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. expectations, especially avoiding the usual pracice of assuming adaptive expectations and using lags of inflation as proxies for inflation expectations. We find that the estimated NAIRU is fairly vaiable and explains a great deal of the low frequency dynamics of the actual unemployment rate. For example, form 2004 to 2011, actual unemployment dexlined by 6.5 percentage points. Our estimates suggest thet 5/5 perecntage points (most of the reduction) were due to a decline in the NAIRU. We also found that estimated NAIRU fits very well in a Beveridge curve, and thus helps to identify the close relationship btween job evcancies and unemployment.

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