More on Unemployment

Since I posted something on the equilibrium unemployment rate or NAIRU (the minimum unemployment rate consistent with low and stable inflation), it has become a really hot political topic in Canberra.

I also participated in the subsequent debate on the topic in various blogs. Let me summarize my views – under three propositions.

  1. The problem we are all concerned about how to reconcile the current low unemployment rate with low inflation – is not one which requires immediate drastic macro-economic policy action. This argument is in two parts.The difficulties in measuring the underlying inflation rate and the benign behaviour of wages all suggest that our current inflation is not a really fundamental problem driven principally by domestic excess demand. The recent acceleration in underlying inflation is in good part the INDIRECT result of higher energy and food prices. While the RBA measure discounts for these volatile items it does not exclude the indirect effects. So it could be that we have a world-wide cost-push inflation scenario rather than a domestic demand-pull scenario. And wages are behaving well so far. While inflation expectations are rising, the mechanism by which this will affect wages in a low-unionized and decentralized wage bargaining system is far from clear.In any case, I argued that the world economic slow down, fragile credit markets and the lagged impact of past interest rate increases would all slow domestic demand anyway and there is a danger of over-reaction by the RBA.
  2. Contrary to the above, the RBA and Treasury seem to fervently believe that the current unemployment rate is unsustainable (well below the NAIRU) and that there are no convincing signs of a self-correcting economic slow down in Australia.So we must expect harsh monetary and fiscal action in the months ahead. I hope however that the Treasury will also explore some action to achieve a better unemployment/inflation balance. We all know how to reduce the NAIRU in the longer term but what can be done in the short term?. John Quiggin suggests a wage subsidy. I aslo feel that Ian Harper should ease the threat of wage inflation by awarding a very moderate minimum wage increase and he should get the Governments support.
  3. If harsh fiscal action is needed, it is important that it be sensitive to the regional imbalance in employment opportunities.

Against this background, I was prompted to write a letter to the AFR (published today).

Malcolm Turnbull might be viewed by some as a smartie or a master of pop quizzes but his economic advisers are feeding him very clever questions which defy most economists.

The first relates to the equilibrium unemployment rate consistent with low and stable inflation (the so-called NAIRU) which appears to be above the current rate of 4.1% (which could well prove a mirage). Most economists can think of ways of improving the inflation/unemployment balance in the long term (such as through reforms of the labour market, education, training and improved infrastructure) but few can think of anything that can work quickly. Perhaps Turnbulls question will force the Treasury to think more about the latter. And thats all to the good.

The second issue raised by Turnbull was even more challenging how to address the geographic and regional imbalances in employment opportunities and the insensitivity of monetary policy to such imbalances. Again, this is a good question which Treasury should ponder about when it advises Swan on the structure of fiscal spending.

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Greg
13 years ago

Harsh? How about a price freeze? Maybe not.

derrida derider
derrida derider
13 years ago

Fred, I think you’re spot on about the causes of inflationary pressures being badly misdiagnosed by Treasury and the RBA. I dread that we might see another example of faulty economic theory leading to faulty policy, with very sad real-world results.

If generals always prepare for the last war, so do economists. The obsession with potential wage cost pressures (which is what a NAIRU-based approach implies)is quite misplaced in present circumstances.

conrad
conrad
13 years ago

“While inflation expectations are rising, the mechanism by which this will affect wages in a low-unionized and decentralized wage bargaining system is far from clear”

I would have thought that a lot of people lucky enough to be working in areas where there are not enough people being trained would be looking for a decent rise and probably getting it (unionized or not). I imagine this would have long ago caused a fair bit of wage inflation had we not also had record levels of skilled immigration at the same time. Of course, the downside of having record levels of immigration (especially of rich people) and moderate birth rates is that inflation is simply going pop up in other places like the housing market, which is currently going through the roof (both for sales and rentals), despite dropping in many other countries.

Jc
Jc
13 years ago

The second issue raised by Turnbull was even more challenging how to address the geographic and regional imbalances in employment opportunities and the insensitivity of monetary policy to such imbalances. Again, this is a good question which Treasury should ponder about when it advises Swan on the structure of fiscal spending.

We live interesting times. It’s going to be very interesting to see what gillard comes up with that allows for regional wage differentiation when the state apparatus that used to do that has been basically knocked out of the ballpark by the previous government. I can’t see how they can possibly manage this under a federalized award system and not allow the market to sort it out without truly screwing it all up.

Fred, monetary policy can’t be used to figure this stuff out. It’s not that it’s insensitive, it the wrong instrument. It would be like a surgeon using orthopedic tools to remove a gallbladder with a surgical saw and drill. Blood would be splattering everyhwhere.

sdfc
sdfc
13 years ago

Higher inflation begets higher inflation. Higher inflation is here and needs to be dealth with now. Any cash rate increases can just as easily be reversed. When circumstances change policy will change.

Right now however monetary policy is loose and needs to be tightened. Just take a look at M3 growth.

As for workchoices, the only thing I see it doing was to place the brunt of wage restraint on the most vulnerable members of society. I noticed on the telly the other night that Tony Abbott wasn’t too pleased about being asked to bear the same burden.

Jc
Jc
13 years ago

the only thing I see it doing was to place the brunt of wage restraint on the most vulnerable members of society.

How so, as new jobs went gangbusters over the period. We still have the old IR laws and wages rose 4% for the past year.

I noticed on the telly the other night that Tony Abbott wasnt too pleased about being asked to bear the same burden.

No one should be asked to bear any burden over wage negotiations. A person should get the maximum he can negotiate without having to be told by an elected official they need to show restraint.

Sinclair Davidson
Sinclair Davidson
13 years ago

Very minor quibble; union coverage is much greater than union membership, but the general point ‘the mechanism by which this will affect wages in a low-unionized and decentralized wage bargaining system is far from clear’ is still largely correct. As long as the wage bargaining system remains decentralised I can’t see how wages could generate macro problems.

conrad
conrad
13 years ago

SD — I don’t see why you think a decentralized wage bargaining system will you save you from wage inflation. Its again a problem in HK (although nothing like the problems of the early 90s — a good example of wage inflation despite low unionization and decentralized bargaining), although I think they have been saved by increases productivity so far. A quick search around the web shows that at least for professional wages (not generally unionized) wage inflation is becoming a world-wide problem. For example, a quick web search gets to web pages like this:

http://www.apegnb.ca/index.php?option=com_content&task=view&id=76&Itemid=2

Maybe I’m pessimistic (or perhaps I’m in the wrong profession :) ) but I can’t see how these types of shortages are not going to lead to wage inflation, which is only going to be moderated by either a recession caused by our government or external forces (like the US), especially given the aging workforce (i.e, fewer professionals). Or is it the case that I am incorrectly assuming that increases in professsional wages have less effect than increases from other sectors and that they don’t flow on to other groups?

Sinclair Davidson
Sinclair Davidson
13 years ago

Conrad – from your link

Employers in Singapore (55%), New Zealand (40%), and Australia (38%) are experiencing wage inflation the most due to increased competition for available professional talent.

Price going up to reflect a shortage is not inflation – that’s how the system is supposed to work.

sdfc
sdfc
13 years ago

Wages increased 4.0% over the past year did they? I suppose thats what the wage price index says (4.2%).

It may come as a surprise to you but the composition of society is not uniform and not everybody is in the same bargaining position. As far as I see it, in a tight labour market the only way policies such as workchoices can keep a lid on wage inflation, as its proponents contend, is by removing some of the protections afforded to the most vulnerable members of society.

Of course we can talk about productivity trade offs but that was happening pre-workchoices. Excluding the annual reviews of the minimum wage we havent had a centralised wage system since 1993.

Im sorry but I have little sympathy for Tony Abbott. After all he had little sympathy for the elementary production and service workers of this world when he was out championing the brave new world of workplace relations.

Fred Argy
Fred Argy
13 years ago

Conrad, I agree that our immigration policy (long term and 457 work visas) has increased the elasticity of labour supply and this has reinforced the flexibility of Australia’s labour market and helped to restrain wage growth and holddown the NAIRU. The same immigration policy will continue under Rudd.

I also agree that immigration is adding to housing inflation and it is here (especially in the rental market) that one sees a genuine example of “demand pull” at work, but this is a specific problem that requires a specific solution rather than a macroeconomic onslaught.