On the occasion of Jared Bernstein’s and Dean Baker’s publishing an essay on how low an unemployment rate we can tolerate before inflation spirals out of control, it’s worth linking back to a something I wrote in 2010 about James Galbraith’s views on the matter.
Even supposing that there actually is a NAIRU (i.e., a level of unemployment below which inflation will start accelerating), and even supposing that something bad will happen if we cross below that line, it’s not as though we lose control of the ship right then. At that point we know what happens: the Federal Reserve jacks up interest rates, unemployment skyrockets (particularly as mortgage rates rise and employment in the housing sector collapses), and inflation drops back down. It’s happened before. We have control over this. Doesn’t the Federal Reserve just need to signal that it takes its dual mandate seriously? If everyone believes that the Federal Reserve will bring the hammer down if inflation rises too high, what’s the big deal? Better to let inflation rise too high because unemployment was allowed to drop too low, and correct the problem later, than allow millions of people to remain involuntarily idle.