NAIRU

NAIRU stands for the non-accelerating inflation rate of unemployment. It is the level of unemployment at which the inflation rate does not rise or fall, given the economy’s expected inflation and its structural conditions. In essence, it is the unemployment rate that is consistent with stable inflation.

In the Phillips curve framework, there is a short‑run trade-off between unemployment and inflation: unemployment below the NAIRU tends to put upward pressure on inflation, while unemployment above it tends to slow inflation. In the long run, as price and wage expectations adjust, the unemployment rate is thought to return to the NAIRU, implying no sustained trade-off between inflation and unemployment.

NAIRU is not directly observable; it is estimated from econometric models and is time-varying, influenced by demographics, policy, productivity, and labor-market institutions. Different models can yield different estimates, and the concept remains inherently uncertain.

Policy use of NAIRU involves guiding decisions so that unemployment is kept near its NAIRU to stabilize inflation. If the NAIRU is misestimated or shifts due to structural changes, policy can inadvertently fuel inflation or raise unemployment. Some schools of thought emphasize rules-based or inflation-targeting frameworks, while others highlight the potential for hysteresis and permanent effects of unemployment on skills and welfare.

Critics argue that NAIRU assumes a stable natural rate and omits factors such as demand shocks, hysteresis, skill depreciation, and evolving institutions. Its estimation is controversial, and reliance on a fixed NAIRU can lead to policy errors if the true rate is changing.

Overall, NAIRU serves as a conceptual tool to understand inflation dynamics and the potential long-run level of unemployment, rather than a precise, observable target.