“Heigh-ho, Heigh-ho, it's off to work we go…” Or, at least, we need to. The more people in jobs, the better it is for the economy. Higher employment means greater spending, which spikes inflation and leads the RBA to raise interest rates. It’s an important relationship to understand before you can get your head around the NAIRU or ‘Non-Accelerating Inflation Rate of Unemployment.’ Long, boring name. Fabulous economic theory.

The NAIRU is the rate of unemployment that keeps inflation stable. The theory says that if an economy’s unemployment rate is at 5% and inflation is at 2% for an extended time, then its NAIRU is 5%. If unemployment rises, inflation will go down. If unemployment drops below the 5% NAIRU, the labour market tightens, workers demand higher wages and prices go up, according to the laws of supply and demand.

Australia’s unemployment rate is currently a quite low 5.5%. The RBA says our NAIRU is 5% and that’s why inflation isn’t moving. Once unemployment falls below the 5% NAIRU, wage and inflationary pressures should create interest rate rises. A lot of people expect to see the NAIRU drop below 5% within the next three or so years, so things should start moving then.

Or, so the theory goes.

Right now, the UK, Japan, USA and New Zealand have unemployment below their NAIRUs but their respective wage growth is barely responding. Some people believe that, because of this, Australia’s NAIRU could drop as low as 4.5% before we see any real change. Theories about why the NAIRU is not playing ball include the usual suspects like job stealing technology, globalisation and underemployment.

But don’t discount NAIRU as a concept, yet. Keep an eye on it.

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