More again on unemployment

In recent months, in newspaper articles and letters and in Club Troppo positings, I have been hammering the theme that (a) the short term inflation risk is largely cost push and only marginally driven by excess demand (as reflected in wages and profit margins) (b) the RBA and Government attack on aggregate demand appears disproportionate and (c) the longer term challenge is to find a way of sustaining 4% unemployment with tolerable inflation.

My letter in today’s Australian is at it again. It is set out below.

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The Reserve Banks decision to raise the cash interest rate threatens to push up joblessness well above the current official rate of 4.1% (equivalent to an under-utilization rate of nearly 7% if one allows for under-employment and discouraged workers).

The monetary authorities may have decided that the current jobless rate is incompatible with low and stable inflation and may welcome a moderate rise say to 5%. But, with all the other forces bearing down on demand, such as the high Australian dollar, the slow-down in world economic growth, the share market slump, the increased aversion to risk in debt markets and the lagged effect of past rises in borrowing costs, the rise in unemployment could exceed official expectations.

This is the difficult short term economic reality we face. But, longer term, the authorities must look for ways of improving the unemployment/inflation balance.

* At a statistical level, they need to look critically at the adequacy of the present RBA measure of underlying inflation as a trigger for interest rate increases. Does it truly reflect excess demand pressures in the economy and does it discount fully for cost-push factors?

* They also need to ask themselves why a temporary non-accelerating inflation rate of, say, 3.5 to 4% poses greater economic and social risks than an unemployment rate of 5 to 6%.

* Most fundamentally, the Government needs to make sure the labour market of the future is able to deliver adequate structural wage flexibility and occupational and geographical mobility. This can be achieved through a mix of the stick radical award simplification and work-conditional welfare and the carrot – improved adult education and training opportunities; more effective relocation incentives to encourage people to move to booming parts of the employment market; tax offsets for vulnerable low-skilled, low-paid workers and targeted wage subsidies.

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derrida derider
derrida derider
13 years ago

I was always taught that because of the “long and variable lags” in monetary policy’s action upon the real economy that central banks should focus on expected conditions in about 2 years time. And Fred is quite right to point out that we can expect some disinflationary pressures between now and then.

It seems to me the RBA is doing the “much too much, much too late” thing again with monetary policy. It should certainly have been running a tighter policy as soon as it became evident we were in a strong and sustained commodity boom, and now it is overcorrecting. This could easily set off a decade or so of boom and bust cycles.

Jc
Jc
13 years ago

Fred:

How do you ro anyone know if monetary policy is too tight or loose for that matter? What’s the reference point? I don’t see we have one. The only reference point we have is actually watching economic conditions which is a look back function.

Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
13 years ago

Fred,

At last I like your formulation. “[T]emporary non-accelerating inflation rate of, say, 3.5 to 4%”.

This is very different to the previous formulation which suggests to the suspicious that you are invoking some old Phillips curve idea that there’s a clear tradeoff. I agree that if we have cost push coming through in a bunch of areas – which we do – that it might well be the case that the most growth promoting way to accommodate it is to allow prices to grow by around 4% temporarily. But then again that’s pretty much where we are now, and we need to get the rate back down to the band – don’t we? If you say ‘no’ then ‘temporary’ is really permanent.

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