Estimation of NAIRU with Inflation Expectation Data

Abstract

Estimating natural rate of unemployment (NAIRU) is important for understanding the joint dynamics of unemployment, inflation, and inflation expectation. However, existing literature falls short of endogenizing inflation expectation together with NAIRU in a model consistent way. We estimate a structural model with forward and backward looking Phillips curve. Inflation expectation is treated as a function of state variables and we use survey data as its noisy observations. Surprisingly, we find that the estimated NAIRU tracks unemployment rate closely, except for the high inflation period (late 1970s). Compared to the estimation without using the survey data, the estimated Bayesian credible sets are narrower and our model leads to better inflation and unemployment forecasts. These results suggest that monetary policy was very effective and there was not much room for policy improvement.

Keywords: NAIRU; New Keynesian Phillips Curve; Infation Expectation

JEL Classification: C32; E31; E32