Yahoo Finance The Aussie economy is finally starting to pick up
Economists, including at the Reserve Bank of Australia (RBA), were blind-sided when employment growth remained strong in 2018 and early 2019 despite the clear slump that was unfolding in the economy.
It is why they universally failed to forecast the need for lower interest rates.
Now, there appears to be a rush to the other side of the ship with forecasts of near zero interest rates and possible money printing on the basis of the current weakening in the labour market, even though there is growing evidence that the economy is starting on the early stages of a pick-up.
It is to be hoped that this current misunderstanding of basic economics does not lead to a policy error, akin to the one which saw the RBA resist interest rate cuts even though the economy was in a nose dive.
The issue here – the ‘basic economics’ if you like – is a long established and immutable fact that the health of the labour market lags trends in the economy.
This lag has been evident for many decades, across all industrial countries.
It means that a change in momentum in the economy, up or down, takes around 6-18 months to show up in a material change in the labour market.
Here’s how the lag works
A business sees an increase in their sales and profits for a month or two as the broader economy gathers upside momentum.
The business owner, who cannot be sure whether this is a temporary blip or a more permanent pick-up in the pace of growth, makes do with current staffing levels.
Perhaps employees work longer hours or there is a change in the businesses priorities with existing staff allocated to the areas that need resources to meet the lift in activity.
The business, in the short term, holds off the expensive and time consuming task of hiring more staff in case the pick-up is in fact temporary.
In terms of the economic data, there is a clear increase in activity yet no significant change in momentum in the broad labour market indicators.
If, after a little more time, the business owner finds that the pick-up in business activity is sustained, the business will need to hire more staff.
And even then, the task of hiring more people takes time.
All of which means that many months can transpire after the improvement in the economy before there is an improvement in the labour force data.
This is the lag, that shows up in every change in economic momentum in every business cycle.
Of course, the opposite lags are evident when the economy slows.
In this case, firms are reluctant to reduce their staffing levels in case the dip in activity is temporary.
In other words, firms, quite rightly and prudently, need confirmation of the change in business conditions because responding with a change in staffing levels.
To the here and now
The labour market data are weaker now that at the start of the year.
The unemployment and underemployment rates have both edged up.
All competent economists would have seen this coming as the economy started its per capita recession in the September quarter 2018.
Indeed, that is the time, around the middle of last year, that the RBA should have been cutting interest rates to minimise the risk of a labour market deterioration.
To its credit, the RBA has now cut interest rates in recent months.
At the same time, the election result has locked in a change in sentiment surrounding the housing market and income tax cuts are starting to trickle into people’s bank accounts.
With that, there is a clear turn in house prices, the stock market is strong, and exports, business investment and government spending are continuing to add to economic activity.
And while the economy is only in the early stages of a pick-up from the per capita recession, the outlook for late 2019 and into 2020 is increasingly positive, aided by an ongoing solid expansion in global economic activity.
This means that the labour market will start to improve over the next six to 12 months, even if the next few months sees a few weak results.
Until the economy locks in a lift in growth, the unemployment rate is likely to rise is response to the prior period of economic funk.
Forward looking economists will be forecasting an improvement in the labour market into 2020, a result which means that not much more policy stimulus is needed to deliver a long overdue jump in economic activity.
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