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 natural rate of unemployment was introduced by Milton Friedman in 1968, in his article “The Role of Monetary Policy”, following his presidential address delivered at the annual meeting of the American Economic Association, in 1967. It is based in Knut Wicksell’ concept of “natural” rate, which defines how there will be no permanent changes in the considered variable below or above its natural level.
The natural rate of unemployment defines the level at which unemployment will remain, no matter how great the effects of monetary policy. The only way to permanently keep unemployment under its natural rate is to resort to higher and higher inflation rates, which in turn would be highly hazardous for the economy. This can be easily understood using an expectations-augmented Phillips curve.
Even though the natural rate of unemployment is usually merged in the economic literature with the term NAIRU, there are a few differences between both terms. 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||