The Perverse Circularity of NAIRU-Driven Economic Policy in Canada By

The fundamental idea behind the concept of the NAIRU — the non-accelerating inflation rate of unemployment — is that macroeconomic stimulus (fiscal or monetary policy changes to increase aggregate demand) can lower unemployment to its “natural” rate, but further stimulus accelerates wage-driven inflation with no permanent decrease in unemployment. The concept, originally put forward by Milton Friedman as the “natural rate of unemployment,” goes beyond the older notion of a Phillips curve tradeoff between inflation and unemployment to imply that unemployment below the “natural” rate leads not just to inflation, but to accelerating inflation. NAIRU theory as presented by the Organization for Economic Co-operation & Development in its Jobs Study (1994) and annual Economic Surveys of member countries further holds that the natural rate of unemployment is determined primarily on the supply side of the labour market — that is, by the decisions of workers to accept or reject jobs at wages offered by employers. The basic premise is that the characteristics of the labour market (e.g., the level of minimum wages, the strength of unions, the availability of unemployment insurance benefits, as well as the labour force participation rate of supposedly marginal groups, such as women and youth) will result in wage-driven inflation if unemployment is allowed to fall below the supposed NAIRU. Indeed, the OECD makes explicit reference, not to the NAIRU, but to a NAWRU, or “non-accelerating wages rate of unemployment. ” The fundamental idea is that unemployment is needed to discipline workers’ wage demands and that their ability to bid up wages is greatest in the presence of labour market “imperfections” or “rigidities,” such as legislated minimum wages, collective bargaining and the availability of non-wage income. In the case of Canada, the OECD emphasizes the work “disincentives” held to be created by the national system of Unemployment Insurance. While the politically charged notion that unemployment must be kept high in order to keep inflation low and stable is rarely heard in the everyday discourse of Canadian democratic politics, it is clear NAIRU theory is more than an abstract economic theory. Indeed, it closely informs the actual practice of Canadian economic policy. The present government’s key economic policy document, Agenda: Jobs and Growth — A New Framework for Economic Policy, released by the Department of Finance in October 1994, argued the “core rate or NAIRU [is] the rate of unemployment which cannot be forced lower without causing inflation to accelerate. If an attempt is made to push unemployment below the core rate — e.g., by highly stimulative macroeconomic policy — the economy produces little extra real output or jobs, except very temporarily. Instead, the economy spins its wheels by generating an upward spiral of higher prices and wages which is unsustainable. ” (Department of Finance, 1994: 20) Citing the Bank of Canada’s then most recent analysis (Rose, 1988), it went on to suggest that the NAIRU in Canada “is now at least 8 per cent. ” In early 1997, Finance Minister Paul Martin publicly distanced himself from NAIRU theory, suggesting a much lower unemployment rate of 5 per cent was both desirable and achievable without risking accelerating inflation (“Martin Fuels Jobless Rate Debate,” Globe & Mail, Feb. 24, 1997). Similarly, senior Bank of Canada officials, such as Deputy Governor Charles Freedman at the 1998 Canadian Economics Association’s annual meetings have publicly denied NAIRU estimates drive monetary policy. Yet, despite these denials, NAIRU theory is clearly an important basis for Canadian economic policymaking, both at the macro and micro levels. On Feb. 26, 1997, Deputy Finance Minister Scott Clark sent a memo to Martin (obtained via a Canadian Labour Congress Access to Information