Supply Constraints on Employment and Output: NAIRU versus Natural Rate

NAIRU and NATURAL RATE are not synonymous. NAIRU is a macro outcome of an economy with many labor markets in diverse states of excess demand and excess supply. NAIRU represents an overall balance between the inflation-increasing pressures from excess-demand markets and the inflation-decreasing pressures from excess-supply markets. The natural rate, as described by Friedman, is a feature of walrasian market-clearing general equilibrium. While the NAIRU fits into a Keynesian model, the natural rate is an aspect of a New Classical model. The determinants of the two are theoretically different, and so are their implications for policy. The NAIRU varies from time to time as the relationships between unemployment, vacancies, and wage changes vary, and as the dispersion of excess demands and supplies across markets changes. In this decade, these developments appear to be reducing the NAIRU, in contrast to the unfavorable circumstances of the 1970s.