Australian inflation & unemployment: an overview

Australian inflation & unemployment: an overview

Three main measures of inflation in Australia 1. 2. 3. The consumer price index - or CPI. This the main measure used in media and business transactions. Issued quarterly. Gross non-farm product deflator. This broader than CPI as it includes prices of capital goods and exports, rather than just consumer prices. Thus of greater interest to economists. Issued quarterly in the National Accounts (ABS 5206.0) The "underlying" rate of inflation. This is simply the CPI, with the more volatile prices excluded: eg. petrol, vegetables, government taxes and charges. Issued quarterly. Used for Reserve Bank's inflation target.

Three main explanations of inflation Keynesian: Inflation simply caused by demand for goods and services outpacing growth in their supply In simple terms Monetarist: " Inflation is "always and everywhere a monetary phenomenon". (M. Friedman) Supply-siders: Emphasize cost-push inflation - particularly wage growth

Inflation (%) No simple relationship between inflation & unemployment 12 10 8 6 4 2002-03 2 1981-82 1989-90 1988-89 2001-02 2000-01 1999-2000 1985-86 1998-99 1986-87 1987-88 1990-91 1997-98 1982-93 1984-85 1994-95 1995-96 1996-97 1983-84 1991-92 0 6 7 8 9 1 But note: unemployment Unemployment(%) 0 is lower than early 1990s 1993-94 Australia 1992-93 1 1

Why simple wage rise-unemployment trade-off story broke-down Supply side shocks - quadrupling of world oil price in 1974-75 - sent cost inflation skyrocketing Higher inflation set in. But Phillips Curve had been based on a world where this did not happen - where, if inflation did rise, it would not be expected to remain high. Big policy implication: higher inflation would not guarantee higher growth and lower unemployment. Hence, inflation had to be taken more seriously than Keynesians had argued.

Wage growth & the CPI: a close relationship 18 16 14 12 10 8 6 4 2 0-2 -4 && % change on a year earlier Note how crazy wage policy was in early 1980s! & && & & & & & & && && && & & & &&& & & && & & & & & & Average weekly earnings &&&& &&& & & && & && & & & & & && && && && && & & & & & && Consumer price index NB: Wage growth> CPI = rise in real wages &&&& & & &&&& & &&& 123412341234123412341234123412341234123412341234123412341234123412341234123412341234 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 ABS 6301.0/6401.0

Main reasons for restraining inflation 1. 2. 3. 4. Inflationary expectations will be kept low, thereby helping to keep interest rates down. (The reason? - the higher the expected inflation rate the greater the interest rate charged.) With low inflation, asset prices do not rise as quickly and capital gains are generally less. This should produce reduced interest in purely speculative investment. Lower inflation also reduces the attractiveness of borrowing. In eras of high inflation, such as the late 1980s, debt servicing was easier as borrowers were paying back their loans with dollars which were falling sharply in real value. Hurts lower income groups the most.

Why inflation unlikely to return to late 1980s levels Domestic reasons: Sharp rises in service sector productivity from job shedding will restrain cost rises Unions more restrained than 1980s & losing influence Consumers and business expectations of inflation now much lower than early 1990s International: Asian industrialisation & sharp fallsin their currencies will keep import price growth low. World manufacturers will keep investing in lowest cost areas.

In sum: key reasons for restraining 1. 2. 3. inflation Inflationary expectations will be kept low, thereby helping to keep interest rates down. (The reason? - the higher the expected inflation rate the greater the interest rate charged.) With low inflation, asset prices do not rise as quickly and capital gains are generally less. This should produce reduced interest in purely speculative investment. Lower inflation also reduces the attractiveness of borrowing. In eras of high inflation, such as the late 1980s, debt servicing was easier as borrowers were paying back their loans with dollars which were falling sharply in real value.

Unemployment: key facts & trends

Unemployment: some views "A recession is when your neighbour is unemployed; a depression is when you too join the dole queue." " The rate of unemployment is 100 per cent if it is you that is unemployed". "A man willing to work, and unable to find work, is perhaps the saddest sight that fortune's inequality exhibits under this sun." (Thomas Carlyle, nineteenth century Scottish historian)

Unemployment: stocks & flows Successful job searchers Laid off Unemployed Employed Drop outs New entrants Retirees Recruits Out of workforce

Structural unemployment Unemployment which is a product of a mismatch between the needs of employers and the skills and training of the labour force. This can be a product of many factors

Frictional unemployment Unemployment resulting from the fact that employees must move from one job to another, whenever demand changes from one product - or service - to another. This category of unemployment can never be eliminated or reduced to zero

Cyclical unemployment An excess supply of labour over demand for labour Most marked in recessions and depressions when demand for goods and services falls And demand for labour falls

Unemployment high in Australia 12 unemployment rate, % 10 8 6 UK Australia 4 2 Japan USA AUSTRALIA Japan UK USA 0 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 OECD Economic Outlooks OECD forecasts

How unemployment is measured In Australia, persons categorised as unemployed are persons aged 15 and over who were not employed during the survey weekand who had: Actively looked for full-time or part-time work at any time over the previous month or were available for work in the survey week or would have been available except for temporary illness or waiting to start a new job within a month from the survey week and would have started if the job had been available to them or waiting to be called back to a job from which they had been stood down without pay for less than four weeks.

How Australian unemployment is different now to 20 years ago 1. 2. 3. A higher % of the unemployed is now concentrated in the middle-aged groups - lower in under 21 groups. The average duration of unemployment is much longer. Female unemployment rates did not rise as much in the early 1990s downturn as in past recessions and generally have been lower than male.

Blue collar males suffer biggest retrenchments Blue-collar men 1.92 Blue-collar women 0.54 White-collar men 0.46 White-collar women 0.39 ABS 0 0.5 1 1.5 2 Total number of retrenchments, 1985-1997, millions

Source: RBA Australian Economics Statistics, 1949/50 to 1994/95/ABS 6202.0 Job growth lags labour force growth 12 10 8 6 4 2 0 Millions of persons Labour force Year ended June figures Employment Note 1990s gap 1970 1980 1990 2000 1000 '000s of persons unemployed So up went unemployment 800 600 400 200 0 1970 1980 1990 2000

Participation rate rise made it harder 65 64 63 62 61 60 12 11 10 9 8 7 6 5 to decrease unemployment rate % Participation rate Trend NB: trend rise MJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDM 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 NB: unemployment trending downwards - especially since mid 90s MJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDMJSDM 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 0304 RBA Australian Economics Statistics, 1949/50 to 1994/95/ABS 6202.0

Female participation rate rise, meant job creation had to be greater 90 % 80 70 60 50 40 30 20 1970 1980 1990 Note rise in married females rate Males Married females Unmarried females Total females Data source: RBA Occasional Paper No.8. Participation rate = % of working age population either in work or actively seeking it.

Slowdown in profits often sees unemployment rise & converse 12 Annual av. unemployment rate, % Corporate profits, $s, millions 120 10 100 8 80 6 4 2 0 Unemployment rate (left axis) 1975 1980 1985 1990 1995 Year ended June Note slackening of profit growth, saw rise in unemployment in early 80s and 90s Profits (right axis) Source: ABS 5204.0 & 6203.0. "Profits" = corporate gross operating surplus 60 40 20 0

Wage growth & unemployment: no simple relationships 12 10 8 6 % annual av. unemployment rate, % Note wage explosions followed by sharp rise in unemployment AWE, % annual change But wage slowdown in 1990s did not produce immediate unemployment fall 30 25 20 15 4 10 2 Unemployment rate (left axis) 0 AWE, % annual change (right axis) 1975 1990 1985 1990 1995 2000 ABS 6302.0/ 5 0

But high earnings growth upped unemployment in early 1980s & 0.18 ratio 1990s % of workforce 14 # 0.17 # # # # # # # # # # # # 0.16 # # # # # 0.15 # Earnings/employment* Unemploy. rate (right axis) * real wages, salaries & supplements/employment 0.14 75/76 77/78 79/80 81/82 83/84 85/86 87/88 89/90 91/92 Professor Tom Valentine, UWS # 12 10 8 6 4 2 0

Importance of wage levels? 1. 2. 3. There is now general agreement that the sharp rises in unemployment in most Western countries - including Australia - in the early 1980s were related to "wage explosions". However, wage rises were far less dramatic in the early 1990s and cannot simply explain current levels of unemployment. Indeed, Bob Gregory of the ANU has estimated that to restore full employment in Australia would require a drop in average real wages of 35 per cent. Such a cut would be politically impossible.

And Even if wages did fall sharply they would still be well above those of our Asian neighbours Interestingly though, the countries with the greatest differentials between youth and adult wages have the lowest youth unemployment rates But merely lowering wages will not guarantee that jobs will be created for all who want them - has to be sufficient demand

Govt. spending & unemployment: 10 8 6 4 2 no simple relationship % annual change unemployment rate % & & & & & & & & & & & & & & & & & & & & & 12 10 8 6 4 0-2 -4 Comm. govt outlays & Unemploy. rate (RHS) 82/83 84/85 86/87 88/89 90/91 92/93 94/95 96/97 98/99 00/01 2 0

Immigration intake adjusted according to unemployment rate 12 10 8 6 4 2 0 Unemployment rate Net migration, year to June 30 Miigration intake '000s 1980 1985 1990 1995 2000 180 160 140 120 100 80 60 40 20 0 RBA Occasional Paper No.8 RBA & ABS 3412.0

Role of social welfare? Professor Richard Layard of the London School of Economics found: 1. 2. the countries with the highest levels of long-term unemployment tend to have the most open-ended & generous unemployment benefits, whereas the countries with lower levels of long-term unemployment tend to have dole payments that cut out after a set period.

The unemployment equation

Key factors behind job growth 1. 2. 3. 4. 5. Expected demand for output of goods and services Existing capacity utilisation Existing and expected wage levels Existing and expected interest rates The availability of suitable labour.

The natural rate of unemployment 1. 2. 3. Even during peak years, the unemployment rate never reaches zero. Its lowest resting spot is called the natural rate of unemployment, Historically, it has fluctuated between 2 and 5 percent of the labour force in industrial countries. But this "natural rate" impossible to measure with any accuracy. Some economists believe it simply an ideological construct. Recently,however, the rate has lingered well above 5 % in many industrial countries, suggesting that the unemployed have been taking longer to find a new job or have dropped out of the labour force entirely.

Effects of a high natural rate of unemployment Labour market tightens & inflation rises With high natural rate, when unemployment falls Authorities forced to slow economy sharply, raising unemployment again

Trouble is, estimates of Australia's natural rate vary greatly 10 Estimated natural rate of unemployment, % 9 8 7 6 5 Crosby & Olekains(1998) Debelle & Vickery (1997) OECD (1995) Treasury 4 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Debelle, G. & Borland, J. (1998), Unemployment and the Australian Labour Market, RBA

The "hysteresis effect": academics wrong! 12 10 8 Av. rate, %. year ending June ie. unemployment rate highs higher Unemployment rate 6 4 2 ie. ANU academics argued unemployment not falling as much in response to growth pickups But has virtualy done so! 0 1975 1980 1985 1990 1995 2000

Causes of "hysteresis effect"? 1. 2. 3. Technological change reducing jobs for unskilled employees Public and private sector now much "leaner" Real wage rises in upturns means that employers face higher wages & thus are encouraged to replace labour with machines

Surveys of employers also suggest the following important 1. 2. 3. "On-costs" - eg. superannuation contributions, workers' compensation contributions, payroll taxes etc. - add an average 12% to cost of employment Work attitudes - particularly among the young. Hence strong preference given to married women and to increasing overtime for existing staff Penalty rates - but these were reduced in the late 1990s

How industrial relations changes have helped cut unemployment 1996 ACT Greater flexibility for employers More jobs & lower labour costs Less trade union power Means skilled will be better off, unskilled likely to be main victims More competitive economy Improved balance of payments, higher growth & lower interest rates

Unemployment rate lags changes in GDP growth rate 12 10 Av. rate, %. year ending June Unemployment rate 8 6 GDP(A) growth rate 4 2 Message: Strong 0 growth crucial if unemployment -2 is to fall solidly 1980 1985 1990 1995 2000 http://www.oecd.org/

Unemployment: the core problem 1. 2. 3. 4. Generally, the economy has not been growing fast enough to match the trend increase in the labour force Structural and technological change has also reduced demand for more unskilled labour If the workforce keeps growing at around 1.5 % and productivity at 1.5-2.0 %, this will require annual average GDP growth of at least 3.25 per cent just to stop unemployment rising again Like it or not, policy has to encourage employers to create more new jobs