More on the natural rate of unemployment

The WSJ printed a letter about the article I linked in the previous post and then had a related article. See Was the Phillips Curve Ever a Reliable Tool?

Here is the letter:

"Prof. Blinder suggests nobody knows what the nonaccelerating rate of unemployment (Nairu), the neutral (natural) rate of interest (aka r-star or r*) and the Phillips curve are today. This is hardly new. Estimates of Nairu and the Phillips curve have changed constantly over the last 50 years. Alan Greenspan noted this fact at the December 1995 Federal Open Market Committee meeting: “saying that the Nairu has fallen, which is what we tend to do, is not very helpful. That’s because whenever we miss the inflation forecast, we say the Nairu fell.” Other FOMC participants made similar comments at other meetings, e.g., at the February 1999 meeting William Poole, president of the St. Louis Fed, said, “the Phillips curve is an unreliable policy guide”; Edward Boehne, president of the Philadelphia Fed, said “Nairu . . . has about zero value in terms of making policy.” The natural rate of interest is also essentially impossible to measure and, hence, a useless guide for policy.

The truth is making monetary policy is no more difficult or easier today than it ever was. The problem is Mr. Blinder and others have deluded themselves into believing that measures of these concepts have been useful for making policy, even though he notes that the correlation between the unemployment rate and changes in inflation has been essentially zero for nearly 30 years. Inexplicably, he and others choose to ignore the fact that these concepts have had to be re-estimated continuously when their forecasts proved to be wrong.

Dan Thornton, Ph.D.
Valley Park, Mo.
Mr. Thornton is a retired vice president of the Federal Reserve Bank of St. Louis."

See also Unemployment Plunge Raises Stakes in Fed’s Goldilocks Conundrum: Danger of an overheating economy looms ever closer—or not, as theories increasingly come up short by Harriet Torry of The WSJ. Excerpts:

"Ryan Sweet, an economist at Moody’s Analytics, says Nairu is the economics profession’s Loch Ness monster: You might think you’ve seen it, but it’s always hard to know.

Over the past seven decades, Nairu has ranged from about 4.6% to just over 6%, according to the Congressional Budget Office’s economic projections.

Complicating matters, Nairu estimates rely on a contentious theory that falling unemployment pushes up prices and wages. That relationship appears to have broken down in recent years, when inflation remained below the Federal Reserve’s 2% target even as the jobless rate steadily declined.

There are several explanations for why. Nairu itself might not be a useful guide. Or the U.S. might not be at full employment yet. The White House’s chief economist, Kevin Hassett, said last month that full employment “could be in the threes now.”

A broader measure of unemployment that includes workers stuck in part-time jobs or too discouraged to search for work remains high, suggesting slack remains in the labor market. The measure fell to 7.8% in April from 8% in March, whereas in December 2000 it stood at 6.9%.

Former Fed Vice Chairman Alan Blinder points to his “traumatized worker” theory. “Workers still remember the bad old days and they’re more interested in job security than they are in seeking out a raise,” he said.

The Fed’s rough estimate for Nairu is now around 4.5%. Officials project the actual jobless rate will drop to 3.8% by end of this year and reach 3.6% in 2019 and 2020."