NAIRU

• Today’s employment white paper has adopted the broadest-ever definition of what “full employment” means for Australia.
• The new paper says closer to 2.8 million Australians are either underemployed or out of work – equivalent to one-fifth of the current workforce.
• The white paper still cautions that “full employment” does not mean zero unemployment.

Underemployment and unemployment approach 2.8 million

• While 539,700 Australians are unemployed, there are another 1 million who are employed but want to work more.
• And there are another 1.3 million “potential workers” who are interested in working, but not currently actively looking.
• This lifts the total number of Australians who are in some way unemployed to 2.8 million, according to the white paper.

Employment white papers date back to WWII

• This isn’t the first Australian government employment white paper.
• That 1945 white paper was inspired by the British white paper released in 1944, which set out an ambitious plan to carry forward the high employment achieved during wartime into peacetime.

No specific target for our unemployment rate

• The 1965 Vernon Report on the economy was more optimistic, defining full employment as an unemployment rate of 1 to 1.5%.
• The Keating government’s Working Nation paper – released in 1994 when unemployment was almost 10% – adopted a target of 5% by 2000.
• The words, but not the numbers, in today’s employment white paper are consistent with an unemployment rate of 4% or lower.

Few ideas for lifting productivity

• The white paper identifies labour productivity (output per hour worked) as crucial to increasing the purchasing power of wages, yet details few ideas for increasing it.
• Labour productivity has slowed over recent decades, and in recent years has actually fallen.
• Declining labour productivity is also likely to reflect the gradual shift from manufacturing to services.
• Read more:
  Government's employment white paper commits to jobs for all who want them – and help to get them

  But weak productivity probably also reflects other things.

• That decision is to commit future governments and the Reserve Bank to full employment, and, more importantly, spell out what that means.
• Tuesday’s Reserve Bank decision not to increase interest rates further makes it more likely we could end up with a more ambitious target.

Australia’s daunting post-war challenge

• In the 20 years leading up to the war, more than 10% of workforce had been out of work, climbing to 25% during the depression.
• Their challenge was to find jobs for the 1 million defence staff who would be returning to civilian life.
• It was also one Coombs himself adopted as the first head of the Reserve Bank of Australia from 1960.

Finally setting a jobs target

• That final report pointed out the bank’s target for inflation is specific – defined in a written agreement with the treasurer as “2-3% on average, over time”.
• In contrast, the bank’s target for employment has no numbers attached – resulting in inflation getting prioritised.
• While it is true that putting a number on a target doesn’t guarantee an outcome, the number put on the inflation target does seem to have helped bring it down.

Moving unofficial targets of the past

• And it’s worth clarifying that the target can’t be an unemployment rate of zero.
• There will always be some temporary unemployment as people move between jobs.
• That was its estimate of the “non-accelerating inflation rate of unemployment” (also known as NAIRU), the rate needed to stop shortages of useful workers pushing up inflation.

The lower our target, the more secure we will be

• A lower target of 3% (not too far above the 2% Australia achieved from 1940 to 1974) would do much more than put people into jobs and better use our resources.
• It would help us adapt to change in the way we are going to need to.

Creating confidence to face change

• Hawke agreed with him that the economy would have to change and some industries would have to die.
• When people knew they could get another job, they would accept change.
• If Chalmers and the Reserve Bank adopt an ambitious target, they’ll create it and set us up for the challenges ahead.

• In this article, we study the causes of the stability of US inflation over the business cycle since the 1990s.
• We conclude that it is mainly due to a reduced sensitivity of firms pricing decisions to their cost pressures.
• Ignoring this observation could impair the ability of monetary policy to steer inflation toward its objective.

Inflation has become insensitive to the business cycle

• US inflation used to rise during economic booms, as businesses charged higher prices to cope with increases in wages and other costs.
• When the economy cooled and joblessness rose, inflation declined.
• Since then, US inflation has remained remarkably stable, even though economic activity and unemployment have continued to fluctuate.
• For example, shortly after the Great Recession, the unemployment rate reached 10%, but inflation barely dipped below 1%, leading many economists to look for the missing deflation (e.g.
• More recently, with unemployment below 5% for almost four years and inflation persistently under 2%, attention turned to explaining what is holding inflation back (e.g.

Is the stability of US inflation due to changes in the functioning of labour markets, a flatter Phillips curve, or improved monetary policy?

• What explains the emergence of this disconnect between inflation and unemployment? Economists have explored three main classes of explanations.
  1. The functioning of labour markets has changed in the last three decades, making unemployment a poorer indicator of both the degree of resource under-utilisation in the economy (sometimes referred to as “economic slack”) and of the cost pressures faced by firms.
  2. Firms’ pricing decisions have become less sensitive to these cost pressures. In economic jargon, this phenomenon corresponds to a flattening of the so-called Phillips curve – a relationship capturing the fact that a boost in production typically pushes up the cost of production inputs, and thus leads to higher output prices.
  3. Policy has become more successful in stabilising inflation (McLeay and Tenreyro, 2019).
  • In this article, we discuss the relative merit of these three explanations based on evidence from a combination of state-of-the-art macro-econometric techniques.
  • [2] The bulk of this empirical evidence points towards the second explanation a flatter Phillips curve due to the reduced sensitivity of firms pricing decisions to their cost pressures as the main driver of inflation stability.
  • In terms of policy, this finding implies that inflation has become harder to steer, unless monetary authorities systematically take into account the flattening of the Phillips curve.

Our findings

• In contrast, inflation has become insensitive to business cycle fluctuations.
• This observation rules out changes in the functioning of labour markets as a leading explanation for the inflation-business cycle disconnect.
• This leaves us with two possible explanations on the table, a flatter Phillips curve and improved monetary policy.
• Monetary policy can limit their impact on inflation by leaning against the wind, that is, by counteracting their effects on economic activity as well.
• Therefore, if improved monetary policy is behind inflation stability, these demand shocks should have minor effects both on inflation and unemployment after 1990.
• Figure 1 plots the responses of unemployment and inflation to a demand shock before and after 1990.
• [3] The last two panels show that the response of inflation to demand shocks has indeed become significantly more muted since 1990.
• If this analysis is correct, the fact that economic activity collapsed while inflation did not fall substantially suggests that the Phillips curve must be flat.
• This flattening of the Phillips curve is also what we find by estimating the New York Fed DSGE model before and after 1990.

What’s next in terms of research in this area?

• Investigating the deeper forces behind the flattening in the Phillips Curve is outside the scope of our analysis and it is still an open question in the specialised literature.
• The most prominent hypothesis attributes the reduced responsiveness of prices to cost pressures to the increased relevance of global supply chains, heightened international competition, and other effects of globalisation (e.g.
• Understanding this further is of first order importance for central banks, and it is expected to be the focus of intensive research efforts going forward.

References