Non-Accelerating Inflation Rate of Unemployment

The Non-Accelerating Inflation Rate of Unemployment (or NAIRU) is a theoretical maximum level of activity (minimum level of unemployment) in the economy which is unlikely to cause inflation to accelerate. It is a critical input into monetary policy, particularly when the Reserve has a mandate to achieve full employment without exacerbating inflation. Due to business cycles the economy may at times operate with levels of unemployment either above or below the NAIRU. Measures of the NAIRU balance inflation and labour market conditions and attempt to control for changes in labour productivity.

There are a number of alternative macroeconomic measures of labour costs for businesses. The following compares the NAIRU implied by:

• Unit Labour Costs (ULC): measure compares labour compensation per unit of output to productivity. Because ULC growth reflects both wage changes and productivity shifts, it is conceptually close to the marginal cost variable in many Phillips curve frameworks, although it can be volatile and subject to revision.
• Wage Price Index (WPI): tracks the price of a fixed basket of jobs over time, holding job composition constant, and provides a clean measure of underlying wage trends, but it excludes bonuses and labour market compositional effects.
• Average Earnings: is a broad measure of labour compensation per hour worked, capturing actual labour costs paid by employers, but it is sensitive to compositional changes in the workforce.

Inflation observation equation incorporates measures of lagged inflation, future expectations and labour market conditions including unemployment, underemployment and productivity:

Labour cost observation equation is the same for each measure (ULC, WPI, and AE), substituting each for lc in the observation equation below:

NAIRU transition equation, driving both inflation and labour costs, is a simple AR(1) process:

The following illustrates the results of the dynamic linear model estimates for in comparison to the actual unemployment rate since 2000. In recent periods the NAIRU has declined since the COVID pandemic, with

Model performance summary

The following summarises the model's performance. The variables following as closely as possible those used in Cusbert 2017, although the shorter fitting period has necessitated a few changes. The impact of import price inflation and oil prices is less, these impacts were stronger historically due to the fixed exchange rates and the higher proportion of domestic economic activity leveraging imports (for example in manufacturing). Secondly labour market and social security changes have introduced a persistence of underemployment as a contribution to available labour hours.