Estimation of a time varying NAIRU for Iran and its Implications for Economic Policy

Among the several concepts encompassed by the idea of an equilibrium rate of unemployment the NAIRU appears as the more interesting one for a central bank since it focuses directly on inflation. The Phillips equation we consider is very close to the so-called "triangle model" suggested by Gordon, where inflation rate is determined by three factors: adaptive expectations and inertia, excess demand or shortage - estimated by the gap between the actual unemployment rate and the NAIRU - and supply shock variables. We regard the NAIRU as a time-varying parameter and estimate a state space model composed of a random walk process that describes its variations over time and of a Phillips equation and Okun's law. The estimation of the state-space model yields empirical results for Iran that shows average of NAIRU in the whole period is around 11.07 that is high in comparison with developed countries however the final state of NAIRU is 13.48. Such rate of NAIRU contains some important points for the policymakers in the case of inflation. In the other words implementing policies to reducing unemployment rate without increasing product capacities may lead to higher inflation so policymakers should focus more on enhancing labor and capital productivities and improvement of doing business indicators.