Laurence Ball

The NAIRU in Theory and Practice

This paper discusses the NAIRU -- the non-accelerating inflation rate of unemployment. It first considers the role of the NAIRU concept in business cycle theory, arguing that this concept is implicit in any model in which monetary policy influences both inflation and unemployment. The exact value of the NAIRU is hard to measure, however, in part because it changes over time. The paper then discusses why the NAIRU changes and, in particular, why it fell in the United States during the 1990s. The most promising hypothesis is that the decline in the NAIRU is attributable to the acceleration in productivity growth.

Aggregate demand and Long-Run Unemployment

WHAT DETERMINES the unemployment rate? In answering this question, mainstream economics draws a sharp distinction between the short run and the long run. According to the conventional view, short-run movements in unemployment are strongly influenced by monetary policy and other determinants of aggregate demand. In the long run, however, unemployment returns to a natural rate or NAIRU (the nonaccelerating-inflation rate of unemployment), which is determined by labor market frictions. The NAIRU can change over time for microeconomic reasons, such as changes in labor market institutions. But the conventional wisdom holds that the NAIRU is unaffected by aggregate demand, and thus that demand does not influence long-run unemployment trends. This paper argues that this conventional view is wrong. Monetary policy and other determinants of aggregate demand have strong effects on long-run as well as short-run movements in unemployment. And this is not just a theoretical point. Over the last twenty years the behavior of demand accounts for much of the differences across countries in the evolution of unemployment. Aggregate demand has long-run effects on unemployment because of what Olivier Blanchard and Lawrence Summers have called hysteresis.(1) At a given point in time, there exists a NAIRU: pushing unemployment below a certain level causes inflation to rise. But as demand pushes unemployment away from the current NAIRU, this causes the NAIRU itself to change over time. A number of authors (including myself)(2) have presented empirical evidence in favor of hysteresis, but many students of unemployment remain unpersuaded. The broad goal of this paper is to bolster the case for hysteresis in industrial countries in the 1980s and 1990s. This paper also documents two specific aspects of hysteresis that are important in recent history. The first concerns the role of monetary policy in determining whether hysteresis arises--whether a cyclical rise in unemployment causes a rise in the NAIRU. Here I primarily examine the early 1980s, when most member countries of the Organization for Economic Cooperation and Development (OECD) experienced recessions arising from disinflationary monetary policy. In some countries, such as the United States, the rise in unemployment was transitory; in others, including many European countries, the NAIRU rose and unemployment has remained high ever since. I argue that the reactions of policymakers to the early-1980s recessions largely explain these differences. In countries where unemployment rose only temporarily, it did so because of strongly countercyclical policy: after tight policy produced a recession to disinflate the economy, policy shifted toward expansion, reducing unemployment. In countries where unemployment rose permanently, it did so because policy remained tight in the face of the 1980s recessions. This analysis implies that passive macroeconomic policy during a recession has a high cost: it can lead to permanently higher unemployment. And there do not appear to be substantial benefits from such inaction. I find that countries that combated recessions with expansionary policy still obtained lower inflation from the initial rise in unemployment. Countries that kept policy tight did not gain an additional reduction in inflation. Most previous discussions of hysteresis focus on its role in explaining increases in unemployment. The second part of my analysis asks whether hysteresis works in reverse--whether demand expansions can produce permanent decreases in unemployment. Here I examine the period from 1985 through 1997, when several countries emerged as success stories in reducing unemployment. In particular, I identify four countries where unemployment has fallen substantially since 1985--Ireland, the Netherlands, Portugal, and the United Kingdom--and contrast them with countries where unemployment has stayed high. I find that reverse hysteresis helps explain the success stories: their decreases in unemployment were caused largely by demand expansions. …

A Sticky-Price Manifesto

Macroeconomists are divided on the best way to explain short-run economic fluctuations. This paper presents the case for traditional theories based on short-run price stickiness. It discusses the fundamental basis for believing in this class of macreconomic models. It also discusses recent research on the microeconomic foundations of sticky prices.

Another Look at Long-Run Money Demand

This paper investigates the long-run demand for M1 in the postwar United States. Previous studies, based on data ending in the late 1980s, are inconclusive about the parameters of postwar money demand. This paper obtains precise estimates of these parameters by extending the data through 1996. The income elasticity of money demand is approximately 0.5, and the interest semi-elasticity is approximately -0.05. These parameters are significantly smaller in absolute value than the corresponding parameters for the prewar period.

Disinflation with imperfect credibility

This paper presents a theory of the real effects of disinflation. As in New Keynesian models, price adjustment is staggered across firms, As in New Classical models, credibility is imperfect: the monetary authority may not complete a promised disinflation. The combination of imperfect credibility and staggering yields more plausible results than either of these assumptions alone. In particular, an announced disinflation reduces expected output if credibility is sufficiently low.

Intergenerational Risk Sharing in the Spirit of Arrow, Debreu, and Rawls, with Applications to Social Security Design

This paper examines the optimal allocation of risk in an overlapping‐generations economy. It compares the allocation of risk the economy reaches naturally to the allocation that would be reached if generations behind a Rawlsian “veil of ignorance” could share risk with one another through complete Arrow‐Debreu contingent‐claims markets. The paper then examines how the government might implement optimal intergenerational risk sharing with a social security system. One conclusion is that the system must either hold equity claims to capital or negatively index benefits to equity returns.

Long-Term Damage from the Great Recession in OECD Countries

This paper estimates the long-term effects of the global recession of 2008-2009 on output in 23 countries. I measure these effects by comparing current estimates of potential output from the OECD and IMF to the path that potential was following in 2007, according to estimates at the time. The losses in potential output range from almost nothing in Australia and Switzerland to more than 30% in Greece, Hungary, and Ireland; the average loss, weighted by economy size, is 8.4%. Most countries have experienced strong hysteresis effects: shortfalls of actual output from pre-recession trends have reduced potential output almost one-for-one. In the hardest-hit economies, the current growth rate of potential is depressed, implying that the level of lost potential is growing over time.

The Distributional Effects of Fiscal Consolidation

This paper examines the distributional effects of fiscal consolidation. Using episodes of fiscal consolidation for a sample of 17 OECD countries over the period 1978–2009, we find that fiscal consolidation has typically had significant distributional effects by raising inequality, decreasing wage income shares and increasing long-term unemployment. The evidence also suggests that spending-based adjustments have had, on average, larger distributional effects than tax-based adjustments.

Is Equilibrium Indexation Efficient

This paper investigates the welfare properties of equilibrium indexation in a decentralized economy. If indexation is costless, so all firms index, then the equilibrium degree of indexation is efficient. But if indexation is costly and this leads some firms not to index, equilibrium indexation is inefficient because indexation has externalities for nonindexed firms. Firms choose too little indexation if labor demand is more responsive to movements in real money than to movements in real wages. The results do not depend on the relative importance of real and nominal shocks.

The Deficit Gamble

The historical behavior of interest rates and growth rates in U.S. data suggests that the government can, with a high probability, run temporary budget deficits and then roll over the resulting government debt forever. The purpose of this paper is to document this finding and to examine its implications. Using a standard overlapping-generations model of capital accumulation, we show that whenever a perpetual rollover of debt succeeds, policy can make every generation better off. This conclusion does not imply that deficits are good policy, for an attempt to roll over debt forever might fail. But the adverse effects of deficits, rather than being inevitable, occur with only a small probability.