The NAIRU and informality in the Mexican labor market

Summary

Focus

Reading the economic cycle is essential to implementing monetary policy. A key topic is whether employment is approaching its potential: the unemployment rate at which inflation remains constant in the absence of supply shocks (NAIRU). In Mexico and other Latin American countries, the sizeable number of informal workers makes it challenging to estimate the NAIRU. Since Mexico does not have unemployment insurance, workers who become unemployed immediately need to find a new job. The informal sector's flexibility allows it to absorb most of the people who cannot find a job in the formal labour market. As a result, the unemployment rate in Mexico is low and does not fully reflect labour market slack.

Contribution

We estimate the NAIRU for Mexico. As standard measures may not depict labour slack accurately, we also estimate the NAIRU with an alternative measure of "unemployment" that includes unemployed workers and informal wage earners as an indicator of labour underutilisation. This methodology could be a useful tool for monetary policy analysis in emerging economies with significant informal labour.

Findings

Our results suggest that the NAIRU and labour market slack follow similar patterns over time using either indicator of labour market underutilisation (the traditional one or the one which includes the informal sector). However, according to one model, the indicator that includes informal wage earners seems to predict inflationary pressures better when the unemployment gap is close to zero. Thus, it appears to anticipate the inflationary pressures observed in 2007–08 more clearly than the traditional slack indicator. In addition, both estimates show labour market slack decreasing throughout 2016 and approaching zero. The indicator that includes informality shows relatively more slack, consistent with the absence of significant wage pressures observed during this period.

Abstract

The non-accelerating inflation rate of unemployment (NAIRU) is not directly observable, and the presence of informal workers imposes an additional challenge in its estimation. In this paper, we present an estimation of the traditional NAIRU for Mexico and an alternative measure that includes informality as an indicator of labor underutilization. We find that both measures of NAIRU and the associated labor market slack indicators follow similar patterns over time. However, the slack estimated with the indicator that includes informality seems to predict inflationary pressures more accurately when the unemployment gap is close to zero.

JEL classification: E26, E32, E52.

Keywords: unemployment, informality, NAIRU, business cycle.