A Qualification

In all our discussions of the Friedman Curve, we have assumed that the NAIRU is constant. It is pretty clear that the NAIRU has changed over time, as nearly as we can approximate it. Most economists would agree that microeconomic changes could shift the NAIRU by making labor markets more or less effective. But can changes in the NAIRU make a difference for macroeconomics?

Some economists see the NAIRU as being effected by "hysteresis" or "path dependence." This means that the NAIRU of today depends on the history ("hystery") or path of unemployment in the past. There is some evidence to support this view:

The longer an individual is unemployed, the more difficult it is for that person to find a job.
When unemployment is high, people tend to remain unemployed for longer periods.
Thus, a long period of high unemployment increases the number of people for whom a new job is very difficult.
That means that accelerating inflation sets in at a higher unemployment rate than otherwise.
In other words, the NAIRU has gotten bigger because of the period of high unemployment.

This seems to describe the European experience in the last quarter of the 20th century. After a period of quite low unemployment rates in the 1960's, (especially in Germany) unemployment rates rose in the 1970's and have remained quite high ever since, as if the NAIRU had risen up to meet the actual unemployment rate. Conversely,

When unemployment is low, periods of unemployment are short, and even some hard-to-employ people get jobs.
Thus, a long period of high unemployment reduces the number of people for whom a new job is very difficult.
That means that accelerating inflation sets in at a lower unemployment rate than otherwise.
In other words, the NAIRU has gotten smaller because of the period of low unemployment.

Of course, there have to be some limits to this -- the NAIRU is unlikely to go to zero! But we don't know what the limits are, and path dependence tells us that there could be some circumstances in which a macroeconomic policy aimed at low unemployment could have some long-term benefits.

Next: Reconsidering Goverment Policy