Typology of Anti-NAIRUvians

The NAIRU Theory or Natural Rate Theory of Unemployment essentially consists of two propositions about the Phillips curve (the relationship between inflation and unemployment as nominal aggregate demand* varies):

1. The Phillips curve is downward-sloping in the short run.
2. The Phillips curve is vertical (or possibly upward-sloping) in the long run.

Accordingly, there are essentially four ways to challenge the theory:

1. Argue that the Phillips curve is vertical in the short run, as in many real business cycle models.
2. Argue that the Phillips curve is horizontal in the short run, as in my suggestion here
3. Argue that the Phillips curve is downward-sloping in the long run, as in Tobin’s “greasing the wheels” theory.
4. Argue that the Phillips curve has the required NAIRU properties in theory but that it is so unstable and unpredictable as to render the concept useless in practice. (This seems to be roughly the argument made by Bob Hall recently.)

(I have ignored the possibility of an upward-sloping short-run Phillips curve because it just seems too silly to me. Any upward-sloping short-run Phillips curve that anyone is likely to advocate will either be approximately vertical or approximately horizontal.)

It is clear that these different challenges to the NAIRU theory have very different policy implications. For example, if you believe challenge #1, you might argue for aggressive policy tightening in response to any increase in the inflation rate above your preferred target, whereas if you believe challenge #3, you might argue for no tightening at all. And while challenge #4 is perhaps the most viable, it also raises the question of what alternative one might use to guide policy, and if there is no viable alternative, one has to wonder how Fed policy has managed to be so successful over the past 20 years. Anyhow, it is incumbent upon those who challenge the NAIRU theory to identify the specific nature of their challenge.


* I use the word “nominal” to accommodate those who don’t believe in the concept of aggregate demand. If you don’t like the phrase “aggregate demand,” how about “velocity-adjusted nominal money supply.”