The NAIRU (non-accelerating inflation rate of unemployment)
Expert reviewed • 14 August 2024 • 7 minute read
The Non-Accelerating Inflation Rate of Unemployment (NAIRU) is a key economic concept that refers to the level of unemployment at which inflation remains stable. It represents the equilibrium between the labour market and price stability. When the actual unemployment rate is below the NAIRU, inflation tends to rise; conversely, when it is above the NAIRU, inflation tends to fall.
What is the NAIRU?
The NAIRU is based on the relationship between unemployment and inflation. It is often illustrated by the Phillips Curve. The concept assumes that there is a specific rate of unemployment that is consistent with a stable rate of inflation. If unemployment falls below this rate, the labour market tightens, leading to wage increases and, subsequently, higher inflation. If unemployment is above this rate, there is slack in the labour market, leading to lower wage growth and lower inflation.
In 2019, the RBA stated that the Australian NAIRU should sit at around 4.5% in a stable economy. However, in 2021, the RBA governor at the time, Philip Lowe, noted that "it is certainly possible that Australia can achieve and sustain an unemployment rate in the low 4s."
The Manipulation of the NAIRU in Australia
The Reserve Bank of Australia (RBA) and other economic institutions regularly estimate NAIRU for policy purposes. In Australia, the NAIRU has followed the following trends:
- Historical Estimates: In the 1990s, NAIRU in Australia was estimated to be around 7-8%. However, it has generally trended downwards since then.
- Recent Estimates: As of 2021, the RBA estimated Australia's NAIRU to be around 4.5%, although with a wide range of uncertainty (roughly between 3.5% and 5.5%).
- Declining Trend: The downward trend in NAIRU estimates reflects structural changes in the Australian economy, including labour market reforms and increased labour market flexibility.
- Policy Implications: The RBA uses NAIRU estimates to guide monetary policy decisions. When unemployment falls below the estimated NAIRU, it may indicate inflationary pressures, potentially prompting tighter monetary policy.
Furthermore, Australia has failed to maintain unemployment at the NAIRU, due to various external factors, such as the COVID-19 pandemic. The graph below demonstrates this.
As seen in the graph, in the last decade, Australia's unemployment rate has consistently sat above the NAIRU. This was the trend until the COVID-19 pandemic, where we see Australia's unemployment rate drop below the NAIRU. These irregular changes have made it hard for Australian policy decision makers to implement policies, and thus stabilise unemployment.
Criticisms and Limitations of NAIRU
While NAIRU is a useful concept in macroeconomics, it has several limitations and criticisms:
- Measurement Uncertainty: The NAIRU cannot be directly observed and estimates can vary widely.
- Instability: The NAIRU can change over time, making it difficult to use as a policy target.
- Policy Lag: By the time policymakers identify a deviation from NAIRU, economic conditions may have already changed.
- Alternative Factors: Some economists argue that factors other than labour market tightness (e.g., global economic conditions, expectations) may have more significant impacts on inflation.