The last few months has seen an extraordinary, and frankly long overdue, rethink in economics and policy from the Reserve Bank and Australia, Treasury and the Government.
All of a sudden, the focus of economic policy is getting back to full employment – giving a job to everyone who wants one, as long as the annual inflation rate stays within a 2 to 3 per cent range.
It is odd, to say the least, that the conversion in thinking occurred when the economy was being impacted by the deepest recession since the 1930s. This saw the unemployment rate spike and was significantly higher than was the case in the years prior to the COVID-19 pandemic arriving.
The current thinking and research suggests that the economy needs to grow fast enough to create enough work to get the unemployment rate down to around 4.5 per cent, perhaps a little lower. At this rate, workers will have sufficient sway to get annual pay rises around 3.5 per cent, which in turn will see inflation locked in to the target range.
For many years, Treasury did precious little public work on full employment, focussing instead on getting the budget back to surplus and government debt lower. This was a bad misuse of its resources.
At the same time, the RBA seemed convinced that it was wise to ‘lean against’ increased house prices, with inflation and the labour market secondary issues. This meant monetary policy was kept tight and as a result, the unemployment rate hovered around 5.25 per cent and wage growth plummeted to record lows.
It was a plain and simple policy misjudgement or error.
In late 2020, the RBA saw the light. It embraced full employment for the first time in recent history and in doing so gave a commitment to keep interest rates at 0.1 per cent until the full employment was locked in and annual inflation was at the target.
It reckons this interest rate will need to remain in place until at least 2024 for it to hit this goal. This ‘dovishness’ is most welcome.
Recent economic news
The latest labour force data showed the unemployment rate at 5.5 per cent, which is clearly some way from the new target.
In normal times, a sustained period of very strong economic growth would be needed to get firms hiring.
The good news is that there are a number of forward indicators that suggest the economy is strong enough to get the unemployment rate significantly lower in the year ahead.
The highly influential NAB monthly survey of business conditions confirmed a buoyant tone in the economy, with strong demand for labour and a near record high in capacity utilisation.
Such was the optimism in the NAB survey and the extreme pressure on business capacity that a fall in the unemployment rate towards 4.5 per cent and lower is on the cards by late 2021 or early 2022.
Of course this business optimism has to be sustained and then translated to economic activity, but for now, the readings are clearly upbeat.
Added to that are readings from ANZ job advertisements and the Seek measure of job vacancies.
These are well above the pre-COVID-19 level and suggests business demand for workers is very strong. As these vacancies are filled, the unemployment rate will fall.
Rounding out the possibility, even probability, for a near term move in the unemployment rate to 4.5 per cent, are stories of skill shortages as the economy takes off and the international borders are closed to visa workers. This means that businesses are likely to be willing to take on workers and where possible, undertake on the job training.
It has been over four decades since Australia enjoyed an unemployment rate below 4 per cent. There have been a few very short run periods when it hit 4.5 per cent, but these were fleeting.
The aim for policy is to get the economic conditions such that when the unemployment rate dives to around 4.5 per cent, it not only is locked in at this level but can continue to edge lower.
Not only would this mean jobs for tens of thousands of people who can build their economic security by undertaking paid work, but it would also feed into expectations for decent increases in real wages, buoyant consumer spending which in turn would feed back into a positive outlook for the economy.
This so-called virtuous cycle of economic growth.
It can be achieved and policy makers have in their power the ability to achieve it. Let’s hope they don’t squib on this important economic and social policy reform.