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.
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.