NAIRU

NAIRU stands for Non-Accelerating Inflation Rate of Unemployment. It is the unemployment rate at which inflation is stable — neither rising nor falling — because the labour market is in equilibrium. When unemployment falls below NAIRU, the labour market is "overheated": workers have bargaining power, wages rise above productivity, and firms pass costs on through price increases, causing demand-pull inflation to accelerate. When unemployment is above NAIRU, the market has slack, wage growth is subdued, and inflation decelerates.

The concept is the foundation of the Phillips Curve — the empirical relationship between unemployment and inflation. Central banks use NAIRU estimates to judge whether their policy stance is appropriate: if unemployment is 0.5 pp below NAIRU, they know inflationary pressure is building. The Federal Reserve's longer-run unemployment projection in the SEP is effectively their published NAIRU estimate — currently around 4.0–4.2%.

The fundamental problem with NAIRU is that it cannot be directly measured. It must be estimated using economic models, and estimates vary significantly. In the 1990s, most Fed economists estimated the US NAIRU at around 5.5–6.0%. As unemployment fell below 5% without triggering inflation, the estimate was revised down. By the late 2010s, unemployment reached 3.5% with minimal inflation, suggesting NAIRU had fallen further still — perhaps to 3.5–4.0%.

This uncertainty has policy consequences. If the Fed overestimates NAIRU, it will tighten policy prematurely (believing the labour market is overheated when it isn't), causing unnecessary unemployment. If it underestimates NAIRU, it will allow genuine overheating. The Bank of England explicitly warns in its Monetary Policy Reports that NAIRU estimates carry "substantial uncertainty". The Congressional Budget Office estimates NAIRU annually alongside potential GDP.

One of the major macroeconomic developments of the 2010s was the apparent "flattening" of the Phillips Curve: the relationship between unemployment and inflation became weaker. Even as unemployment fell well below estimated NAIRU, inflation barely responded. Explanations include: globalisation (import competition limiting domestic pricing power), better-anchored inflation expectations (reducing second-round effects), technological deflation (e-commerce and digital goods driving persistent goods price decline), and structural labour market changes (gig economy reducing bargaining power).

The 2021–23 episode challenged the flattening hypothesis: inflation surged dramatically even as unemployment was at historic lows, suggesting the Phillips Curve had steepened again — perhaps because the supply-shock component of that inflation overwhelmed the normal demand channel. The output gap and NAIRU interact to determine inflationary pressure: both matter simultaneously.