Macroeconomics :: Economy Economics Essays

Macroeconomics â€Å"How might a country go about lowering its NAIRU? What are the welfare implications of so doing?† In tackling this question, we will adopt a theoretical approach in the sense that we will focus on an economy and explain the determinants of NAIRU as well as the policy options. But it seems logical to first introduce the concept of NAIRU, or the non-accelerating inflation rate of unemployment, which will be interchangeably used with the â€Å"equilibrium rate of unemployment†. According to Carlin and Soskice , the central concept of equilibrium unemployment can be defined as â€Å"the rate of unemployment at which the expected real wage that results from wage-setting decisions is equal to the real wage implied by price-setting decisions†. Stiglitz argues that the NAIRU is used as a theory to understand the causes of inflation (predicting the changes in inflation rates) and is important because it enlightens the relation between unemployment and increasing inflation. The NAIRU corresponds to the rate of unemployment which is consistent with an unchanging inflation rate, and further reflects how the economy behaves out of equilibrium. Unless employment is at equilibrium level, inflation will increase or decrease until it reaches the NAIRU, the level of output and employment at which inflation is constant. In fact, Stiglitz explains that when unemployment is below the NAIRU, real wages demands are greater than the amount firms are willing to pay. At equilibrium, the behavior of wage-setters is compatible with that of the price-setters. His point is indeed that â€Å"if NAIRU exists, it must be changing over time† . What is more, Stiglitz identifies four phenomena that can change the NAIRU, namely changing demogra phics of the labor force, the productivity growth becoming more in line with worker expectations, an increase in the competitiveness of the labor and product market (through greater openness and trade), and finally hysterisis, which says that a higher NAIRU will generate an even higher one. He also discards the theory according to which productivity rate affects the equilibrium rate: productivity only has a temporary influence through the â€Å"wage-aspiration† effect. According to Altig and Gomme , the NAIRU is thought to represent a â€Å"speed limit† for economic activity: â€Å"it measures a nation’s sustainable production capability†. If the economy grows faster than its resources can support over the long-run, that is when the unemployment rate falls below the NAIRU, then price pressure builds and inflation rate accelerates.