non-accelerating inflation rate of unemployment (NAIRU)
NAIRU stands for the non-accelerating inflation rate of unemployment. Milton Friedman who criticized the basis for the original Phillips Curve in a speech to the American Economics Association in 1968 gave the concept to us. Milton Friedman was one of the founding fathers of Monetarism - a theory of inflation that gained ground in the late 1960s and 1970s and formed the basis for much of Thatcherite economics during the 1980s and early 1990s.
The NAIRU is the rate of unemployment when the rate of wage inflation is stable
Milton Friedman's Attack on the Phillips Curve - Inflation Expecatations
Milton Friedman accepted that the short run Phillips Curve existed - but that in the long run, the Phillips Curve was vertical. In other words, he argued that in the long run, there is no trade-off between unemployment and inflation. He argued that each short run Phillips Curve was drawn on the assumption of a given expected rate of inflation. So if there were an increase in inflation that drove inflationary expectations higher, then this would cause an upward shift in the short run Phillips Curve. Boosting AD (i.e. through higher government spending or lower taxes) only has a temporary effect on unemployment.
Friedman's view was that governments could not permanently attempt to drive unemployment down below the NAIRU - the result would be higher inflation, eventually a return to higher unemployment but with inflationary expectations increased along the way.
In the diagram above, the government introduces an expansionary macroeconomic policy designed to reduce unemployment by boosting AD. This takes the economy from A to B with inflation at 5%. In time, workers expect inflation of 5% and so bid for higher money wages. This leads to an increase in firms' costs, so, at that price level, real output falls, unemployment rises and the short run Phillips Curve shifts from SRPC1 to SRPC2 (B to C). So, though in the short-run a trade-off may occur, in the long-run unemployment is stuck at N, NAIRU.
There has not been one steady curve showing the relationship over the past thirty years. What is also interesting to note is the change in the gradient of the curve in recent times: what seems to be the case is that inflation is far less volatile now than it used to be, so that for a given fall in unemployment, for example, the increase in the inflation rate is much smaller than it would have been in the 1980s.
There has clearly been an improvement in the trade-off between unemployment and inflation in the last ten - fifteen years. Unemployment has fallen on a sustained basis and yet inflation has remained stable and (since 1997) comfortably within the Government's chosen target for RPIX (2.5% pa +/- 1%)
Policy implications of this change: The changing nature of the trade-off between unemployment and inflation changes the landscape for monetary and fiscal policy. If there has been a genuine fall in the NAIRU and an improvement in the trade-off, this suggests that the Bank of England could allow the country to grow at a faster rate without running the risk of breaking its inflation target of 2½% per year - that is to say, the trend growth rate of the economy may have risen.
Economists at Oxford Economic Forecasting estimate that the NAIRU has been falling fairly consistently during the 1990s and stands in 2001 at a level of approximately 4.5% of the labour force. By this measure, actual unemployment lies below the NAIRU, although unemployment using the labour force survey measure is somewhat higher. And other measures of unemployment and economic inactivity in Britain portray unemployment as being even higher than the published official data.
Our estimated NAIRU is substantially below that of Germany and France - although some way above that for the United States and Japan. The Netherlands (another country to have introduced widespread labour market reforms over the last fifteen years) is also estimated to have a lower NAIRU than the UK.
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