Question

1.) NAIRU is the rate of unemployment consistent with a stable rate of inflation, and it is conceptually derived from the Friedman-Phelps Phillips Curve relationship, which shows the relation between inflation and unemployment.  Underlying the Phillips Curve relation is the wage-bargaining process. Friedman-Phelps argued that workers start their bargaining position by attempting to get an increase in wages equivalent to expected inflation over the next year (a cost of living adjustment), then additional wage gains are based on how high or low the current rate of unemployment is.

The FED uses NAIRU as its guide for when to raise its target interest rate; however, NAIRU continues to change, specifically the FED's estimate of NAIRU has continued to decline. Since NAIRU is derived from the Phillips Curve relation as described above, explain why NAIRU has declined over time.

2.)   Milton Friedman, the father of Monetarism, stated that inflation is everywhere a monetary phenomenon, and suggested central banks caused inflation by printing too much money relative to the supply of goods.  Based on what you've learned about how money is created, critically assess this view that an increase in the money supply by the central bank is the cause of inflation?

Answer 1

1. NAIRU is an acronym for Non accelerating Inflation Rate of Unemployment. It refers to a level of unemployment below which the inflation is expected to rise. In US, it ranges between 5% and 6 % generally. The concept of NAIRU originated from the analysis of the Philips curve which initially explained the inverse relation between unemployment and inflation levels. Since the Philips curve had no well established theoretical base, a natural rate hypothesis was put forward by Friedman which stated that any given labor market structure involves a certain amount of unemployment. It also stated that unemployment below the natural rate could be achieved only with the help of increasing inflation.

                                  The fall of NAIRU in the recent times has been attributed to the following factors

· Global competition practices.

· Immigration policies and practices across the globe.

· Rising factors that have been weakening the bargaining positions of laborers.

· Rapidly declining prices in the electronic market.

· Sharp decline in the health costs over time.

· Improvements in the Consumer Price Index with decline in traditional supply shocks.

· Increased use of flexible temporary employment.

· Step-up in productivity growth without increase of wages.

· The shifting demographics of labor force in the market

                                              All the above factors have been instrumental in the falling NAIRU levels over the recent times.