Finance Minister Grant Robertson expects the new Reserve Bank Governor Adrian Orr to review the bank’s modelling that currently shows unemployment cannot go any lower without generating an inflation surge. Bernard Hickey reports.
The Reserve Bank revealed last week for the first time where it saw the non-accelerating inflation rate of unemployment, which is often referred to in economic circles as the NAIRU or full employment.
It is seen as the level of unemployment below which the economy begins to overheat and generate uncomfortably high wage and price inflation. It is often referred to as a type of economic speed limit. The risk for the Government is that the Reserve Bank might stymie its attempts to push unemployment below four percent.
The NAIRU is hard to measure, but it is a concept commonly used by central banks to understand the productive capacity of the economy and to set interest rates so the economy does not overheat. The Reserve Bank effectively uses this idea of a speed limit to determine when it needs to push on the economic brake of higher interest rates.
If the Reserve Bank over-estimates the NAIRU, it will put up interest rates earlier and by more than it needs to. If it underestimates the NAIRU, then it will leave interest rates too low for too long and allow inflation to accelerate, potentially to above its 1-3 percent band target.
Until this week, the Reserve Bank kept its measure of NAIRU under wraps, arguing it was too difficult to find and unreliable, although some economists said it was used internally as part of a set of models for the economy’s ‘output gap’, which measures how far away the economy is from running on all its cylinders. However, Treasury has published its measure of the economy’s speed limit and late last year it estimated the NAIRU had fallen from 4.5 percent to around 4.25 percent.
The debate is particularly hot because the Government is reviewing the Reserve Bank Act with the aim of including a mandate to maximise employment alongside the Reserve Bank’s current single mandate to target low and stable inflation — currently defined as 1-3 percent. To formally target maximum employment, the Reserve Bank and Treasury would have to come up with some sort of measure of full employment, which at the moment most see as being the NAIRU.
This debate over exactly where the NAIRU is means even more for New Zealand economists because the founding father of the idea that reducing unemployment will necessarily increase inflation was New Zealand’s most influential economist, Bill Phillips. He came up with the idea of the Phillips Curve, which measures this relationship between falling unemployment and rising inflation.
It is especially topical now that New Zealand’s unemployment rate has fallen to a nine-year low of 4.5 percent.
Are we there yet? RBNZ says yes
The Reserve Bank said on Wednesday in its Monetary Policy Statement that its recent research estimated the NAIRU at 4.7 percent, which implied it thought the economy was already running above its speed limit and therefore about to generate significant inflation pressures that would require interest rate hikes to suppress. Somewhat strangely therefore, the Reserve Bank itself left the Official Cash Rate on hold this week and forecast no rate hikes until late next year, with just two more or 50 basis points by 2021.
The problem for the Reserve Bank is that there are few signs in Statistics New Zealand figures of any sort of wage inflation breakout, and others, including the Treasury, see the NAIRU as closer to 4.0 percent, or even below 4.0 percent.
It is an especially hot topic for the new Government because it wants to drive unemployment below 4.0 percent and is nostalgic for the days in late 2007 when unemployment fell to 3.3 percent – although most economists think the economy was over-heating at that time. Core inflation rose over 3.0 percent in late 2007 and early 2008.
But many think this time is different, with globalisation and new technology making it easier for the economy to grow quickly with both low unemployment and low wage inflation as the rise of the gig economy, casualisation of labour and deunionisation have made it harder for workers to extract significant wage inflation. However, the jury is out and some economists see the argument that ‘this time it’s different’ as risky, given economic relationships often return to their averages in the long run.
Finance Minister Grant Robertson said this week after the MPS and release of the December quarter labour force figures that he had long held the view that the changing nature and structure of labour markets here and overseas meant the NAIRU levels talked about by the Reserve Bank needed to be revisited, and that unemployment could be pushed below four percent without an inflation break-out.
“History tells us it is possible to see unemployment fall below these levels without a major impact on inflation,” he told Newsroom in an interview.
Determination to see jobless rate with a three in front of it
The Government aimed to get unemployment below 4.0 percent, he said.
“I’m determined we’ll get there,” he said.
He expected both the Treasury and the Reserve Bank under Adrian Orr to do more work to understand how the changing nature of work was changing relationships between employment growth and inflation.
“I’m sure that the incoming Governor will focus on that, both in terms of the changing objectives of the Act, and in policy targets agreement,” he said.
Robertson and Orr will have to agree a new Policy Targets Agreement before he starts on March 27. Its makeup will give a strong indication of how the new Government wants to see the new Governor interpret the Act, and the direction of the current two-stage review of the Reserve Bank Act and how the Reserve Bank operates within that.
“There has been a long held and traditional view about the NAIRU at the Reserve Bank, and I don’t think there’s any doubt that the new incoming Government will take another look at that,” Robertson said.
“It’s a very live issue,” he said.
“It’s our long held view that we can do better without causing more inflation.”
Robertson pointed to the figures in Wednesday’s wage figures showing the under-utilisation rate had risen to 12.1 percent in the December quarter and remained significantly higher than before 2007.
The number of people saying they would work longer hours if they could find work rose by 7,000 to a record-high 122,000 in the December quarter. That adds to the strangely identical 122,000 people who are officially fully unemployed. A further 99,000 are also under-utilised in that they are classed as in the workforce but not immediately available for work.
He also pointed to modest wage growth in the December quarter figures and the conundrum seen around of the world of strong jobs growth without much wage growth.
“It’s a quandary faced all over the world that it [wage growth] hasn’t happened. It’s a global issue while inflation remains as low as it is,” he said.
“Bringing wages up is an important part of what we’re working on.”
‘I’m keeping a close eye on it’
Robertson said he wouldn’t be telling the Reserve Bank what to do with interest rates or monetary policy when asked if it should be cutting interest rates to help get unemployment below four percent.
“What the Bank does is their call, but I’m keeping a close eye on where wages are going over the medium term,” he said.
He pointed to Treasury’s forecasts in December of unemployment nudging below four percent and wage inflation up from under 2 percent in 2017 to over 3 percent by 2020.