NAIRU

NAIRU or "non-accelerating inflation rate of unemployment" in macroeconomics refers to the degree of unemployment in an economy at which the inflation doesn’t increase, i.e., it remains constant. The difference between the natural rate of unemployment and the NAIRU rate is termed the ‘unemployment rate gap.’

Unemployment (or employment) and inflation are two important macroeconomic parameters. When unemployment falls, inflation rises due to increased demand. Thus, NAIRU is significant in economics as it helps the government establish the equilibrium between employment and inflation. In the U.S., it is estimated at around 5-6%.

• NAIRU is the lowest unemployment rate attained by not making the wages grow and the inflation rise.
• It is similar to the natural unemployment rate in that they both measure the percentage of the unemployed population. Still, it is studied in correlation with inflation, whereas NRU has many other factors acting on it too. 
• The non-accelerating inflation rate of unemployment (NAIRU)was initially termed the non-inflationary rate of unemployment (NAIRU). Economists Franco Modigliani and Lucas Papademos introduced it in 1975.

NAIRU in macroeconomics was first introduced by Franco Modigliani and Lucas Papademos. But they called it NIRU, or the non-inflationary rate of unemployment. However, to expect a ‘non-inflationary’ situation would not be ideal, as inflation is mostly present. But it is possible to maintain it at a constant rate. Hence, ‘non-inflationary’ became ‘non-accelerating inflation.’

The concept is significant because if the NRU falls below it, then inflation will start rising. But how exactly does this happen? When unemployment falls, more people get to work for an income. Hence, consumer spending increases, and so does demand. This further pushes the price levels upward, contributing to rising inflation.

On the other hand, when unemployment rises, the contrary happens. Therefore, NAIRU is the breaking point to maintain the most desirable level of inflation and unemployment. So, it is obvious that zero unemployment or full employment will not be seen as favorable in such a case. Therefore, even the government will hope to maintain some residual unemployment.

So, how to calculate the NAIRU rate? Simple. It cannot be calculated. However, it can be determined when the inflation is constant. For example, if the inflation is at a constant 2% for a period, the corresponding unemployment rate is the lowest unemployment rate which doesn’t cause inflation to increase. The Fed maintains it at 5-6% in the U.S., whereas in Australia, it was below 5% before COVID-19.

Many factors influence the non-accelerating inflation rate of unemployment. Let’s take a brief look at them.

1. Training initiatives by the government – If the government starts training individuals to make them capable of landing jobs, then employment will increase.
2. Technological developments – It is increasingly becoming easier to find and get a job using the internet. Nevertheless, technological developments like automation and mechanization are threatening the livelihoods of the workforce and causing unemployment.
3. Underemployment – It refers to the underuse of a worker, leaving them with less work and fewer wages. If the firm strives to use the full potential of a worker, their wages will increase, causing inflation.
4. Labor scarcity – This implies a shortage of supply in the labor market, probably due to workers losing their skills over time after prolonged periods of unemployment. This will make NAIRU higher, but it will fall when firms start recruiting people with lower skills.

The non-accelerating inflation rate of unemployment can be represented graphically using the short-run Phillip’s curve. The unemployment rate is plotted against inflation along X and Y-axes, respectively.  

In the short run, the natural rate of unemployment (NRU) is equal to NAIRU at A. Hence, inflation is constant, as indicated by the straight line parallel to the Y-axis. If the unemployment rate falls to, say, B due to government intervention or some other economic factors, the inflation will rise to C. As seen from the graph, inflation at C is higher than at A. However, in the long-run, constant shifts in wage levels, aggregate demand, unemployment, and prices will make NAIRU equal to the unemployment rate.

Though both the non-accelerating inflation rate of unemployment and the natural rate of unemployment (NRU) focus on the labor market and the unemployed population, the former focuses more on the correlation between unemployment and inflation. NRU, on the other hand, considers the level of unemployment that occurs as a result of many economic factors. For example, unemployment can occur due to economic recession, decreased demand, technological developments, and even socio-political issues.

In the short run, there is mostly a difference between the two unemployment parameters. This difference between the NAIRU and the NRU is called the unemployment rate gap. Here’s a graphical representation to understand the concept better. 

A positive gap denotes the region where the NRU exceeds the NAIRU and the inflation is low. On the contrary, in the negative gap, the NAIRU exceeds the NRU, and the inflation is high.

This article has been a guide to NAIRU and its definition. We explain the factors influencing it, a graph, and compare it with the natural rate of unemployment. You can learn more about it from the following articles –

• Disguised Unemployment
• Unemployment Compensation
• Natural Unemployment