Will Low Unemployment Cause Accelerating Inflation?

Jon Economy

In August the US unemployment rate closed at 4.4% against 4.3% in the month before. The relatively low unemployment rate seen by some commentators as implying that the US is almost at the so-called natural rate, which believed to be at around 4.5%.
It is held that once the unemployment rate falls below an “optimal” rate -called the Non-Accelerating Inflation Rate of Unemployment (NAIRU) -it sets off an inflationary spiral. This acceleration in the rate of inflation takes place through increases in the demand for goods and services.
It also lifts the demand for workers and puts pressure on wages, reinforcing the growth in the rate of inflation.
The NAIRU is an arbitrary measure, derived from a statistical correlation between changes in the consumer price index and the unemployment rate.
What matters in the NAIRU framework is whether the theory “works”, i.e., whether a decline in the unemployment rate below the NAIRU results in the acceleration in the rate of inflation.
Using statistical correlation as the basis of a theory means that “anything goes.” For example, let us assume that a high correlation has been found between the income of Mr. Jones and the rate of growth in the consumer price index. The higher the rate of increase of Mr. Jones’ income, the higher the rate of increase in the consumer price index.

This post was published at Ludwig von Mises Institute on Sept 8, 2017.