Mohamed El-Erian raises the possibility that the future will be one in which “full employment” is as high as seven percent. That is, the Federal Reserve will not be able to push employment lower than that without sparking inflation

This possibility of a very high and persistent unemployment rate is not, as yet, part of the mainstream deliberations. Instead, the persistent domination of a "mean reversion" mindset leads to excessive optimism regarding how quickly the rate will max out, and how fast it converges back to the 5 per cent level for the Nairu (non-accelerating inflation rate of unemployment).

The US faces a material probability of both a higher Nairu (in the 7 per cent range) and, relative to recent history, a much slower convergence of the actual unemployment rate to this new level.

I don’t yet see a higher NAIRU or natural rate of unemployment – at least in the way that I think about the natural rata – in our future. I tend to think of the natural as being determined by structural features of the market such as the ratio of service sector workers to manufacturing workers. The more service sector workers the lower the natural rate, for example. Perhaps, there is some deeper paradigm shift that I have not yet internalized. So far, however, I don’t see it.

I do see a prolonged stint away from the natural rate and very weak recovery.

HT: Salmon