Non-Accelerating Inflation Rate Of Unemployment - NAIRU

What is the 'Non-Accelerating Inflation Rate Of Unemployment - NAIRU'

The non-accelerating inflation rate of unemployment (Nairu) - also referred to as the long-run Phillips curve - is the specific level of unemployment that is evident in an economy that does not cause inflation to rise up. NAIRU often represents equilibrium between the state of the economy and the labor market.

BREAKING DOWN 'Non-Accelerating Inflation Rate Of Unemployment - NAIRU'

In 1958, New Zealand born economist William Phillips wrote a paper titled The Relation between Unemployment and the Rate of Money Wage Rates in the United Kingdom. In his paper, Phillips described the supposed inverse relationship between unemployment levels and the rate of inflation. This relationship was referred to as the Phillips curve. However, during the severe recession of 1974 to 1975, inflation and unemployment rates both reached historic levels and people began to doubt the theoretical basis of the Phillips curve. Milton Friedman and other critics argued that government macroeconomic policies were being driven by a low unemployment target and that caused the expectations of inflation to change. This led to accelerated inflation rather than reduced unemployment. It was then agreed that government economic policies should not be influenced by unemployment levels below a critical level also known as the “natural rate of unemployment."

The Nairu was first introduced in 1975 as the noninflationary rate of unemployment (NIRU) by Franco Modigliani and Lucas Papademos. It was an improvement of the concept of “natural rate of unemployment" by Milton Friedman.

The Correlation Between Unemployment and Inflation

Suppose that the unemployment rate is at 5% and the inflation rate is 2%. Assuming that both of these values remain the same for a period of time, it can then be said that when unemployment is under 5%, it is natural for an inflation rate of 2% to correspond with it. Critics cite that it is unlikely to have a static rate of unemployment that lasts for long periods of time because different levels of factors affecting the workforce and employers (such as the presence of unions and monopolies) can quickly shift this equilibrium.

Theory Properties

The theory states that if the actual unemployment rate is less than the Nairu for a few years, inflationary expectations rise so the inflation rate tends to increase. If the actual unemployment rate is greater than the Nairu, inflationary expectations fall so the inflation rate slows down and there is disinflation. If both unemployment rate and Nairu are equal, the inflation rate tends to stay the same.

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