The document discusses the concept of the Non-Accelerating Inflation Rate of Unemployment (Nairu). The Nairu represents the lowest level of unemployment an economy can sustain before wages and prices begin to rapidly increase. It captures both parts of the Federal Reserve's dual mandate to achieve maximum employment and price stability. However, estimating the precise Nairu is difficult because the relationship between unemployment and inflation has changed over time and the Phillips Curve is no longer stable. Nonetheless, the Federal Reserve monitors unemployment relative to estimates of the Nairu when making decisions around interest rates and monetary policy.

1. An Explainer Post from
Ed Dolan’s Econ Blog
What is the Nairu
and Why does it Matter?
Posted December 18, 2016
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2. The Wonkiest Number in Economics
 Nairu (or NAIRU) stands for Non-
Accelerating-Inflation Rate of
Unemployment
 As unemployment falls, tightening
labor and product markets put
upward pressure on wages and
prices
 The Nairu is supposed to capture
the sweet spot—the lowest level to
which the unemployment rate can
safely fall before inflation starts to
accelerate
December 18, 2016 Ed Dolan’s Econ Blog
In the 1960s, Milton Friedman
introduced the term natural rate of
unemployment. Today, many
economists treat Friedman’s “natural
rate” as a synonym for Nairu

3. The Nairu and the Fed’s Dual Mandate
 Under its so-called dual mandate,
the Fed is supposed to aim for
maximum employment and stable
prices.
 The Nairu captures both parts of
the dual mandate, being the
maximum employment that is
consistent with inflation that does
not accelerate from month to
month.
December 18, 2016 Ed Dolan’s Econ Blog
Federal Reserve Headquarters
Washington, DC

4. The Nairu and the Fed’s Dual Mandate
 To put the dual mandate to work,
economists at the Fed must attach
numbers to both of its parts
 The Fed has set its inflation target at
2 percent annually, measured by the
personal consumption expenditure
(PCE) index
 The unemployment target—the
Nairu—is harder to pin down exactly
December 18, 2016 Ed Dolan’s Econ Blog

5. The Phillips Curve (1960s)
 Back in the 1960s things
seemed easier
 At that time, the pattern of
inflation and unemployment fit
closely around a negatively
sloped line called a Phillips
curve
December 18, 2016 Ed Dolan’s Econ Blog

6. Using the Phillips Curve to Find the Nairu
 Given a Phillips curve and an
inflation target, it would be easy
to find the Nairu
 Just look for the intersection
December 18, 2016 Ed Dolan’s Econ Blog

7. The Disappearing Phillips Curve
 Unfortunately, the Phillips curve did
not turn out to be stable
 In the 1970s, the Phillips curve
shifted higher
 During more recent economic
expansions it is hard to see any
pattern resembling a negatively
sloped Phillips curve
December 18, 2016 Ed Dolan’s Econ Blog

8. The Nairu Since 1950
 With no stable Phillips curve to
go by, economists use other
statistical methods
 This chart shows estimates by
the Congressional Budget
Office of the Nairu (or natural
rate of unemployment, as the
CBO still prefers to call it)
December 18, 2016 Ed Dolan’s Econ Blog

9. Natural vs. Actual Unemployment Rates
 This chart compares the CBO
estimates of the natural rate of
unemployment (Nairu) with the
actual rate
 The actual rate rises above
the natural rate during
recessions and falls below it
during expansions
December 18, 2016 Ed Dolan’s Econ Blog

10. A Case in Point: December 2016 Fed Action
 In November 2016, the
unemployment rate fell below
the Nairu (4.8 percent) for the
first time in eight years
 The inflation rate was
increasing, but not yet at the
Fed’s 2 percent target
 The combination was enough
to trigger an interest rate
increase by the Fed—only the
second since the Great
Recession started
December 18, 2016 Ed Dolan’s Econ Blog

11. Summary: Why the Nairu Matters
 The Nairu is an estimate of the
unemployment rate below
which inflation begins to
accelerate
 It is difficult to measure exactly
and varies from year to year
 Despite problems of
measurement, the relationship
of actual unemployment to the
Nairu strongly influences
monetary policy
December 18, 2016 Ed Dolan’s Econ Blog

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