how nairu came about
in 1958 new zealand born economist william phillips wrote a paper titled the relation between unemployment and the rate of money wage rates in the united kingdom in his paper phillips described the supposed inverse relationship between unemployment levels and the rate of inflation this relationship was referred to as the phillips curve 6 however during the severe recession of 1974 to 1975 inflation and unemployment rates both reached historic levels and people began to doubt the theoretical basis of the phillips curve 78milton friedman and other critics argued that government macroeconomic policies were being driven by a low unemployment target which caused the expectations of inflation to change this led to accelerated inflation rather than reduced unemployment it was then agreed that government economic policies should not be influenced by unemployment levels below a critical level also known as the natural rate of unemployment 9nairu was first introduced in 1975 as the noninflationary rate of unemployment niru by franco modigliani and lucas papademos 10 it was an improvement on milton friedman s concept of the natural rate of unemployment 11the correlation between unemployment and inflationsuppose that the unemployment rate is at 5 and the inflation rate is 2 assuming that both of these values remain the same for a period it can then be said that when unemployment is under 5 it is natural for an inflation rate of over 2 to correspond with it critics cite that it is unlikely for a static rate of unemployment to last for long periods of time because of different levels of factors affecting the workforce and employers such as natural disasters and political instability that can quickly shift this equilibrium the theory states that if the actual unemployment rate is less than the nairu level for a few years inflationary expectations rise so the inflation rate tends to increase if the actual unemployment rate is higher than the nairu level inflationary expectations fall so the inflation rate decreases if both the unemployment rate and the nairu level are equal the inflation rate remains constant nairu vs natural unemploymentnatural unemployment or the natural rate of unemployment is the minimum unemployment rate resulting from real or voluntary economic forces natural unemployment reflects the number of people who are unemployed due to the structure of the labor force such as those replaced by technology or those who lack specific skills to gain employment the term full employment is a misnomer since there are always workers looking for employment including college graduates or those displaced by technological advances in other words there is always some movement of labor throughout the economy the movement of labor in and out of employment whether it s voluntary or not represents natural unemployment nairu has to do with the relationship between unemployment and inflation or rising prices nairu is the specific level of unemployment whereby the economy does not cause inflation to increase limitations of using nairunairu is a study of the historical relationship between unemployment and inflation and represents the specific level of unemployment before prices tend to rise or fall however in the real world the historical correlation between inflation and unemployment can break down also many factors impact unemployment besides inflation for example workers who lack the skills needed to get a job would likely face unemployment while the workers who have the skills are likely to be employed one of the challenges lies in estimating the nairu level for different groups of workers who have different skill sets 