The non-accelerating inflation rate of unemployment (NAIRU) is one of the most important methods that Central Banks use to measure the current health of an economy. This theory suggests that there is a trade-off between unemployment and inflation. Specifically, when Unemployment is at the NAIRU level, inflation is steady; when unemployment rises, inflation decreases; and when unemployment drops, inflation increases.

How is the NAIRU Level Determined?

Unfortunately, there is no set formula that can be used to determine the NAIRU level. As such, economists and central banks have been forced to rely on intricate statistical models that are then used to put the NAIRU level somewhere between 5% and 6%.

What Benefits Does NAIRU Provide?

Knowing what the NAIRU level is can be beneficial for central banks as it provides useful context and insight into their inquiry into inflation and unemployment. This, in turn, allows them to tailor their policies to achieve their end goal of maximum employment and price stability.

What Are The Downsides?

Perhaps the biggest downside to the NAIRU is that it does not take into account the plethora of factors that can influence unemployment besides inflation. This means that the connection between inflation and unemployment may not hold true in certain situations. This can cause central banks to make the wrong assumptions, which could lead to costly mistakes.

Overall, the NAIRU is a valuable tool when assessing economic activity and setting appropriate policies. Knowing the current state of play with regards to the NAIRU level is crucial for central banks to ensure more accurate decision making.