Estimating the NAIRU for Israel, 1992–2011

17/04/2013 |  Elkayam David, Ilek Alex
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Monetary Policy and Inflation
We use a state space model to estimate the time-varying NAIRU for Israel for the period 1992–2011. We specify a forward looking Phillips curve, and use data on inflation expectations derived from the bond market in Israel ("breakeven inflation") as a proxy for inflation expectations. This enables us to avoid making an assumption regarding the formation of expectations, especially avoiding the usual practice of assuming adaptive expectations and using lags of inflation as proxies for inflation expectations. We find that the estimated NAIRU is fairly variable and explains a great deal of the low frequency dynamics of the actual unemployment rate. For example, from 2004 to 2011, actual unemployment declined by 6.5 percentage points. Our estimates suggest that 5.5 percentage points (most of the reduction) were due to a decline in the NAIRU. We also found that the estimated NAIRU fits very well in a Beveridge curve, and thus helps to identify the close relationship between job vacancies and unemployment.
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