" be denoted as NW.
• In the current institutional structure, the number NW is equal to the the unemployment rate, or involuntary unemployment (IU).
• In the current institutional structure, there is a number NAIRU for which inflation will not accelerate only if NW = NAIRU. (It accelerates upwards if NW < NAIRU, and downwards if NW > NAIRU.)
• If we change institutional structure, NAIRU is unchanged.
• If we implement a Job Guarantee, the term NW = (percentage of workforce in the Job Guarantee) + (people in the workforce who refuse to take a Job Guarantee job). (This latter term is presumed to be very small.)
• Because a Job Guarantee job is assumed to be better than unemployment, there is less disciplining effect. Therefore, the new point of inflation stability is NAIRU + k, where k > 0.
Although this analysis is simple, it runs into obvious problems.
• NAIRU is obviously not a constant in the current institutional environment. Any attempt to specify NAIRU as a constant fails statistically.
• We have no idea what determines NAIRU in the current environment. It is estimated by a statistical procedure that tells us what NAIRU would have to be if the gap (NW - NAIRU) explained inflation acceleration. This procedure is obviously non-falsifiable; any variable correlated to the business cycle would yield just as useful predictions when the same procedure is applied to it. Correlation does not imply causation, and all that.
• If NAIRU was invariant to institutional structure, it would be the same for all countries. It obviously is not.
• There is no way to estimate k in the absence of a working Job Guarantee. Even if it is positive, is it larger than the errors in the estimate of NAIRU?
• No microfoundations. There is no explanation why this model would work, other than some vague discussion about the cost of losing a job.
• Incoherent model dynamics. The model implies that if the initial JG pool was too small, the economy would explode in a puff of hyperinflation. Imagine that the JG wage is fixed for all time (0% inflation policy). If NW < NAIRU + k, the model says that (wage) inflation will accelerate upwards. However, the gap between the private sector wage and the JG wage would be expanding, and there would be less incentive to enter the program. The result is that JG spending would decrease. How does a shrinking spending programme that buys a real input at a fixed price going to cause increasing inflation? And if we flip the sign, the result is even more ridiculous. If the JG pool gets too large, the private sector wage falls at an accelerating rate, and so we simultaneously have expanding JG spending, a shrinking labour force, and falling inflation. In other words, the predicted sign from the model appears backwards.
• Critically dependent upon the specification of "potential." If we use potential GDP to estimate the output gap, it is unclear whether implementing a Job Guarantee affects potential private sector GDP. (The accounting for the output of the Job Guarantee programme is going to raise issues.)
• Plausibility is terrible (related to microfoundations). In what sense does an excessive number of French-speaking unemployed workers in the GaspĂ© influence wage determination in (mainly English-speaking) Calgary? The usual state of affairs is that the bulk of the unemployed are in "low pressure" regions, and so it is unclear that we can relate aggregate unemployment to aggregate inflation.
• It ignores existing labour market research. There is a large body of work discussing "hysteresis": long-term unemployed becoming viewed as "unemployable," and no longer mattering for "disciplining" wages. Re-attaching such workers to the job market (which is a major objective of the Job Guarantee) would effectively raise the size of the workforce. It is unclear what might happen to the measured unemployment rate (such people typically are dropped from the workforce in surveys in the current environment), but total private sector workers (and presumably output) would be higher. In other words, the postulated "k" effect is smaller than hysteresis-reduction gains. Since the objective of policy is to raise living standards (and not play games with questionable survey definitions), the Job Guarantee would be an unambiguously superior outcome.
• Is a Job Guarantee job really better than unemployment benefits for many workers? For the upper half of the income distribution, the Job Guarantee wage is as irrelevant as the minimum wage. Meanwhile, given rampant wage inequality, the top half of the distribution rakes in a lot more than half of the total wage bill. In other words, how can the existence of the programme move that whole mass of salaries?
• The analysis is static. If the Job Guarantee wage is high enough to pull employees away from existing jobs, those employers have no choice but to either raise wages or invest to increase productivity. With investment higher, so will be potential output, and the estimated NAIRU could end up lower.
• Completely ignores other variables, such as the gap between average private sector wages and the Job Guarantee wage. Can the same level of NW be as inflationary (deflationary) if the Job Guarantee wage is 20% of average private wages instead of 50%?

As an aside, the whole premise of DSGE macro was to avoid analysis like this. We have an attempt to analyse a new policy framework based on a questionable fitting of historical data. Instead, DSGE macro was to replace that with an in-depth analysis of the decision-making process of economic agents, and so behaviour would be invariant to institutional change.

(c) Brian Romanchuk 2017

1. Nice post. I hadn't understood what Wren-Lewis was saying there about NAIRU and a Job Guarantee and figured it was the usual JG will be inflationary because unemployment would be below the non-accelerating rate. Of course, MMT solves this by just pointing out how useless NAIRU is :).

1. I couldn’t figure it, since I assumed that “he cannot really mean that”. I guess he didn’t think about the dynamics for more than a minute or two.

2. “How useless NAIRU is”. So there’s no relationship between inflation and unemployment? Great: in that case why don’t the advocates of “NAIRU is useless” advocate a massive increase in demand with a view to drastically cutting unemployment? Reason is that they know perfectly well that THERE IS a relationship between inflation and unemployment.

3. Ralph, I know you have read Mitchell on this subject and I think you would agree that for the most part MMT considers the NAIRU concept to be useless. THERE IS NOT necessarily a relationship between inflation and unemployment. MMT says that inflation will be caused by excessive spending when supply and its growth is constrained. There are many possibilities for inflation that do not at all depend on the unemployment rate. And there are many unemployment rates that can correspond with non-accelerating inflation rates. Which means tying a level of unemployment to observed inflation is useless. That is what NAIRU is- useless.

4. So where is all the inflation in nature at full employment, Ralph?

Over time, the real goods we get in return for our day's work (which is the true constant) have undergone massive 'price' deflation and will continue to do so.

And yet, people like you still argue that others must not work in order that you can have even more.

Why don't YOU volunteer to not work if you believe it's true?

2. I’m not greatly impressed by Brian’s criticisms of Wren-Lewis’s claim that a relatively well paid JG jobs put upward pressure on inflation, and for the following reasons.

Brian says “NAIRU is obviously not a constant in the current institutional environment. Any attempt to specify NAIRU as a constant fails statistically.”

My answer to that is that no one ever said NAIRU was constant, far as I know. Plus the fact that some relationship like NAIRU is not constant does not mean one cannot make various valid statements about relevant variables. For example if the gravitational constant keeps changing randomly between plus or minus 50%, it would still true to say that apples will fall from trees towards the centre of the earth.

Next, Brian says “We have no idea what determines NAIRU in the current environment.”

I suggest anyone with a small amount of common sense has at least SOME IDEA what determines NAIRU. For example it is obviously true to say that the more skilled the workforce is, the lower will NAIRU be all else equal. And for second example, a recent spell of high unemployment probably induces unions to moderate their wage demands for a year or two and thus reduce NAIRU.

Next Brian says “If we change institutional structure, NAIRU is unchanged.”

My answer to that is that if Brian wants to accuse Wren-Lewis of saying or implying something obviously absurd, Brian needs to produce some very detailed explanation.

I don’t have time for any more of Brian’s points. But I’ll end by saying that Wren-Lewis’s point (which incidentally is not original) is quite clearly valid: i.e. the higher is JG pay, the less the incentive for those concerned to sek regular jobs which in turn cuts aggregate labour supply to the regular jobs market, which in turn is inflationary, unless AD is cut.

1. NAIRU is the exhaustion of the unemployment buffer at specific micro-physical points in the currency area sufficient to cause a dynamic feedback effect that impacts inflation. That happens because the unemployment buffer is insufficient threat to the labour services of private firms and policy is too lose.

You don't get anywhere near that on a Job Guarantee because you actually set policy *tighter* than you would under monetary policy targeting. You never want the non-guarantee employment buffer to exhaust anywhere. But because Job Guarantee cleans up crap private firms and is spatially targeted to areas without enough work (unlike tax credits which are pro-cyclical spatially and pro-crap firms) you actually get a higher aggregate across the currency area, by lowering the peak points that cause the problem under MP targeting.

2. I am not greatly impressed with Ralph's comments here or at Mainly Macro.

Thank goodness the gravitational constant does not change like the NAIRU (estimate? is that what we can call it?). If it did I would never get on an airplane again.

So here is a reply to your comment at Mainly Macro which I didn't submit because Simon likes everything to be polite-

Ralph Musgrave, there are surely many naive people in this world. Luckily we have more sophisticated people like yourself to explain things to us. But it is possible that you may not realize that in the country I live in (the USA), there really are not any benefits that a person gets just for being unemployed past the end of unemployment insurance- typically 26 weeks. And you had to be employed for quite a while to be eligible for that in the first place. So I am not sure Calmfors' particular criticism of the Job Guarantee would apply here in the US.

I don't have time for any more of Ralph's points, if that's what they are.

3. Ralph,

According to SWL’s model, if you create a JG with a high wage, it causes deflation. A large numbet of people join the programme, and the NW percentage is greater than NAIRU, and *inflation has a negative acceleration*.

If you cannot see that as absurd, you cannot be helpd.

As for you other points, they have no value. He made a specific numerical claim, and without a reliable numerical model, that claim is invalid.

3. As a layman, I have some serious questions about the NAIRU concept. First, it has never been observed. Second, takes the actions of employers as a given, like a force of nature. Third, it ignores general properties of long lived complex adaptive systems, which is that they tend to at least temporary stability, if not equifinality. Economists are quick to embrace the concept of equilibrium, except in the case of the NAIRU. The A stands for "accelerating", which means not only persistent inflation, which a kind of arms race could generate as employers and workers vie for the economic surplus, but runaway inflation. Yes, we have seen runaway inflation, but only as a result of low unemployment? Bueller?

1. I have developed a proof that there is no equivalent to NAIRU in an economy with a JG, but there is no space to write it here.

Actually, the proof is coming in a few days.

2. Looking forward to it, Brian.

Happy Thanksgiving!

Note: Posts may be moderated, and there may be a considerable delay before they appear.

Although I welcome people who disagree with me, please be civil.

Please note that my spam comment filter appears to dislike long "anonymous" posts.

Note: if you want to post comments from Apple devices (iPhone, iPad), you apparently need to turn off "prevent cross-site tracking" in Safari privacy settings. (The reason presumably is that another URL handles comments, and so the user session needs to be preserved when redirected to that site. I don't like this, but this is not enough to make me switch my hosting service.)