Shifting Sands and Policy Failures
INTRODUCTION In Chapter 3 we traced the route that natural rate economists took in resisting the Keynesian consensus in the post-Second World War period. Their attempts were bolstered in the late 1960s by the inﬂationary impulses associated with the Vietnam War which provided opportunities for natural rate economists to attack activist macroeconomic policy. However the paradigm break, and the resurgence of pre-Keynesian (natural rate) thinking, came with the economic dislocation that followed the ﬁrst oil price rise in 1974 and the resulting international inﬂation surge (Thurow, 1983). As explained in Chapter 3, the natural rate approach redeﬁned full employment in terms of a unique unemployment rate (the NAIRU) where inﬂation is stable. The NAIRU is determined by supply forces and is invariant to Keynesian demand-side policies. The approach alleged that free markets guarantee full employment and Keynesian attempts to drive unemployment below the NAIRU will ultimately be self-defeating and inﬂationary. The Keynesian notion that unemployment represents a macroeconomic failure that can be addressed by expansionary ﬁscal and/or monetary policy was categorically rejected, with little resistance oﬀered by those who had advocated this position over many years. Instead, the new macroeconomic orthodoxy was built on the assertion that unemployment reﬂects supply failures such as poor incentive structures facing individuals as a result of welfare provision, skill mismatches and excessive government regulations (OECD, 1994). Extreme versions of the natural rate hypothesis consider unemployment to be voluntary and the outcome of optimising choices by individuals between...
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