NAIRU

The concept arose in the wake of the study of the Phillips curve which demonstrated an observed negative correlation between the rate of unemployment and the rate of inflation (measured as annual nominal wage growth of employees) for a number of industrialised countries with more or less mixed economies. This correlation persuaded some analysts that it was impossible for govenments simulaneously to target both arbitrarily low unemployment and price stability, and that, therefore, it was government's role to seek a trade off between unemployment and inflation which matched a local social consensus.

Critics of this analysis argued that the Phillips curve could not be a fundamental of economic equilibrium because it showed a correlation between a real economic variable and a nominal economic variable. Their counter analysis was that government macroeconomic policy (primarily monetary policy) was being driven by an unemployment target and that this caused expectations to shift so that steadily accelerating inflation rather than reduced unemployment was the result. The resulting prescription was that government economic policy (or at least monetary policy) should not be influenced by any level of unemployment below a critical level - the NAIRU.

The NAIRU theory mainly intended as an argument against active Keynsian demand management and in favor of free markets. There is for instance no theoretical basis for predicting the NAIRU. monetarists instead support the generalized assertion that the correct approach to unemployment is through microeconomic measures (to lower the NAIRU whatever its exact level), rather macroeconomic activity based on an estimate of the NAIRU in relation to the actual level of unemployment.