NAIRU

You students out there, see, even our politicians get hot and sweaty about plain old economic terms. Yesterday’s hot bed was the ‘non-accelerating inflation rate of unemployment’ or NAIRU. For the uninitiated, let me quote from my favourite economics textbook.

[The NAIRU] is the level of unemployment that does not result in increases in the inflation rate.

In theory, the Reserve Bank can go to town in squeezing the money supply to fight inflation and it won’t effect the NAIRU but it will impact on short-term unemployment. And so what is the level of the NAIRU at the moment? Well, inflation is accelerating, so it is higher than our current unemployment rate.

But there is something very important here: the NAIRU does not change with current discretionary policy variables. It relates to structural factors. So when Malcolm Turnbull asks this question:

“If the treasurer regards that (NAIRU) rate to be higher than 4.1 per cent, how many Australian jobs does he believe should be sacrificed to achieve it?”

a possible answer could be: none; at least if we are patient. Not that it is easy to do, but the government could try and put in place programs that will eventually reduce the NAIRU. Indeed, it appears to have fallen since I was an economics student and gets lower with every edition of my favourite textbook. The problem is that until that is done, our inflation rate will stay high and maybe get higher if unemployment stays down. Near as I can tell, that is what the Treasurer actually said.

The one thing we can do with the NAIRU is probably put a figure on it (or at least a range) by looking at how fast inflation has accelerated and decelerated in the past. That is why the concept is useful.

7 thoughts on “NAIRU”

  1. Last year I produced a graph for advanced macro, plotting the inflation rate against the unemployment rate (data from lists G02 and G07 from the RBA website).

    I started the data from 1990, where the connected dots produced a lovely Phillips curve. In later years (starting around 2000?) the dots produced a second Phillips curve, which was at the left of the original.

    This made me (and my lecturer) believe that over the period the NAIRU shifted left in Australia, allowing lower unemployment.

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  2. Shouldn’t that be:

    [The NAIRU] is the lowest level of unemployment that does not result in increases in the inflation rate” ?

    Otherwise every level of unemployment above the NAIRU would satisfy the condition of being a NAIRU.

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  3. So, this economics of yours requires that capable people who want jobs are denied jobs and income? It is a form of musical chairs where you do not care who is denied a living except that some number are unemployed to make your formula work. The reality is that these abstractions like labor and unemployment resolve to real people with real lives.

    One could drive a car two ways: Adjust the throttle to maintain the speed you want. That seems fairly straight forward.

    One could alternately set the throttle high and manage the speed with the brakes. The level of braking that sets the correct speed would be the non accelerating rate of braking. Try that with your car, not mine.

    As to NAIRU, try that with your economy and people, not mine.

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  4. Hi Fred,

    I like the braking analogy. Though I guess you could say that for better or worse the car is rolling down the hill at the moment and seems to be gathering speed without the accelerator! So managing the speed with the brake seems to be the only option (in a choice between braking and accelerating, that is). That’s the problem with driving the economy – the road’s not flat, it’s full of peaks and troughs and unexpected potholes.

    It’s probably also worth thinking about the fact that you can see lowering the NAIRU as being more about improving people’s lives than being callous about them; if the NAIRU is too big, then when unemployment is low policies to slow the economy that may result in a rise in unemployment are not offset by a fall in inflation and everyone loses.

    In that sense, the NAIRU is like the effectiveness or braking power of the car. The lower the NAIRU, the better the brakes, and the less dramatic force it takes to slow the car down. No one denies that slamming on the accelerator and then slamming on the brake makes for a bumpy ride; indeed, if we focus on building better brakes then we can hopefully smooth out that ride.

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  5. Fred, I am not sure the car anology you use makes sense. It is not that the NAIRU implies somehow pushing and pulling at the economy at the same time.

    The NAIRU does not imply abandoning people, it simply says that there would appear to be a floor to unemployment below which inflation starts to accelerate. And this casue all kind of other consequences (which we are seeing around us now).

    A more apt analogy might be to consider a car trying to drive on an icy road, you can start driving and more but at a certain speed, you loose grip and start to slip all over the road. There is a speed limit above which you cannot go without the other consequences.

    the policy solution is not to continue to try and speed up, but rather to get out and put on chains or some other change to permanently change the speed you can get to without slipping.

    So it is with the NAIRU, the real policy issue over the long term is what can we do to lower the NAIRU?

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  6. I suppose the simplest answer for fred is that economics and NAIRU tries to describe something, not to create it. Economists didn’t invent it, they discovered it.

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  7. “there is something very important here: the NAIRU does not change with current discretionary policy variables”

    Which is just where a lot of people take issue with the way the NAIRU is used: the NAIRU appears to be powerfully influenced by the current state of the labour market, which in turn is a product of past discretionary variables.

    Which makes it, a la the Lucas critique, pretty well useless as a guide to current policy (as distinct from a conceptual aid). You’re much better off targeting inflationary expectations, etc as a guide to monetary policy rather than allowing the unemployment rate to enter your reaction function. Leaving unemployment to the microeconomists (who know a lot about it) will keep it lower in the long run.

    I actually think that Treasury has made mistakes by adopting a macro model that pulls the future rate of unemplyment back to a fixed NAIRU. It’s been a source of systematic forecasting error by them (though of course they’re not Bob Crusoe).

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