When should budget repair start? Australia’s treasurer reckons we should go back to our national pastime — worrying about deficits — when the unemployment rate hits 6%.
There’s only one problem with that. The budget documents say unemployment won’t be low enough to generate wages growth and inflation until it is down to 5%. That gap matters.
Here’s how the fiscal strategy is described:
The COVID-19 economic recovery plan will focus on achieving a strong recovery to quickly drive down the unemployment rate. This phase will remain in place until the unemployment rate is comfortably below 6%.
But it should keep going until the unemployment rate is lower. Here’s why.
It’s all about the NAIRU
The estimate of the level of unemployment that causes inflation is a key input to economic policy.
This is important to understand. There’s a trade-off between inflation and unemployment. The reason we don’t aim for 1% unemployment is evidence that would lead to damaging inflation. Keeping some unemployment in the system is the price we pay for avoiding inflation.
The Reserve Bank of Australia (RBA) will usually start raising interest rates when inflation gets down to around the level that creates a risk of inflation. This number is called the NAIRU, or the “non-accelerating inflation rate of unemployment”.
So what is the NAIRU? This text appears in budget paper 1.
Spare capacity in the economy is expected to be absorbed over about five years. Over broadly the same timeframe, inflation is expected to return to the midpoint of the RBA’s inflation target band and the unemployment rate is expected to gradually converge to 5%, the estimate of the NAIRU.
That made my eyes pop open. Wasn’t the NAIRU estimated to be lower than that just last year?
A little is a lot
The estimate of the NAIRU has been a source of contention in recent years. The RBA’s Luci Ellis spoke about it in 2019 and said this:
We can’t directly observe the NAIRU — we don’t know exactly where it is — but we can infer how far above or below it we are from the behaviour of wages growth and inflation.
Australian inflation has been very much missing in action recently as we all know.
“We have therefore gradually revised down the estimate of the prevailing NAIRU from 5.25% a few years ago to 4.5% now,” Ellis said.
That’s different from the budget estimate — 4.5% and 5% might look close to each other, but in a population like ours a little is a lot. The difference is about 70,000 people out of work.
Even that 4.5% figure might be too high. The RBA puts an error band around its NAIRU estimate that includes numbers from 3.8% to 5.5%.
I find the lower numbers much more convincing. The United States has managed unemployment around 3% without any signs of inflation.
And anyway, the RBA has given us wages growth and inflation well below average for ages. Erring a bit on the high side for a time wouldn’t be the end of the world.
A risk of austerity
There are two problems here. First is that it is economically absurd to have daylight between your estimate of the NAIRU and the point at which you start withdrawing fiscal support. They should be the same number.
If you reckon we won’t get wages growth until we’re down to 5% unemployment, don’t pull the rug out until we’re down there.
Second is this sudden shift in the estimated NAIRU. Why is it suddenly higher? Have the recessionary conditions changed the labour market such that it is higher?
If so this should be made explicit because otherwise it starts to look like it is being massaged upward by a government salivating at the chance to return to its traditional menu of budget rectitude, aka austerity.
When I see 5% as a target, that’s still 1 in 20 Australian workers the government resigns to be unemployed. That’s a lot of people living in poverty.
It’s a rolling 5% though, includes seasonal workers and people between jobs. 0% unemployment wouldn’t be realistic given labour mobility.
The ABS have done some deep-diving on the number of “long-term” unemployed people (52+ weeks, 104+ weeks) and it’s only a small fraction of the overall unemployed population. Obviously neglects those who have given up looking for work all together – but the true number of people unemployed long term is unlikely to be even close to 1/20 at a 5% unemployment rate.
The scary thing is that the figures of people living in poverty is much higher than that (close to 1 in 7), so the number in practice is much worse than my basic interpretation of the numbers before. That rolling workforce includes the underemployed and those in vulnerable jobs.
Except isn’t all ABS ‘deep-diving’ based on the hilarious ABS definition of ‘unemployed’ – working less than 1 hour pw. The real rate of unemployment (including the underemployed and those no longer bothering to look for work) may be four times the ABS rate.
Have to draw the line somewhere, but agree 1 hour/w is laughable. That said – they do look at this too, and it’s usually only a very small number of people working those particularly low hours. Jobkeeper skewed numbers thought so I’ve given up interpreting it all for now.
‘Keeping some unemployment in the system is the price we pay for avoiding inflation’ is economist-speak for deliberately keeping some people unemployed and in dire poverty so that those with wealth do not lose any of it through inflation. The unemployed should be rewarded for their services to our inequitable capitalist society, not demonised.
Yep. Many of the unemployed are offered legalized slavery via phoenixing “labour hire companies” or $42 a day via Centrelink.
Up until the early 70s Australian unemployment rates were ~2%. Governments of both colours used deficit spending to keep it at those levels. Australia did quite well.
Unemployment is largely a political choice, not an economical one.
So true H, ” Uenployment is a political choice…” For too long employers have benefited more from productivity / profit increases via stagnant wages / a large standing army of unemployed.The recent budget will help perpetuate this situation ie it maintains a vast number of unsupported unemployed. According to economist Bill Mitchell the RBA has used monetary policy as a substitute for fiscal policy to maintain unemployment at such high and unnecessary levels – Bill’s point being the elected body of parliament with responsibility for employment has been replaced by an unelected, and some would say politicised, RBA. The threat of high inflation experienced in the 70’s, due to so called greedy Australian unions is a myth condoned mostly by successive LNP govts and their complicit RBA boards and governors.
Another historical fact that bears reconsideration is that pre70 – never mind the 80s neolib mania – the proportion of federal revenues from company/income tax was about 70/15 (the remained was excise on certain exports and tariffs).
Today, thanks the the neolib nightmare inflicted on us the proportion is basically reversed, 70% from individuals, via income and the iniquitous GST, and a paltry 15-20 from corporate tax, when they deign to pay any at all.
I think like a lot of economic concepts, our perception of the future is anchored heavily in the present. Just as an example, a “neutral” monetary policy stance would’ve been 4-4.5% a decade ago. Now those sort of rates would be seen as wildly contractionary.
It’s the same with NAIRU. Sure 4.5% unemployment was probably in the ballpark when joblessness was at 5.1% and we were seeing very modest inflation. But with double-digit unemployment, it seems fairly natural for the NAIRU estimate to drift up slightly.
Plus you’ve got to throw changing participation dynamics into the mix. People leaving/retiring from the workforce, working more casually/from home, and a drop in our skilled migrant intake to almost 0.
That said – agree Govt should make these changing dynamics more explicit, because otherwise easily misconstrued as “economic massaging.”
The NAIRU, as a concept was always, well, just a concept. It is a figure wrapped in a theory inside a classical economics thought bubble.
It may have been real, one day, in the distant past, probably the 70s, maybe, but it might not exist at all. It might be a complete boogie man. Get down.
But that hasn’t stopped the genius practice of economics assuming that it is real, and working from there.
And if it does exist, if it was around 5% in the 70s, then it should be closer to about 2% today. Changes in the definition of unemployed make that so, but then factor in the IR changes which see trade unions largely emasculated, part-time work now making up a large percentage of the workforce, plus the fact that many of those want more hours, plus all the people that have given up looking, or just don’t meet the stringent definition of unemployed for the ABS survey and you can reasonably say that the NAIRU, if it wasn’t a complete fiction, could be as low as 1%. Then factor in that the unemployment rate can only have an inflationary effect on wages, not prices, and therefore their underlying assumption is that wage rises will automatically lead to price rises, an assumption that is shown NOT to be the case in the real world (although it does happen the other way around). So, at best, the NAIRU is a twice removed possible theoretical maybe connector to economic conditions, and it underlies our budget assumptions.
Then factor in that the economics profession really doesn’t have much of a clue as to what causes inflation, that they build edifices of supply side and demand side theories and all other assumptions and carry-ons, and that even when looking into the past they can only theorise about what might have caused the last bout of inflation, with NO proofs, and you realise that economics is something that should no longer be taught at universities.
I am so over our lives and livelihoods being decided by a bunch of boffins with theories that they cannot demonstrate have ANY application in the real world.
Unemployment is a political decision, economics has nothing to do with it. This was all just made up to look like it had something to do with the economy.
The LNP and business generally want you unemployed because they then have a steady supply on tap, and desperate, when they need them, and they don’t have to pay fair wages in the meantime.
One of the better analyses of the irrationality of the priesthood whose claims to foresight, or even plain sight the real world, is not just demonstrable bunkum but destructive in the extreme.
Give the writer a gig.