Working Paper

How natural is the natural rate?

Abstract: In the last two decades the one macroeconomic concept which has become standard equipment in macroeconomics is the Natural Rate Hypothesis (NRH). The NRH is usually embodied as a vertical aggregate supply curve and forms a cornerstone of the \"policy ineffectiveness\" proposition. We emphasize that the driving power of the policy ineffectiveness proposition derives from the joint assumptions that (a) the aggregate supply curve is vertical and (b) that the aggregate supply curve is independent of aggregate demand. ; We claim that this usage of the NRH is inappropriate for many purposes. It results from a trivialization of the supply structure of the economy and has little justification if it is intended to analyze the real effects of virtually any imaginable policy. We give some examples where minor modifications to the supply structure generate an aggregate supply curve which is not independent of aggregate demand. With fully informed optimizing agents each policy action will generate a new general equilibrium. Nothing is \"natural\" and little is policy invariant. Evidence is presented to show that the issues raised may be of empirical significance.

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 1984

Number: 1984-010