what is the nairu and why does it matter?
TRANSCRIPT
An Explainer Post fromEd Dolan’s Econ Blog
What is the Nairuand Why does it Matter?
Posted December 18, 2016
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The Wonkiest Number in Economics
Nairu (or NAIRU) stands for Non-Accelerating-Inflation Rate of Unemployment
As unemployment falls, tightening labor and product markets put upward pressure on wages and prices
The Nairu is supposed to capture the sweet spot—the lowest level to which the unemployment rate can safely fall before inflation starts to accelerate
December 18, 2016 Ed Dolan’s Econ Blog
In the 1960s, Milton Friedman introduced the term natural rate of unemployment. Today, many economists treat Friedman’s “natural rate” as a synonym for Nairu
The Nairu and the Fed’s Dual Mandate
Under its so-called dual mandate, the Fed is supposed to aim for maximum employment and stable prices.
The Nairu captures both parts of the dual mandate, being the maximum employment that is consistent with inflation that does not accelerate from month to month.
December 18, 2016 Ed Dolan’s Econ Blog
Federal Reserve HeadquartersWashington, DC
The Nairu and the Fed’s Dual Mandate
To put the dual mandate to work, economists at the Fed must attach numbers to both of its parts
The Fed has set its inflation target at 2 percent annually, measured by the personal consumption expenditure (PCE) index
The unemployment target—the Nairu—is harder to pin down exactly
December 18, 2016 Ed Dolan’s Econ Blog
The Phillips Curve (1960s)
Back in the 1960s things seemed easier
At that time, the pattern of inflation and unemployment fit closely around a negatively sloped line called a Phillips curve
December 18, 2016 Ed Dolan’s Econ Blog
Using the Phillips Curve to Find the Nairu
Given a Phillips curve and an inflation target, it would be easy to find the Nairu
Just look for the intersection
December 18, 2016 Ed Dolan’s Econ Blog
The Disappearing Phillips Curve
Unfortunately, the Phillips curve did not turn out to be stable
In the 1970s, the Phillips curve shifted higher
During more recent economic expansions it is hard to see any pattern resembling a negatively sloped Phillips curve
December 18, 2016 Ed Dolan’s Econ Blog
The Nairu Since 1950
With no stable Phillips curve to go by, economists use other statistical methods
This chart shows estimates by the Congressional Budget Office of the Nairu (or natural rate of unemployment, as the CBO still prefers to call it)
December 18, 2016 Ed Dolan’s Econ Blog
Natural vs. Actual Unemployment Rates
This chart compares the CBO estimates of the natural rate of unemployment (Nairu) with the actual rate
The actual rate rises above the natural rate during recessions and falls below it during expansions
December 18, 2016 Ed Dolan’s Econ Blog
A Case in Point: December 2016 Fed Action
In November 2016, the unemployment rate fell below the Nairu (4.8 percent) for the first time in eight years
The inflation rate was increasing, but not yet at the Fed’s 2 percent target
The combination was enough to trigger an interest rate increase by the Fed—only the second since the Great Recession started
December 18, 2016 Ed Dolan’s Econ Blog
Summary: Why the Nairu Matters
The Nairu is an estimate of the unemployment rate below which inflation begins to accelerate
It is difficult to measure exactly and varies from year to year
Despite problems of measurement, the relationship of actual unemployment to the Nairu strongly influences monetary policy
December 18, 2016 Ed Dolan’s Econ Blog
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