Lunchtime Must-Read: Roger Farmer: NAIRU Theory–Closer to Religion than Science

An alternative way of making the same point is to say that with an accelerationist Phillips Curve and an estimated slope coefficient of 0.25, while we can trace 3.5%-points of the 2.7%-point acceleration of inflation in the 1950s and 3.0%-points of the 4.5%-point accelerations of inflation in the 1960s to an average unemployment rate below a 6% NAIRU, we can only trace 1.7%-points of the 7.6%-point acceleration of the 1970s, and only 2.2%-points of the 8.9%-point deceleration of the 1980s to an average unemployment rate about a 6% NAIRU. In the 1990s unemployment was below the NAIRU on average and would have tended to raise the inflation rate by 1.0%-points, but it fell by 1.8. In the 2000s unemployment was below the NIRU on average and should have raised inflation by 1.2%-points, but it fell by 0.2%-points. That is not an impressive empirical record at all.

Roger Farmer: NAIRU theory–closer to religion than science: “According to the NRH, unemployment differs from its natural rate…

…only if expected inflation differs from actual inflation…. The probability that average expected inflation over a decade will be different from average actual inflation should be small. If the NRH and rational expectations are both true simultaneously, a plot of decade averages of inflation against unemployment should reveal a vertical line at the natural rate of unemployment…. This prediction fails dramatically…. Defenders of the Natural Rate Hypothesis might choose to respond to these empirical findings by arguing that the natural rate of unemployment is time varying. But I am unaware of any theory which provides us, in advance, with an explanation of how the natural rate of unemployment varies over time. In the absence of such a theory the NRH has no predictive content. A theory like this, which cannot be falsified by any set of observations, is closer to religion than science.

October 6, 2014

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