Another strange non-death: the NAIRU and the ideational foundations of the Federal Reserve’s new monetary policy framework

Abstract

Monetary policy has long relied on the ‘natural rate hypothesis’, suggesting that after an economic shock the unemployment rate will automatically return to its supply-side ‘natural’ rate or NAIRU. Macroeconomic developments since the 2008 financial crisis have challenged this hypothesis, forcing the US Federal Reserve to conduct a strategic review of its monetary policy framework, published in 2020. We conducted an in-depth case study of the Fed through a content analysis of 120 speeches given by the Fed’s top-level body (FOMC) from 2012 to 2022. We show that policy learning has occurred in that FOMC members have problematised the NAIRU either on (1) epistemological grounds, acknowledging the risk of relying on NAIRU estimates, or on (2) ontological grounds, highlighting the endogeneity of the NAIRU to monetary policy. While both interpretations lead to a more expansionary monetary policy stance, the differing motivations matter for future policymaking. In the case of (1) the rationale is mainly to a avoid downward de-anchoring of inflation expectations, whereas with (2) it is to deliberately chase hot labour markets and a high-pressure-economy. Our speech analysis shows that (1) has been far more dominant in the FOMC, indicating incremental rather than fundamental ideational change.