NAIRU

NAIRU means the non-accelerating inflation rate of unemployment: an unemployment rate consistent with stable inflation under a specified model and set of conditions. Stable inflation can be positive; it does not mean an unchanged price level. The concept is used to assess labour-market slack, but the NAIRU is not directly observable. [1]

A simple Phillips-curve formulation

An illustrative expectations-augmented Phillips curve can be written as:

pi_t = pi_t^e - a (u_t - u_t*) + v_t, a > 0

Here pi_t is inflation, pi_t^e expected inflation, u_t unemployment, u_t* the model's benchmark rate, and v_t a supply-shock term. If expected inflation equals the previous period's inflation, subtracting that previous rate gives:

pi_t - pi_(t-1) = -a (u_t - u_t*) + v_t

With v_t = 0, unemployment below the benchmark implies rising inflation; at the benchmark inflation is unchanged. This acceleration result depends on the expectations assumption and treatment of shocks. Ball and Mankiw discuss why the interpretation depends on the monetary regime. It is not a universal rule that any observed fall in unemployment must increase inflation. [2]

Terminology and the natural rate

Modigliani and Papademos used the related term noninflationary rate of unemployment (NIRU) in 1975. They defined a threshold above which inflation could be expected to decline, with a qualification for initially low inflation. Their wording should not be retrospectively presented as an original use of the acronym NAIRU. [3]

The natural rate of unemployment and NAIRU are often used approximately interchangeably, as in Ball and Mankiw's framework. Other authors distinguish them. Estrella and Mishkin define NAIRU for a short-run inflation forecast and separate it from the longer-run natural rate. Under that definition, price shocks or productivity changes can shift the short-run NAIRU. A comparison between estimates therefore requires knowing their definitions and horizons. [2,4]

Estimation and revision

Cusbert describes an RBA model that infers a changing NAIRU from inflation and wage-growth data using a Kalman filter. Its estimates can be revised when new observations arrive, including estimates for previous years. Omitted influences on wages or inflation may be absorbed into the estimated NAIRU without establishing a change in the underlying benchmark. [5]

The Philadelphia Fed's documentation of Federal Reserve staff estimates records changes in definitions, including whether temporary productivity effects were included. A dated estimate and a retrospectively revised estimate are different objects; neither should be reported as a directly measured constant. [6]

Policy use and controversy

The RBA treats the unemployment gap as one of several inputs into forecasts and policy assessment. Labour-market matching, bargaining arrangements and persistent effects of unemployment (hysteresis) can affect the benchmark; it is not necessarily fixed. [1]

Staiger, Stock and Watson find imprecise NAIRU estimates and other inflation indicators at least as useful as unemployment in their 1997 study. This supports scrutiny of a single-number policy threshold, rather than proving that every Phillips-curve model is useless. [7]

Shiori's editorial position: an estimate should be accompanied by its country, period, data vintage, inflation measure, model and uncertainty. Calling a rate "natural" or inflation-stabilising does not establish that it is socially desirable.

Sources

• [1] Reserve Bank of Australia, The Non-Accelerating Inflation Rate of Unemployment (NAIRU), explainer.
• [2] Laurence Ball and N. Gregory Mankiw, The NAIRU in Theory and Practice, Journal of Economic Perspectives 16(4) (2002), 115-136, especially 117-119.
• [3] Franco Modigliani and Lucas Papademos, Targets for Monetary Policy in the Coming Year, Brookings Papers on Economic Activity 1 (1975), 141-165, especially 142.
• [4] Arturo Estrella and Frederic Mishkin, Rethinking the Role of NAIRU in Monetary Policy: Implications of Model Formulation and Uncertainty, Research Paper 9806 (1998), abstract; see also Carl E. Walsh's discussion of the distinction.
• [5] Tom Cusbert, Estimating the NAIRU and the Unemployment Gap, RBA Bulletin (June 2017), estimation, revision and omitted-variable discussion.
• [6] Federal Reserve Bank of Philadelphia, NAIRU Estimates from the Board of Governors, prefatory note.
• [7] Douglas Staiger, James H. Stock and Mark W. Watson, The NAIRU, Unemployment and Monetary Policy, Journal of Economic Perspectives 11(1) (1997), 33-49, abstract.