1) What is NAIRU?

 The non-accelerating inflation rate of unemployment (NAIRU) is the degree

of unemployment that occurs in an economy without causing inflation to rise.
To put it another way, if unemployment is at the NAIRU level, inflation will
remain constant. NAIRU is frequently used to indicate the status of the
economy and the labour market.
 It is the lowest amount of unemployment that may exist before inflation begins
to rise. Inflation is stable while unemployment is at the NAIRU level; when
unemployment rises, inflation falls; when unemployment falls, inflation rises.
 On the downside, NAIRU does not account for a range of factors other than
inflation that affect unemployment; also, the historical link between inflation
and unemployment might break down, making NAIRU less effective.

2) Using logical interpretation of data provided in the following articles, what do

you think is the correct estimate of NAIRU in US?

NAIRU is inferred from the present economy's unemployment rate and inflation rate
rather than being computed accurately using particular criteria. The NAIRU for the
United States is now expected to be in the range of 5% to 6%. The articles illustrate
that a fixed NAIRU that displays a decline in unemployment below the point where
inflation can arise is impossible. It is demonstrated in article number 1, where there
was previously a dispute regarding whether there had been an increase in structural
unemployment as a result of a mismatch between skill requirements and job
availability. The Congressional Budget Office estimated the NAIRU to be
approximately 5.5 percent at the time, and the Feds had a similar estimate. However,
at the time, the unemployment rate was 7.7%.

3) Of what role do the Phillips curve play in guiding the Fed to determine the
monetary policy?

In the short run, Philips curve describes the link between inflation and unemployment.
The government conducts monetary policy through increasing the money supply. As a
result, interest rates fall and investment rises. As output rises, enterprises will hire
more people, lowering unemployment. However, inflation will rise when income
rises, but because wages are sticky, this will not be reflected in the economy right
once. As a result, according to the Philips curve, the unemployment rate will fall as
inflation rises.

4) Please read the article “Unemployment looks like 2000 again. But wage growth
doesn’t”. by Enrie Tedesche.
It is commonly understood that as unemployment level falls, wage rate will rise across
all groups of employed people. Recent data in US shows that the level of unemployment
has fallen over the years, averaging about 4% over the past year. Moreover, job
opening are at record high, implying that demand for labour is high. As labour gets
scarce, it is expected that wages will increase. However, wage growth currently in US is
much slower than during corresponding situation earlier, 2.9% over the past year
compared to 4.2% in 2001.

a. According to the author what are the different reasons that may explain the slow
wage growth in US?
According to the author, there might be three possible explanations for the modest wage
growth rate in the United States.
 Slack in the labour market – There is more slack in the labour market. Slack is the
difference between the quantity of work that the economy might sustain and the
amount of work that is now available. The employment-to-population ratio is
substantially lower than it was in 2001, indicating that pay growth is closely linked.
 Inequality — Rising inequality and employees' weaker negotiating power (due to
declining unionisation) may have had an impact on pay growth rates.
 Declining Productivity - As the population becomes older, productivity may decline,
resulting in a slower pace of pay rise.

b. What is the relation between wage growth and productivity?

Weaker wage growth is frequently accompanied by a slowing of productivity increases.
Wage increases are proportionate to the increase in the value of the product. However,
productivity growth has been declining for some years. Even in high-skilled positions, where
productivity is expected, this is apparent. The modest wage increase may be linked to a
number of variables, but one that cannot be overlooked is the productivity aspect.
5) Consider the following extended classic economy (in which the misperceptions theory
holds):
AD, Y = 300+10(M/P)
SRAS, Y = Y-bar + P – Pe
Okun’s Law (Y – Y-bar)/Y-bar = -2(u – u-bar)
Full employment output Y-bar = 500
Natural employment rate u-bar = 0.06
a) Suppose that the money supply M = 1000 and that the expected price level Pe =
50. What are the short run equilibrium values of the output Y, the price level P
and the unemployment rate u? What are the long run equilibrium values of these
three variables?

In Keynesian equilibrium,

Aggregate Demand = Aggregate Supply

300 + 10 (1000/P) = 500 + P – 50
300 + 10000/P = 450 +P
 P2 + 150P -10000 = 0
P = 50

Y = 500 + 50 – 50
Y = 500

Okun’s Law, (500 – 500)/500 = -2(u – 0.06)

0 = -2u + 0.12
2u = 0.12
U = 0.06

For long run equilibrium, Y = Y

On solving for Y, u and p in long run equilibrium, we get

Y = 500
P = 50
U = 0.06

b) Now suppose that an unanticipated increase raises the nominal money supply to
M = 1260. What are the short-run equilibrium values of output Y, the price level
P, and the unemployment rate u? What are the new long-run equilibrium values
of these three variables? In general, are your results consistent with an
expectations-augmented Philips curve?

M = 1260
AD, Y = 300 + 10 (1260/P)
SRAS, Y = 500 + P – 50

On equating AD = AS
300 + 10 (1260/P) = 500 + P – 50
300 + 12600/P = 500 + P - 50
P = 60

Y = 500 + 60-50
Y = 510

Equating in Okum’s Law Equation, (510 – 500)/500 = -2(u – 0.06)

0.02 = -2u + 0.12
2u = 0.1
U = 0.05

In long run when, the Prices will be equal to expected price,

P = 60, Y = 510, u = 0.05

Yes, the results are consistent with an expectations-augmented Phillips curve.