Non-Accelerating Inflation Rate Of Unemployment

Published Oct 25, 2023

Definition of Non-Accelerating Inflation Rate of Unemployment (NAIRU)

The Non-Accelerating Inflation Rate of Unemployment, also known as NAIRU, is the level of unemployment at which inflation remains stable. It represents the lowest rate of unemployment that an economy can sustain without causing an acceleration in inflation. The theory behind NAIRU suggests that there is a trade-off between inflation and unemployment, and policymakers must carefully manage the unemployment rate to maintain price stability.

Example

Let’s consider an economy with a current unemployment rate of 5%. According to the NAIRU theory, this rate may be considered the natural rate of unemployment at which inflation remains stable. If the unemployment rate falls below this level, to say 4%, it could signal an overheating economy with increased demand for labor, leading to higher wages, and ultimately, higher prices. This increase in prices would result in inflationary pressures.

On the other hand, if the unemployment rate rises above the NAIRU level, let’s say to 6%, it could indicate a weak economy with excess supply of labor. This surplus of labor would lead to lower wages and reduced consumer spending, resulting in deflationary pressures.

Therefore, policymakers aim to manage the unemployment rate close to the NAIRU level to prevent inflation from spiraling out of control or the economy from stagnating.

Why NAIRU Matters

NAIRU is an important concept for policymakers and central banks when developing monetary policy. It helps them understand the relationship between unemployment and inflation and guides them in making decisions to maintain price stability. By keeping the unemployment rate close to the NAIRU level, policymakers strive to balance the needs of both low unemployment and low inflation.

Understanding NAIRU also assists in predicting the effects of various policy interventions on the economy. For example, if policymakers implement expansionary monetary or fiscal policies to boost employment beyond the NAIRU level, it may lead to inflationary pressures. Conversely, contractionary policies aimed at reducing inflation may result in higher levels of unemployment.

Overall, having knowledge of NAIRU allows policymakers to make informed decisions that aim to achieve a balance between low unemployment and stable prices, enhancing the overall economic well-being of society.