How Low Unemployment Can Lead To An Economic Battle

If you want to sound knowledgeable about a Fed rate hike, just mention NAIRU.

Where are we going? To the war between the rate raisers and waiters.

The NAIRU Dilemma

We could say that the unemployment rate is a little like Goldilocks. It can’t be too high or too low. It needs to be just right.

And that takes us to NAIRU.

Standing for the Non-Accelerating Inflation Rate of Unemployment, NAIRU just refers to an imaginary line. Below that line low unemployment accelerates inflation as fewer unemployed workers cause the wage increases that boost prices for goods and services. Also though, we don’t want to be above the line where too many people are jobless.

The problem is that no one agrees where to place that NAIRU line. And yet, we need to know where the line is because the minute we cross it, the economy needs a rate hike to lessen the pressure on prices.

So where is it?

You can see below that Federal Reserve estimates of NAIRU have sunk. One reason for its decline is that whenever inflation failed to materialize, the previous NAIRU estimate had to be revised downward.

From: Paul Krugman, NY Times

Our Bottom Line: The War Between the Raisers and the Waiters

Because no one is sure of NAIRU, we have a battle between the interest rate raisers and the waiters. The raisers believe we are at NAIRU’s threshold while the world’s Paul Krugmans are saying that since don’t know NAIRU, “Wait until you see the whites of inflation’s eyes!”

In the war between the raisers and the waiters, both can use NAIRU as a weapon.