Monday, January 17, 2011

Policies Beyond Measure


This one kind of got away from me.

I wanted to show similarities between Billy's view of NAIRU and my view of the "inflation equation" discussed in the past few posts. I ended up confusing his ideas with mine. I noticed this during the writing and should have responded to that red flag, but I didn't. My view of NAIRU, overall, is that I don't know enough about it to comment on it, really.

So take my comments on NAIRU here as Billy's thoughts and my interpretations of Billy's thoughts. I think that's not too far off.

This is an example of what happens when you (meaning, I) don't think about things enough on your own. When you pick up somebody else's idea and run with it. It's like building on a foundation of sponges. It's not good science.

For an example of my thoughts on NAIRU see The Cost that Crippled Growth

Below is the post that got away from me.

Billy Blog's recent When you know they don’t quite get it is in part an evaluation of the NAIRU in relation to policy, and its consequences for inflation and unemployment:

The NAIRU became a central plank in the front-line attack on the use of discretionary fiscal policy by governments. It was argued, erroneously, that ... full employment occurred when the unemployment rate was at the level where inflation was stable.

The estimated NAIRU (it is not observed) became the standard measure of full capacity utilisation. If the economy is running an unemployment equal to the estimated NAIRU then mainstream economists concluded that the economy is at full capacity.

They turned it around. The old standard for "full employment" was that everyone who wanted work could find work. But with NAIRU, full employment became the level of unemployment it takes to keep inflation stable, no matter how much unemployment that turns out to be.

In my recent post, Neil turned things around. As presented by Winterspeak, inflation was the result of income growing faster than "real output." But as Neil has it, inflation is evidence that income is growing faster than real output. In the one view, a cause of inflation is observed. In the other, the existence of inflation is taken as proof income is growing faster than output.

What Billy describes in his post -- what he rejects -- is that an unmeasurable factor, assumed to exist, is used to manipulate levels of inflation and unemployment. This made-up number is used to justify policy that pushes unemployment up.

What I rejected in my post is that an unmeasurable factor, known to exist, is used as part of a calculation that wants to draw a conclusion from the existence of inflation. This made-up number can be used to justify policy that pushes income down.

Neither the NAIRU nor real output can be measured. We "back into" the conclusion that the NAIRU is high, because it takes a high level of unemployment to stabilize inflation. We "back into" the conclusion that income is growing faster than output, because we observe inflation.

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