Nudged by Reality, Policy Makers Admit They’re Wrong, Think About Changing View on Unemployment

Nothing proves your forecast wrong more than, well, what actually happens.

With unemployment, the magic number used to be 5%.  That was the floor for unemployment, before things would start to spiral out of control.

If it fell below that level, then companies would bid against each other for workers, paying more and offering better benefits. The extra cash in the hands of workers would find its way into the economy as those same workers then paid more for goods and services.

The extra payments would drive inflation.

The 5% unemployment rate was known as the non-accelerating inflation rate of unemployment, or NAIRU.

Then unemployment dropped below 5% in the early 2000s without causing much inflation, which led central bankers and economists to scratch their heads.  This conundrum was upstaged by the housing debacle and then financial crisis, but has come back around as unemployment has again dropped below 5%, then 4%, and could drop even further.

Speaking at an event designed to gather views on how the Fed should tweak its policies going forward, New York Fed President John Williams said policymakers are focused on how they can sustain the U.S. economic expansion, maintain a strong labor market and keep inflation low.

In March, the Fed officials thought that NAIRU was around 4.3%, which is down from 4.7% two years ago.  But that’s hard to square with unemployment at 3.6% and inflation not showing up outside of housing and medical costs.

It looks likely that the central bankers once again will lower their estimate. As the saying goes, the stars might lie, but the numbers never do.

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