The NAIRU
Exam note: Be prepared to use the Phillips Curve diagrams to show the NAIRU
•
NAIRU is an acronym for Non-Accelerating Inflation Rate of Unemployment.
•
It is the rate of unemployment at which inflationary pressures are stable
•
It is incorrect to say that the NAIRU is the rate of unemployment when inflation is zero
•
Linked to but not necessarily the same as the natural rate of unemployment
•
If U* is the NAIRU and U is the actual unemployment rate, the theory says that
•
If U < U* for a few years, inflationary expectations rise, so that the inflation rate tends to accelerate;
•
If U > U* for a few years, inflationary expectations fall, so that the inflation rate tends to slow
•
If U = U*, the inflation rate tends to stay the same, unless there is an exogenous shock to the economy
NAIRU for the UK Economy
Percentage of the labour force, source: OECD World Economic Outlook
PERCENT
10.0
10.0
UK NAIRU
9.0
9.0
8.0
8.0
7.0
7.0
6.0
6.0
5.0
5.0
4.0
4.0
12
12
11
Percent
10
11
Unemployment Rate (%)
10
9
9
8
8
7
6
7
6
Average Earnings
5
5
4
4
3
3
2
2
Wage bargaining is crucial to
understanding the NAIRU
The NAIRU assumes that there is
imperfect competition in the labour
market
• Some workers have collective
bargaining power
• Employers have some
monopsony power when they
purchase labour
• Equilibrium level of
unemployment is the outcome
of the bargaining process
between firms and workers
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Source: Reuters EcoWin
What causes changes in the NAIRU?
1. Changes in the collective bargaining power of trade unions
2. Changes in the occupational and geographical mobility of labour
3. Skills of the workforce (i.e. human capital)
4. Participation rates of different groups in the labour market e.g. women’s participation boosted by the
increased availability of child care and effects of tax credits
5. Effects of net inward migration in boosting the labour supply and reducing labour shortages
6. The estimated NAIRU has fallen for the UK from around 8% of the labour force in the late 1980s to 5%
now. Unemployment has fallen without there being a significant acceleration in inflation
Why has the NAIRU declined in the UK?
1. Less trade unionism: Fewer than 30 per cent of people in work in the UK are now members of a trade
union. Their wage bargaining power has been reduced.
2. Fall in long term unemployment which suggests that structural unemployment is now less of a problem
3. Increasing labour supply
4. Product markets are more contestable because of the effects of globalisation and deregulation of markets
5. Fall in inflation expectations - helps to control wage inflation
Caution required on whether the NAIRU will stay low … inflation expectations are rising and the strong net
inward migration of recent years seems to be coming to an end. Also, are trade unions becoming more militant?