On Using NAIRU To Analyse A Job Guarantee

Professor Simon Wren-Lewis wrote "Some thoughts about the Job Guarantee," in which he makes an attempt to analyse a Job Guarantee using the NAIRU concept. The analysis suffers from the well-known defects of NAIRU.



In the article, he argues that a Job Guarantee implementation would cause a one-time upward shock to wages. He argues that this is not "acknowledged" by MMT authors, even though it appears this effect is common knowledge to anyone who has read the MMT literature. As a result, that is a curious argument. However, he then flips to an analysis where the Job Guarantee has no effect on inflation.

However, the situation gets more interesting. He writes (note JG = Job Guarantee, IU = involuntary unemployment, and NAIRU = NAIRU):

Suppose we start with an economy with stable inflation, implying unemployment was at the NAIRU, and introduce JG. As this puts upward pressure on inflation because the costs of losing a job are reduced. the only way of keeping inflation stable is to deflate demand, which of course would reduce output, labour demand and therefore increase the number of people on JG jobs. So if we were to compare two economies where inflation was stable, one with IU and one with JG, the number of JG jobs would exceed IU in the other economy.

This passage would be helped by a clearer mathematical exposition; as it stands, I have to make some guesses as to what he means.

My interpretation of his argument is as follows.

• Let the percentage of the people in the workforce not employed in "regular employment" be denoted as NW. 
• In the current institutional structure, the number NW is equal to the the unemployment rate, or involuntary unemployment (IU).
• In the current institutional structure, there is a number NAIRU for which inflation will not accelerate only if NW = NAIRU. (It accelerates upwards if NW < NAIRU, and downwards if NW > NAIRU.)
• If we change institutional structure, NAIRU is unchanged.
• If we implement a Job Guarantee, the term NW = (percentage of workforce in the Job Guarantee) + (people in the workforce who refuse to take a Job Guarantee job). (This latter term is presumed to be very small.)
• Because a Job Guarantee job is assumed to be better than unemployment, there is less disciplining effect. Therefore, the new point of inflation stability is NAIRU + k, where k > 0.

Although this analysis is simple, it runs into obvious problems.

• NAIRU is obviously not a constant in the current institutional environment. Any attempt to specify NAIRU as a constant fails statistically.
• We have no idea what determines NAIRU in the current environment. It is estimated by a statistical procedure that tells us what NAIRU would have to be if the gap (NW - NAIRU) explained inflation acceleration. This procedure is obviously non-falsifiable; any variable correlated to the business cycle would yield just as useful predictions when the same procedure is applied to it. Correlation does not imply causation, and all that.
• If NAIRU was invariant to institutional structure, it would be the same for all countries. It obviously is not.
• There is no way to estimate k in the absence of a working Job Guarantee. Even if it is positive, is it larger than the errors in the estimate of NAIRU?
• No microfoundations. There is no explanation why this model would work, other than some vague discussion about the cost of losing a job. 
• Incoherent model dynamics. The model implies that if the initial JG pool was too small, the economy would explode in a puff of hyperinflation. Imagine that the JG wage is fixed for all time (0% inflation policy). If NW < NAIRU + k, the model says that (wage) inflation will accelerate upwards. However, the gap between the private sector wage and the JG wage would be expanding, and there would be less incentive to enter the program. The result is that JG spending would decrease. How does a shrinking spending programme that buys a real input at a fixed price going to cause increasing inflation? And if we flip the sign, the result is even more ridiculous. If the JG pool gets too large, the private sector wage falls at an accelerating rate, and so we simultaneously have expanding JG spending, a shrinking labour force, and falling inflation. In other words, the predicted sign from the model appears backwards.
• Critically dependent upon the specification of "potential." If we use potential GDP to estimate the output gap, it is unclear whether implementing a Job Guarantee affects potential private sector GDP. (The accounting for the output of the Job Guarantee programme is going to raise issues.)
• Plausibility is terrible (related to microfoundations). In what sense does an excessive number of French-speaking unemployed workers in the Gaspé influence wage determination in (mainly English-speaking) Calgary? The usual state of affairs is that the bulk of the unemployed are in "low pressure" regions, and so it is unclear that we can relate aggregate unemployment to aggregate inflation.
• It ignores existing labour market research. There is a large body of work discussing "hysteresis": long-term unemployed becoming viewed as "unemployable," and no longer mattering for "disciplining" wages. Re-attaching such workers to the job market (which is a major objective of the Job Guarantee) would effectively raise the size of the workforce. It is unclear what might happen to the measured unemployment rate (such people typically are dropped from the workforce in surveys in the current environment), but total private sector workers (and presumably output) would be higher. In other words, the postulated "k" effect is smaller than hysteresis-reduction gains. Since the objective of policy is to raise living standards (and not play games with questionable survey definitions), the Job Guarantee would be an unambiguously superior outcome.
• Is a Job Guarantee job really better than unemployment benefits for many workers? For the upper half of the income distribution, the Job Guarantee wage is as irrelevant as the minimum wage. Meanwhile, given rampant wage inequality, the top half of the distribution rakes in a lot more than half of the total wage bill. In other words, how can the existence of the programme move that whole mass of salaries?
• The analysis is static. If the Job Guarantee wage is high enough to pull employees away from existing jobs, those employers have no choice but to either raise wages or invest to increase productivity. With investment higher, so will be potential output, and the estimated NAIRU could end up lower.
• Completely ignores other variables, such as the gap between average private sector wages and the Job Guarantee wage. Can the same level of NW be as inflationary (deflationary) if the Job Guarantee wage is 20% of average private wages instead of 50%?

As an aside, the whole premise of DSGE macro was to avoid analysis like this. We have an attempt to analyse a new policy framework based on a questionable fitting of historical data. Instead, DSGE macro was to replace that with an in-depth analysis of the decision-making process of economic agents, and so behaviour would be invariant to institutional change.

(c) Brian Romanchuk 2017