SummaryThere is a relationship between inflation and unemployment that can be easily analysed. Governments around the world take this relationship very seriously, since there will always be a trade-off when implementing economic policies. Even though this relationship was first analysed by Alban William Housego Phillips in 1958, it has since evolved, taking into consideration adaptive and rational expectations.
- Phillips curve
The term NAIRU (non-accelerating inflation rate of unemployment) is a term first used by James Tobin in 1980, in his article “Stabilization Policy Ten Years After”. It refers to the level of unemployment at which the economy settles if monetary policy is held stable. In these terms, it can be associated to Friedman’s natural rate of unemployment.
The NAIRU is based on empirical evidence regarding inflation and unemployment. Indeed, in most countries, inflation rises when unemployment is low because of the higher demand this implies; correspondingly, inflation falls when unemployment is high. This relation explains how unemployment may be above or below the NAIRU level not only because of the effects of monetary policy, but also because other factors such as production costs or trade unions negotiation processes. The Layard-Nickell NAIRU model explains it quite simply.
Even though the term NAIRU is usually merged in the economic literature with the term natural rate of unemployment, there are a few differences between the two. These differences are summarized in the following grid:
|Natural rate of unemployment (NRU)||NAIRU|
|Theoretical starting point|
|Origins of deviation||
|Type of unemployment||
|Uniqueness of equilibrium||