Is the NAIRU more useful in forecasting inflation than the natural rate of unemployment?

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Abstract:

Recent studies have indicated that the terms ‘NAIRU' (non-accelerating inflation rate of unemployment) and ‘natural rate of unemployment' are not interchangeable. While NAIRU is an empirical macroeconomic relationship estimated via a Phillips curve, the natural rate is an equilibrium condition in the labour market, reflecting the market's microeconomic features. This study evaluates comparatively the inflation-forecasting power of alternative time-varying estimates of the natural rate of unemployment relative to the NAIRU. The natural rate of unemployment in the USA since the Second World War is estimated. Three alternative methods are utilized: the Kalman filter, a structural determinants approach, and the Hodrick-Prescott filter. The section that follows assesses how each estimator of the natural rate compares with the others – as well as with the NAIRU derived from a Phillips curve – in forecasting inflationary changes in the USA in the second half of the twentieth century. The analysis reveals that the overall inflation-forecasting utility of the natural rate of unemployment relative to the NAIRU is not very different. Moreover, the conclusion appears to be quite robust to various estimators of the natural rate.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840600701061

Affiliations: Hope College, 41 Graves Place, P.O. Box 9000, Holland, MI 49422-9000, USA

Publication date: October 10, 2006

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