Non-accelerating Inflation Rate of Unemployment

 Nobel Prize winner Milton Friedman laid down the concept of vertical Phillips curve in long-run.  According to Milton in long-run Phillips is not downward sloping reflecting inverse/negative relationship between inflation and unemployment rather it is a vertical reflecting no trade-off between inflation and unemployment.

Thus, in the eyes of Milton downward sloping Phillips curve is a short-term phenomenon. Milton reconcile between the downward sloping and short-run Phillips curve as follows.

Natural rate of unemployment/NAIRU :

Milton states that in long-run there is a single rate of unemployment irrespective of rate of inflation. This rate of unemployment is termed by him as natural rate of unemployment.

This natural rate of unemployment is also known as non-accelerating inflation rate of unemployment (NAIRU) because in long-run, according to Milton, inflation rate does not affect or accelerate unemployment, i.e. for every level of inflation there is a constant unemployment

Derivation of Long-run Phillips Curve :

we have three short-run Phillips curve labelled as PC1, PC2, and PC3, showing negative relationship between inflation (i) and unemployment rate (u). Suppose natural rate of unemployment is u and at this level of unemployment the economy is producing potential output level. Further suppose that, in longrun an economy is in equilibrium at the point E as shown in the figure.

At E, inflation rate is i2, Now, if the government thinks that is very higher and decides to decrease the same, then any expansionary policy (rise in money supply or government expenditure or decrease in tax rate) will increase in inflation only because economy is producing its potential output.

Suppose, due to increase in inflation rate the economy moves from E to F along PC1. You can see that at F unemployment is u which is lower than . In this way, government’s expansionary policy caused to increase inflation but lower unemployment.

But why unemployment has decreased! This is because in increase in inflation causes real wages to fall and this boosts producers to demand more labour. However, as soon as this fact of decline in real wages is realised by workers, then they react over it and start to demand higher money wages or real wages causing cost of production to increase. 

Consequently, labour demand falls and unemployment increases again. So, then the economy would not be stable at point F and it will move towards point G on PC2, where the unemployment rate is again. One point should be noted that at G inflation rate has increased to i2a

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