They are the natural rate of unemployment and the rate of unemployment consistent with stable inflation, usually known as the NAIRU. The concept of the natural rate of unemployment introduced by Milton Friedman and Edmund Phelps 30 years ago is the level of unemployment that – as Friedman famously described – would be “ground out by the Walrasian system of general equilibrium equations” reflecting the structural characteristics of the labour and product markets. Friedman was the first to recognise that this natural rate of unemployment was neither constant over time nor immune to policy influences. The natural rate hypothesis implies a vertical long-run Phillips curve. In other words, if the monetary authorities attempted to “peg” the level of unemployment below the natural rate, then this in time would cause the inflation rate to rise indefinitely. The work of Friedman and Phelps soon proved highly relevant. The futility of using monetary policy to choose between different combinations of unemployment and inflation became only too apparent in the 1970s. Monetary shocks can – and in the early 1980s and 1990s did – cause unemployment to deviate from its natural rate, but only for a period. As inflation expectations catch up with the consequences of the monetary shock, unemployment returns to the natural rate. BIS Review 103/1998  –3–  But the responses of unemployment and inflation expectations to monetary shocks are far from immediate. Indeed, Friedman speculated that the full adjustment to an unexpected change in inflation might take up to “a couple of decades”.
1 Jaison Abel, Jason Bram, Gerard Dages, Richard Deitz, Suzanne Elio, Jack Gutt, and Andrew Haughwout  assisted in preparing these remarks. 2 See, for example, our Report on the Competitiveness of Puerto Rico’s Economy, June 2012, and An Update on  the Competitiveness of Puerto Rico’s Economy, July 2014. 3/3  BIS central bankers' speeches