A termination or reversal of this trend would tend to raise the NIRU, at least temporarily.” It is ironic that two of the most prominent economists of countries synonymous with art and beauty – Italy and Greece – (one a future Nobel prize winner and the other a future central bank governor) should have given birth to an unattractive acronym that has spawned so many even more unappealing cousins. The first, and most feted, offspring – the NAIRU – was introduced by James Tobin five years later. NIRU, NIIRU, NAIRU – tongue twisters for the Financial Times Christmas quiz, or measures of the Inflationary Trigger Point? Take your choice. For the sake of simplicity I shall adopt the conventional term, NAIRU, to represent the entire family. So what is the relationship between the natural rate of unemployment and the NAIRU? The natural rate of unemployment and the NAIRU are quite different concepts. The former describes a real equilibrium determined by the structural characteristics of the labour and product markets – the grinding out of Friedman’s Walrasian general equilibrium system (modified, if necessary, by non-Walrasian features of labour markets such as imperfect competition, search behaviour and efficiency wages). It exists independently of the inflation rate. In contrast, the latter, as well as being affected by these structural characteristics, is also affected by the gradual adjustment of the economy to past economic shocks that determine the path of inflation.
As a Committee, we discussed at some length during the spring of this year why the changes in the quantity measures had not fed through to higher earnings growth. We discussed whether the natural rate of unemployment (and the NAIRU) might have declined due to an increase in trend productivity or improvement in the functioning of the labour market. We also considered whether there had been independent influences on the NAIRU stemming from falls in inflation expectations or the effects of sterling’s appreciation. It is against this background that the MPC’s decision to raise rates in June should be seen. The increase in headline earnings growth to 4.9% in February, from an upwardly revised 4.6% the previous month, appeared consistent with other labour market indicators. But we were fully aware of the evidence suggesting that the rise in earnings growth had been, and for a couple of months would continue to be, affected by unusually large bonus payments. If this was true, earnings growth might well have fallen back once the bonus effect had dropped out. Given the uncertainties in this area, the Committee concluded that it should not place too much weight on the latest numbers. Instead, it stepped back and examined the underlying trend in the labour market over the previous two years. We noted that private sector earnings growth had been rising throughout this period and that reported wage settlements displayed a similar profile.