High under-employment and long-term unemployment are keeping an over-heating economy on ice | Greg Jericho

History suggests we need unemployment to fall further than it is now before we start worrying about inflation

This week the latest inflation figures will be examined closely to see if, for the first time since 2008, we are about to have a break-out of inflation.

But not only do the lockdowns and emergence from the pandemic complicate matters, history would suggest we need unemployment to fall further than it is now before we need to worry about inflation.

Last Friday, while speaking at an international conference, the governor of the Reserve Bank mentioned the non-accelerating inflation rate of unemployment (Nairu).

The term refers to a pretty dry but contested bit of economic theory that is more commonly known as either “full employment” or “natural unemployment” (although even that is contested).

Given in reality you can never get to 0% unemployment, natural unemployment is suggested as being the point you can’t go below without labour constraints causing rising wages that in turn force up prices.

No one knows precisely what the Nairu is at any point in time. We can only estimate – and if you work for the RBA you will develop up a pretty complex mathematical formula to do so.

The RBA estimates that back in the 1980s it was probably about 6%, in the 1990s it rose to as high as 7%, by 2010 it was about 5.5%, and now it is somewhere about 5%.

The reason it moves around is the economy is not static.

When the Reserve Bank adopted its inflation target of 2%-3% of underlying or core inflation after the 1990s recession it seemed pretty clear that so long as the unemployment rate was above 5%, inflation would remain stable.

But once unemployment went below 4.5% in 2007 and 2008 inflation spiked:

If the graph does not display please click here

But since the GFC, inflation has not so much accelerated, as decelerated and has been as often below 2% as above it:

If the graph does not display click here

So what is the Nairu now?

Philip Lowe told his audience on Friday that the RBA does “not have a numerical target and I don’t think it makes sense to do so”.

He suggested that “experience has taught us that the non-accelerating inflation rate of unemployment moves over time and is influenced by many factors outside the control of the central bank”.

He certainly is right there.

One of the main reasons the Nairu moves around and has fallen over the past 20 years is that the level of unemployment that in the past saw wages growing about 3% is much higher than it is now:

If the graph does not display click here

It also means that we very rarely reach a level of unemployment where inflation takes off. In the past 30 years it only happened once during the mining boom:

If the graph does not display click here

So why should we care about it now?

Mostly because with inflation expected to spike due to the pandemic there is going to be a lot of talk about capacity constraints because unemployment is at 4.6% and thus interest rates need to rise to prevent inflation taking hold.

And yet what we have seen over the past decade is not just that inflation has been weak, but that unemployment has become less important at explaining the strength of the labour force.

The main reason has been the increase in underemployment since the GFC:

If the graph does not display click here

The growth of part-time employment has led to more employed people chasing more hours than in the past.

One other aspect has been the growth of long-term unemployed.

At the moment, 29.3% of everyone who is unemployed has been so for more than a year – that is more than double the ratio of long-term unemployed that occurred back in 2008 when the unemployment rate was last below 4.7%:

If the graph does not display click here

On Wednesday the headline CPI inflation number is likely to grow again at a level that would usually be associated with an overheating economy.

But clearly there is a lot of capacity left in the labour market.

In the past, unemployment has needed to go below 4.5% before we have seen a strong increase in underlying inflation. We are around that level now, but the figure makes little sense and explains less of the economy than it once did – especially with high underemployment and long-term unemployment.

In time the economy will grow such that interest rates will need to rise to cool things down. But for now we see an economy affected more by lockdowns and closed borders than exuberance, and those calling for interest rates to rise should hold off.

  • Greg Jericho writes on economics for Guardian Australia


Greg Jericho

The GuardianTramp

Related Content

Article image
Long-term unemployment rates show the jobs picture is not so rosy | Greg Jericho
The new jobs minister should be aware of problems under the surface of the solid-looking employment figures

Greg Jericho

28, Aug, 2018 @12:49 AM

Article image
The only thing we can say with certainty is that the fallout from coronavirus is going to be brutal | Greg Jericho
Parts of the Australian economy will need a decade to bounce back - and some parts will never recover

Greg Jericho

18, Mar, 2020 @4:30 PM

Article image
Australia’s latest wage figures are terrible – and we can’t blame the pandemic | Greg Jericho
Government policy, including limiting public service workers’ pay rise, is contributing to the poor growth

Greg Jericho

18, Aug, 2021 @5:30 PM

Article image
First we feared how bad Australia's economy might get. Now we worry how long it will be so bad | Greg Jericho
The latest jobs data snuffs out hopes that Australia is on the way to post-coronavirus recovery

Greg Jericho

15, Jul, 2020 @5:30 PM

Article image
The virus did not infect a healthy economy – it knocked out one that was already sick | Greg Jericho
The decline of the construction sector in the past decade illustrates the grim economic reality before the health crisis

Greg Jericho

27, May, 2020 @5:30 PM

Article image
Despite the horror of Australia's unemployment numbers, we haven't reached the bottom yet | Greg Jericho
And even if things go as hoped, in two years the unemployment rate will still be 6.5%

Greg Jericho

16, May, 2020 @8:00 PM

Article image
Unemployment figures suit Turnbull, but not those seeking full-time work | Greg Jericho
Figures mask stalled employment growth because of those who’ve stopped looking, which is handy in an election campaign

Greg Jericho

20, Jun, 2016 @1:25 AM

Article image
Job vacancies are up. So why isn't unemployment down? | Greg Jericho
The job vacancies figures are both good and bad. You’re OK if you live in NSW or Victoria, or if you’re looking for part-time work. Not so good for the rest of us

Greg Jericho

04, Oct, 2016 @12:39 AM

Article image
Coalition sweating on drop-off in employment growth as election looms | Greg Jericho
Setting aside leadership shenanigans, the next election may hang on convincing voters better wages will come

Greg Jericho

20, Aug, 2018 @6:00 PM

Article image
Unemployment numbers are low. The next logical step must be higher wages | Greg Jericho
With low numbers of unemployed people available for vacancies, workers are becoming more valuable to employers as they are harder to replace

Greg Jericho

10, Jan, 2018 @5:00 PM