Thus, monetary authorities should simply focus on price stability by targeting the rate of unemployment at which inflation does not increase, referred to as the ‘non-accelerating inflation rate of unemployment’ (NAIRU). But the NAIRU is not immutable. The correct implication, which Phelps repeatedly emphasized, is that governments can implement a variety of policies, particularly structural, to allow the economy to operate at a lower levels of unemployment. As a practical matter, even controlling for expectations (as Phelps’ work insists that we do), the relationship between unemployment and inflation is highly unstable. Changes in education levels, unionization, and productivity are part of the explanation for this instability. But, whatever the reason, policymakers face considerable uncertainty about the level of NAIRU. Thus, they still face a trade-off between pushing unemployment too low, and setting off an episode of inflation, and not pushing hard enough, resulting in an unnecessary waste of economic resources. Inflation “hawks” argue that inflation must be attacked preemptively. While most central banks are inflation hawks, this stance is a matter of religion, not economic science.
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Source : IIPM Editorial, 2006
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