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NAIRU - Economic Paradox

by John Yu

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.

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Last updated: March 19, 2001
Comments from thisisby.us
by lawdog
on Nov. 19, 2007 at 07:43pm
3 Votes

Great post, seeya!

This is one of the most clear and concise explanations of we can attain full employment I've seen. I hope more people begin to see the light on concepts like these BEFORE we shift from oil wars to food wars, or the one everyone's discussing these days: water wars.

by seeya
on Nov. 19, 2007 at 07:48pm
2 Votes

Thanks for your comment, LD!

by corey_tisdale
on Nov. 20, 2007 at 10:15am
1 Vote

I think this is an interesting prospect, but I have some reservations about it:

Congress is mandated by the constitution to control the money supply (let's leave whether or not the Fed is constitutional aside for purposes of this conversation). Congress should not be in the business of controlling farms or agricultural output. We don't have a real time measure of farm production. How would congress accurately control the money supply?

Also, assuming that congress figures out the above, I am under the impression that most of our economic growth is service and knowledge based. How can we have a money supply tied to such a small part of our economic growth without suffering unemployment or lack of new job creation in faster growing sectors?

I am not against having something backing our currency, but I am under the impression that we would need to be "vaultable;" if we cannot remove this commodity from the market, how do we prevent it from being exported without properly adjusting the money supply?

I have more questions, too, but they are dependent upon the answers to these. I hope you respond soon because my curiosity is piqued!

by AndrewKemendo
on Nov. 20, 2007 at 10:38am
0 Votes

What you seem to want is an advanced form of Bartering, however commodities wildly fluctuate by influence of externalities (drought, overproduction, subsidies) such that the market is very slow to adjust - as a store of goods (one of the roles of money) it is about as bad as it gets as it has no ability to be saved. The reason we have a futures exchange is based on this fact.

Basing a currency on commodities is reasonable in theory, and it makes sense from a standpoint of "goods for goods", but in practice it would not serve the purpose of money as being stable and uniformly transferable.

Your Gold argument is a bit skewed however, as it was not practical reasons we went away from gold but central banking tendencies that allow for increased Seigniorage in times where fiscal spending is needed to help buffer the business cycle to allow for deficit spending.

by corey_tisdale
on Nov. 20, 2007 at 12:09pm
1 Vote

Following that line of thought, paper fiat money makes a horrible store of value as well. Notice how you are paying for the Iraq war with the devaluation of all your savings (unless you heavily invested in gold or oil).

By the way, it probably isn't a bad idea to invest heavily in gold and oil.

by AndrewKemendo
on Nov. 20, 2007 at 12:38pm
1 Vote

Indeed, Fiat money is horrible - proof is in most of the Austrian school texts.

by vetinarii
on Nov. 20, 2007 at 07:17pm
0 Votes

I think the catch in your argument is in a tiny parenthesis right in the middle:

"(assuming they are actually producing things needed by the average worker...)"

This question of what, exactly, people should be producing is the very heart of economics, and you can't gloss over it so easily. It's all very well to say "Put people to work growing food!", but what food, and what are you going to do with it once it's grown? Next thing you know, you have a huge agricultural surplus of some sort.

The IMF gets a lot of flak for preaching this sort of right-wing economics, but it's way too simplistic to blame it. If a country and its economy are failing, what's the point in giving them more money to carry on doing what they were doing before? That's like giving money to a gambler or an alcoholic and saying "Here you go".

by seeya
on Nov. 20, 2007 at 07:40pm
1 Vote

So many comments. Thanks folks.

corey_tisdale: I wouldn't have Congress control the money supply in this case. The supply of money would become directly tied to the amount of goods produced. The more goods that are produced, the more money that is issued, backed by those goods. The amount of money in circulation would be controlled by how much producers are making, not by Congress.

It's much harder to back money with service or knowledge - you can't really have a vault of that stuff and issue notes backed by it. However, I don't see it as a problem for national governments to take care of. If your nation's economy is mostly service or knowledge, then sure, you won't have as much control over your money supply as a nation that does produce the commodities that are used to back money. I don't see that as a problem however. If your nation is producing services those commodity producing nations need, then they'll pay you with their commodity-backed notes, and your nation then circulates those notes.

Ultimately, the commodities used to back the notes will have to be things almost everyone uses - notes that will be regularly redeemed for the goods they represent. Grain is good, but it doesn't have to be food. It could be oil, coal, steel, etc. I would assume secondary organizations would be formed that gather up the notes for individual commodities, and issue notes backed by a basket of goods similar to what they use to determine the consumer price index.

I don't see a problem with exports and money supply. There are two things that could be exported: either the commodity-backed notes, or the commodities themselves. If your organization, whether it's a government or not, exports commodities that it's supposed to be holding in reserve, then that's basically violating the terms of the "contract" you agreed to when issuing the notes. There would have to be legal remedies / punishments in this case. Besides, the value of the notes would fall in the same way currency value falls when it's discovered a nation is simply printing money.

If your nation is exporting commodity-backed notes, there's no problem. You get goods in return, and other nations can redeem their notes for the commodities you have in reserve.

by seeya
on Nov. 20, 2007 at 07:55pm
1 Vote

AndrewKemendo, I guess it depends on how you look at it. It's true drought and overproduction make the relative exchange values between grains and currency fluctuate. From one viewpoint, the value of grain is fluctuating wildly with respect to the currency. From the other viewpoint, the value of the money is fluctuating wildly with respect to the grain.

That said, however, I would imagine there would be secondary organizations that buy up many notes backed by individual commodities, by issuing new notes backed by a broad index of goods everyone uses. In this way, fluctuations in the production capacity of one commodity will only have a small effect on the value of the index-backed notes.

by seeya
on Nov. 20, 2007 at 08:03pm
1 Vote

vetinarii, you're right about the risks of agricultural surplus. One solution would be to back notes with a basket of goods like that used on the consumer price index. If the result is that you get a huge surplus of goods on the consumer price index, then that's great - more stuff to go around makes everyone better off.

On the other hand, goods not on the consumer price index will be rarer compared to goods on the index. So you get a kind of inflation, at least with respect to the notes and the goods not on the index. If goods not on the index are needed, and people are willing to pay higher prices for them, then that should encourage more production in those industries.