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Why does a change in the Phillips Curve / NAIRU matter? It matters because of the possible consequences for the operation of government macroeconomic policy. Setting interest rates: Reducing NAIRU will have implications for the setting of short term interest rates by the Monetary Policy Committee. If the MPC believes the labour market can operate with a lower rate of unemployment without the economy risking a big rise in inflation, then the Bank of England may be prepared to run their monetary policy with a lower rate of interest for longer. This has knock-on effects for the growth of aggregate demand as lower interest rates work their way through the transmission mechanism. Forecasts for economic growth: The trade-off between unemployment and inflation affects forecasts for how fast the economy can comfortably grow over the medium term. This information is a vital for the government when it is deciding on its key fiscal policy decisions. For example how much they can afford to spend on the major public services education, health, transport and defence. Forecast growth affects their expected tax revenues which together with government spending plans then determine how much the government may have to borrow (the budget deficit). |