The central bank is at great risk of overshooting its policy settings into higher unemployment and it is workers and small business who will cop it.
Those of us who care about Australians needlessly losing their jobs should worry that the Reserve Bank will keep monetary policy too tight for too long. A Reserve Bank determination to lift the unemployment rate to its target of 4.5 per cent, while bad enough in human terms, could easily lead to overshooting.
A search through Reserve Bank statements over the past year or so raises fears that it is being driven mechanically by flawed modelling rather than by experience and consideration of recent economic indicators that are all turning down.
Here’s the evidence.
In a speech in the middle of last year, now-governor Michele Bullock pointed to Reserve Bank forecasts of unemployment reaching 4.5 per cent by late 2024, adding that this is “not far off some estimates of where the NAIRU might currently be.”
The NAIRU is the non-accelerating inflation rate of unemployment. If the actual unemployment rate is below the NAIRU, then, the argument goes, inflationary expectations will rise, making it much harder for the monetary authorities to return inflation to the target range of 2-3 per cent.
Bullock, in that speech, went to great lengths to explain that the Reserve Bank’s statistical model, which estimates the NAIRU at 4.5 per cent is just one tool in the Reserve Bank’s decision-making kit. Others include the rate of underemployment and the results of liaison with business.
That’s a bit reassuring.
The Reserve Bank’s estimates of the NAIRU have been revised down from as high as 5.25 per cent, the Reserve Bank pointing out in 2019 that over the preceding five years wages growth had been slower than would have been expected based on past behaviour.
Indeed, in a candid assessment, the Reserve Bank has confirmed a history of consistent over-forecasting of wages growth, as if its forecasters were living in the 1970s and early 1980s of centralised wage fixing.
If Reserve Bank officials are determined to slow the economy until the unemployment rate rises to the bank’s estimated NAIRU of 4.5 per cent, it must be because they are concerned about a wage-price spiral setting in. Yet at their October 2023 meeting, Reserve Bank Board members “noted that there were few signs of the risk of a price-wage spiral materialising.”
At their February 2024 meeting, board members noted that wages growth had picked up “but is not expected to increase much further.”
Yet, the Reserve Bank February Statement of Monetary Policy is forecasting the unemployment rate to reach 4.5 per cent by the end of this year – bang on its estimate of the NAIRU.
A suspicious mind would conclude that the Reserve Bank does indeed place a lot of weight on its 4.5 per cent estimate of the NAIRU and is determined to achieve it through continued tight monetary policy.
Unpacking the January labour force numbers beyond the headline unemployment rate, the estimated seasonally adjusted total number of hours worked in January fell by 49 million, a decline of 2.5 per cent on the previous month.
The weakness in the labour market is there for all to see – if they choose to look.
For the past two calendar years the unemployment rate has been below 4 per cent without a sign that inflationary pressures were coming from the labour market.
Looking at what is actually happening in the labour market is a far better guide to monetary policy settings than estimating statistically what would have happened if the labour market were still behaving as it did at some time in history.
There’s no shortage of urgers for the Reserve Bank to keep monetary policy tight for longer. Those of us who worry about the livelihoods of working Australians who lose their jobs or have their hours of work cut back seem to be considered softies, lefties or both.
Remember that small businesses, too, get hammered when interest rates are too high for too long. They share the brunt of any sharp economic slowdown.
The Australian experience of the Reserve Bank keeping rates very low for an extended period followed by a sharp tightening was the 1991 recession. It is a reminder that the Reserve Bank can overshoot with its tightening, with disastrous consequences.
As the Reserve Bank drives towards its targeted unemployment rate of 4.5 per cent, there is no effective braking mechanism. In a research paper the Reserve Bank has acknowledged that monetary policy operates with long and variable lags. If it keeps monetary policy too tight in search of its estimated NAIRU, it is likely that the unemployment rate will whiz past 4.5 per cent towards 5 per cent. Any belated easing of the cash rate would take a long time to translate into an improving labour market.
This is not an argument for an immediate cut in the cash rate, but a reduction in it by the middle of the year, followed by further cuts if the incoming data warrants. In this way, the Reserve Bank could engineer a soft landing, saving lots of jobs and small businesses.
Craig Emerson is managing director of Emerson Economics. He is a distinguished fellow at the ANU, director of the Australian APEC Study Centre at RMIT and adjunct professor at Victoria University’s College of Business.