Where Is the NAIRU? And What Does It Mean for the RBA?

Introduction

The NAIRU – the non-accelerating inflation rate of unemployment – is back at the centre of the Australian monetary policy debate. With the RBA hiking in February and the next meeting in mid-March, the question isn't really about the direction of policy anymore. It's about pace. Should the RBA hike again in March, or wait for the Q1 quarterly data and (depending on that data) act in May?

The answer depends almost entirely on where you think the NAIRU sits.

A Wide Range of Views

Over the past six months, a remarkably diverse set of opinions has emerged on Australia's NAIRU.

At the higher end, the RBA's own models have been producing averages around 4.7–4.8% (as seen in FOI releases), and trending upward. The RBA's published staff assumption sits at 4.5%, though this involves applying downward judgement to models that are pointing higher. 

Zac Gross, writing in the Australian Economic Review in September 2025, ran three different NAIRU models and found they all point to a NAIRU at or above the RBA's published estimate of 4.5% – with his own preferred specification closer to 5%. His key message to the lower-NAIRU camp: "it takes a model to beat a model." Chris Joye's team at Coolabah see the NAIRU in the very high 4s.

At the lower end, commentators have argued for the low to mid 4s. Treasury estimates around 4.25%. Early last year I saw sub-4 estimates, but I have not seen that more recently.

Easy to Build a Model for Either View

The NAIRU is notoriously difficult to pin down. It is unobservable, model-dependent, and subject to wide confidence intervals – Staiger, Stock and Watson's classic finding that the 95% interval spans several percentage points still holds. The NAIRU is not really a labour market statistic. It is a summary statistic of an inflation model. Change the model, change the NAIRU.

I maintain two joint NAIRU–output gap models for Australia. The simpler model uses a Gaussian random walk for the NAIRU, single-slope Phillips curves for prices and wages, and an IS curve — but no open economy block. The more complex model adds a Student-T random walk, regime-switching Phillips curves, an exchange rate equation, import price pass-through, a net exports equation, and an endogenous participation rate response. 

The simple model currently estimates the NAIRU at 4.88%. The complex model puts it at 4.50%. Both are above the current unemployment rate of around 4.2% (for Q3-2025).

The gap between them illustrates a basic modelling truth: the more channels you give the model to explain inflation through non-labour-market factors – exchange rates, import prices, supply shocks – the less work the unemployment gap has to do, and the lower the implied NAIRU. Neither model is wrong. They just allocate the inflation story differently. Both models have reasonably wide confidence intervals.

This is the simple model.

And this is the more complex model.

Why It Matters: 30 Basis Points vs 70 Basis Points

This isn't an academic exercise. The distance between the unemployment rate and the NAIRU determines how urgently the RBA needs to act.

If the NAIRU is 4.5%, the labour market is about 30 basis points too tight. That's a modest gap. The inflationary pressure is real but slow-burning. There is time to wait for more data before moving again.

If the NAIRU is closer to 4.9%, the gap is around 70 basis points. That's a substantially overheated labour market where every quarter of delay compounds the problem. In that world, waiting for the May meeting is costly, and March is the more appropriate time to act.

What Is the Inflation Data Telling Us?

Since mid-2025, inflation has clearly bounced. Trimmed mean has moved back above the RBA's 2–3% target band. The Q4 2025 CPI came in at 3.6% headline, and the December monthly reading was 3.8%.

But – and this is important – the monthly inflation data does not look like it is accelerating. Both the monthly trimmed mean and weighted median have flattened since around mid-2025, sitting stubbornly above the target band but not rising further. The January monthly data, while noisy, is consistent with this picture of sticky-above-target inflation rather than renewed momentum.

This matters because a 70 basis point unemployment gap with a functioning Phillips curve should be generating visibly accelerating inflation. The fact that inflation looks more sticky-above-target than explosively rising is more consistent with the smaller gap story.

My Read

The balance of model evidence places the NAIRU between 4½ and 5 per cent – which is broadly where the centre of gravity among serious model-based estimates sits. The range of views maps neatly onto the range of model specifications, and reasonable people can disagree about which channels matter most.

But the inflation data, as it currently stands, favours the lower end of this range. Inflation is uncomfortably above target, but it is not accelerating in the way you would expect if the labour market were 70 basis points beyond full employment.

That points to a gap closer to 30 basis points than 70. And a 30 basis point gap, while it warrants the hawkish tilt the RBA has adopted, does not demand the urgency of consecutive meetings. The RBA should wait for the Q1 quarterly data, assess whether the picture is confirming or deteriorating, and act in May – which on current data looks more likely than not.

There is a risk I'm wrong. If the NAIRU really is closer to 5%, then waiting costs real credibility and makes the eventual tightening larger. But the inflation data is the best real-time indicator we have of how hard the Phillips curve is working, and right now it is telling a story of pressure, not crisis.