NAIRU
/ NAIRU = NYE-roo /
Suppose unemployment is very low and falling further: firms compete fiercely for scarce workers, push up wages to attract them, and pass those higher costs on as higher prices — so inflation starts to climb. Now suppose unemployment is high: workers are plentiful, wage pressure is weak, and inflation eases. Somewhere in between is a special unemployment rate where inflation neither speeds up nor slows down — it stays steady. That tipping point is the NAIRU.
NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment. It is the unemployment rate consistent with stable, non-accelerating inflation. If unemployment is held below the NAIRU, inflation tends to keep rising; if held above it, inflation tends to fall. In modern macroeconomics the NAIRU is closely related to — often treated as the same thing as — the natural rate of unemployment, though it is defined specifically through its link to inflation rather than through frictional-plus-structural reasoning. It is the unemployment level at which the labour market is balanced enough that price pressures are neither building nor fading.
The NAIRU is the engine behind the modern view of the Phillips curve and a constant guide for central banks: it tells them how low unemployment can go before they should worry about inflation. But it is genuinely hard to pin down. It cannot be observed, only estimated with wide error bars, and it shifts over time, so a central bank that thinks the NAIRU is 5 percent when it is really 4 percent may keep policy too tight and waste jobs. After episodes where unemployment fell well below estimates with little inflation, many economists became more humble about exactly where the NAIRU sits — a reminder that it is a useful guide, not a precise dial.
A central bank believes the NAIRU is about 5 percent. As unemployment drops to 3.5 percent, employers start bidding up wages to fill vacancies, and inflation begins to accelerate — exactly what NAIRU theory predicts when unemployment falls below the threshold. The bank raises interest rates to cool things down.
Below the NAIRU, inflation tends to accelerate; above it, inflation tends to ease.
The NAIRU is an unobservable estimate that shifts over time; economists have repeatedly been surprised by how low unemployment can fall without inflation, so it should never be treated as a precise number.