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RBA deputy governor Michele Bullock: ‘If unemployment remains too low for too long, inflation expectations will rise.’
RBA deputy governor Michele Bullock: ‘If unemployment remains too low for too long, inflation expectations will rise.’ Photograph: Lukas Coch/AAP
RBA deputy governor Michele Bullock: ‘If unemployment remains too low for too long, inflation expectations will rise.’ Photograph: Lukas Coch/AAP

Why does the RBA want unemployment to go up? And what has it got to do with inflation?

The Reserve Bank deputy governor’s assessment that unemployment was ‘too low’ to tame inflation drew anger from unions. But was it correct?

The Reserve Bank’s deputy governor, Michele Bullock, drew some flak this week for saying the unemployment rate would have to rise in order to curb inflation.

What was behind her comments and why has it got some people worried?

It’s all to do with the non-accelerating inflation rate of unemployment, or Nairu. Here’s what you need to know.

What was said?

Perhaps ironically, Bullock’s comments were made in a speech she gave on Tuesday to a business gathering in Newcastle titled “Achieving Full Employment”.

While the RBA’s battle to constrain inflation had been the focus, she stressed that it did not mean the “other part of our mandate – maintaining full employment – has become any less important”.

Visitors to the Reserve Bank’s Sydney headquarters are reminded about the central bank’s legislated objectives…

— (@p_hannam) June 21, 2023

“It is hard to overstate the importance of achieving full employment,” she said, listing the effects from financial to mental and physical health for those unable to find work.

But she sparked angst with comments that implied the current jobless rate – at 3.6% as of May – was probably more than full employment, and hence official interest rates had to rise.

“If unemployment remains too low for too long, inflation expectations will rise, which will make it that much harder for the monetary authorities to bring inflation back down,” Bullock said.

Despite a dozen rate rises in 13 months, the labour market “remains tight, with many firms still finding it challenging to hire workers, and there are still roughly as many vacancies as there are unemployed”, she said.

Screenshot taken from ‘Achieving Full Employment’ speech – Graph 11 showing Labour Market Tightness
Photograph: Reserve Bank of Australia

Who was upset?

The assessment that unemployment was “too low” prompted anger from unions, which have argued the RBA’s rate hikes concentrate pain on workers who would face job cuts as economic activity slows.

As of May, Australia’s unemployed totalled 511,800, according to the Australian Bureau of Statistics. If the jobless rate were to rise to 4.5% by the end of 2024 and the available workforce expanded at the same pace as it has for the past year, the ranks of the jobless will swell by about 150,000. (Treasury has a similar employment forecast.)

“It’s a truly broken system when the RBA’s message to struggling Australians is: some of you need to lose your jobs or we’ll have to smash all of you with interest rate hikes,” said Stacey Schinnerl, the acting national secretary of the Australian Workers’ Union.

“Working people didn’t cause the inflation crisis and yet every solution the RBA suggests involves hurting working people.

“It’s a busted system in need of a complete overhaul.”

What is a sustainable level of unemployment?

The Goldilocks level of joblessness that is considered neutral as far as inflationary pressures go is known as – jargon alert – the non-accelerating inflation rate of unemployment, or Nairu.

As the RBA itself says: “The Nairu is the lowest unemployment rate that can be sustained without causing wages growth and inflation to rise.”

Adding to its mystique, the gauge is only inferred from other measures.

“The Nairu cannot be observed directly,” the RBA said. If wage growth is picking up and inflation is increasing, the unemployment rate is likely below Nairu, as has probably been the case over much of the past year.

The Nairu unemployment rate gap. Photograph: Reserve Bank of Australia

Where does the Nairu sit now?

Selwyn Cornish, an adjunct associate professor at the Australian National University and official historian of the RBA, says opinions vary about where Nairu might land.

“It’s a pretty general concept,” he says. “If you ask 10 people what Nairu might be … you’ll probably get 10 answers.”

Unemployment rate chart by ABS
Australia’s unemployment rate over time. Photograph: Australian Treasury/ABS

Cornish notes the 2% jobless rate that Australian enjoyed during much of the 1960s was in hindsight too low, fostering an inflationary buildup in the following decade (ably assisted by the Opec oil shocks).

In the wake of the second world war, Nairu was assumed to be about 4-5%. A 2021 paper by Treasury concluded that a “prudent” estimate based on the five years before the Covid pandemic placed it at about 4.75%

Bullock herself noted the projected rise in the jobless rate to 4.5% by the end of 2024 was “not far off some estimates of where the Nairu might currently be”.

“In other words, the economy would be closer to a sustainable balance point” at that level, she said.

NAIRU estimate from updated model
The estimated Nairu over time. Photograph: Treasury/ABS

What if Nairu estimates are too high?

Wage increases lagged forecasts for years in the run-up to Covid, suggesting the RBA had kept its cash rate unnecessarily high. That meant people who might have had jobs didn’t get them and the economy missed out on growth.

Economists such as Greg Jericho argue the RBA shouldn’t be panicking now about workers getting paid more.

If Nairu were, say, closer to 4%, the central bank’s work would be all but done. The jobless rate will take time to creep higher, given the lag for rate rises to take effect.

Cornish said the pandemic distorted the economy, from subsidies to keep people in jobs to increased workforce flexibility, most notable in the increased tolerance of staff working from home. More research was needed to understand its impact.

“History doesn’t help us very much here,” he said.

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