Seen and Unseen: NAIRU, informal labor market and talking points for monetary policy

This paper examines how labor-market informality alters the estimation and policy interpretation of the Non-Accelerating Inflation Rate of Unemployment (NAIRU) in an emerging-market context. Using quarterly Peruvian data from 2007 to 2024, we estimate a time-varying parameter unobserved-components model with stochastic volatility following Chan, Koop, and Potter (2016). Bayesian MCMC techniques jointly recover trend inflation, the NAIRU, and the Phillips-curve slope under two alternative measures of slack: the standard unemployment rate and an extended measure incorporating informal workers. The conventional specification implies a rising NAIRU and persistent inflationary pressure. In contrast, the informality-adjusted NAIRU declines, and the Phillips-curve slope flattens, indicating that informal employment absorbs slack and dampens inflationary dynamics. These results suggest that ignoring informality overstates inflation risks and the power of monetary policy, with significant implications for inflation-targeting frameworks in economies with large informal sectors.