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When employment is higher than N" it is easy to find a job, turnover is high, and firms have the incentive to raise wages more than other firms. In the short run, nominal wages are rigid, but, over time, wage inflation will increase and employ- ment will fall. Conversely, if employment is below the natural rate, unemployment is high, wages tend to rise less quickly, and employment increases. Therefore, the only employment level which is consistent with constant wage increases is the natural level of employment N". Why do high wage increases lead to lower employment? We will study the mechanism in more detail when we come to the short-run analysis in Chapters 8-9 and 14. In an economy with a floating exchange rate, the basic mechanism is that higher wage increases lead to higher inflation, so the central bank of the country will raise the interest rate in order to counteract infla- tion. A high interest rate has a negative effect on consumption, investment, and aggregate demand and production, so firms hire fewer workers. In a country that is a member of a monetary union, high wage increases compared with wage increases abroad lead to loss of competitiveness and a reduc- tion in exports. Either way, high wage increases will have negative effects on employment. If employment is above the natural level, wages will increase until employment is brought back to the natural level and wage increases are stabilized at an appropriate level. But how is the real wage determined? To find the real wage, recall the price- setting equation that we derived in Chapter 2: W P= (1+/) MPL