NAIRU - Economic Paradox

by John Yu
cyu@oz.net

You are poor. You don't have enough to eat. You don't have a place to live nor clothes to keep you warm. Neither do those around you. It is a time of great need in your country. Your economy is failing. You wonder what it is you should do. Suddenly an economist from the IMF shows up. "You should do nothing," he says, "In order to be prosperous, the people of your country should just sit around on your butts." "But wait," you say, "We are hungry, we are cold. Shouldn't we be, like, growing food or something?" "No," he wisely replies, "That will cause inflation and make you all poorer than before. Trust me, the equations all work out."

The IMF is the international fireman - but are its firetrucks using water or oil? At times of national economic disaster, it rushes in telling people to raise interest rates and to cut fiscal spending, knowing full well that this will lead to massive unemployment. This will prevent inflation, so the theory goes. Of course, if most people are unemployed, who can afford to buy anything? Prices dropped during the Great Depression.

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment - it is the belief that there is a some "natural" rate of unemployment, below which increased inflation is unavoidable. Inflation is attributed to too much money chasing too few goods. Believers in the NAIRU prescribe fighting inflation by attacking the money side - make sure there's less of it available to chase goods with, by raising interest rates and reducing fiscal spending. The result is unemployment, because some businesses become less able to borrow money to pay workers, while others lose their customers - the government and consumers who are less able to raise the money to buy things. Thus their economic prescription leads to the paradoxical situation in which there is both great need (because of unemployment-induced poverty) and people sitting around not doing anything rather than acting to reduce that need.

One alternative is to attack the goods side - making sure there are enough goods available for the money to chase, thus reducing unemployment in order to combat inflation. Greater supply of goods imply lower prices. However NAIRU believers argue that low unemployment means a scarcity of workers - this will force employers to pay more for labor, thus increasing inflation again - forcing them to raise prices in order to keep their companies afloat. To prevent the economy from "overheating," they argue, unemployment reduction must be accompanied by policies such as eliminating the minimum wage and cutting unemployment benefits (which reduces fiscal spending).

The point they are missing is that less unemployment means people will actually have the money to buy the goods these companies are producing - they will not be struggling if sales are increasing (assuming they are actually producing things needed by the average worker as opposed to luxury goods consumed only by financiers). However, this brings up the deeper question of why the value of money fluctuates with respect to the value of goods at all (not to mention why minimum wage laws would even be needed if employees had control over the pay structure of their own companies - but that's a different discussion).

Today, money is considered its own commodity - it is not backed by other commodities, thus its value fluctuates with respect to the relative availability of various commodities. Previously, money was not its own commodity, but was backed by another - namely gold. This policy was largely abandoned for practical reasons - gold was simply not central enough to the running of an economy to back anything with. This is because gold itself was not originally its own commodity, but had undergone a process similar to what paper currency is going through - its use in daily transactions had become so common that people began to think of it as valuable in itself - something to hoard. Early in the history of money, the dinar (a little more than an ounce of gold) in the Hammurabi Code was actually backed by a true commodity - a stone (about 60 pounds) of wheat.

By definition, the value of money backed by true commodities does not fluctuate relative to the value of the commodities backing it. Thus zero unemployment can be achieved without inflation as long as the money being issued is backed by the goods produced by that additional employment. The NAIRU does not exist (or, rather, is equal to 0%). Money can simply be issued by the producers of true commodities. Since the most vital goods used are what is produced on farms, it is only natural to use farm goods to back money (as was done in the Hammurabi Code), recentering the economic structure on those to whom we most owe our lives - the growers of our food.