The minutes of the Reserve Bank’s June 4 board meeting not merely opened the way to another interest rate cut to 1% — and quite possibly below that — in coming months, they flagged that workers will not be escaping the rut of stagnant wages any time soon. And the bank really doesn’t understand why.
The bank is increasingly pre-occupied with something neither it nor central banks around the world can explain: why wages growth remains sluggish even at low levels — sometimes extremely low levels — of unemployment, and why there hasn’t been an outbreak of inflation, as economic textbooks insist there must. The phrase the bank keeps coming back to is “spare capacity”, and it was the subject of a major discussion at the board meeting — and probably drove the rate cut decision:
Members had a detailed discussion of spare capacity in the labour market. Although difficult to measure directly, the extent of spare capacity in the labour market is an important factor that affects wages growth and price inflation. On a number of measures, it was apparent that the labour market still had significant spare capacity. The main approach to measuring spare capacity is to compare the current unemployment rate with an estimate of the unemployment rate associated with full employment, which is the rate of unemployment consistent with stable inflation. The Bank’s estimate of this unemployment rate had declined gradually over recent years, to be around 4½ per cent currently.
The bank’s head of its economics department, Assistant Governor Luci Ellis, grappled with that figure last week in a major speech when she talked about the challenge of making monetary policy based on “invisible” economic phenomena, such as the bank’s estimate of the non-accelerating inflation rate of unemployment, or NAIRU. That figure, she noted, can’t be directly measured, “but you can guess that you are below it if wages growth is accelerating”. Nonetheless, “there is substantial uncertainty around our estimate of the NAIRU.”
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Like their top economist, the board is also uncertain. According to the minutes, the board noted:
… the significant uncertainty around modelled estimates of the unemployment rate consistent with full employment. They also discussed other measures of spare capacity, including underemployment of part-time workers, recognising that the supply side of the labour market had been quite flexible. Strong employment growth over recent years had encouraged more people to join the labour force, allowing the economy to absorb increased activity without generating inflationary pressure.
In fact, “spare capacity” has been mentioned in every major speech from senior RBA officials on the labour market, wages and the economy now for months. It is the subject of a speech in Adelaide tomorrow by RBA Governor Phillip Lowe, following on from Ellis’ speech. Spare capacity has a clear implication for workers: wage stagnation deliberately engineered is here to stay.
And that’s backed up by what business is telling the bank. From the minutes: “members also noted that an increasing proportion of business liaison contacts were expecting wages growth to be stable in the year ahead, although the proportion of contacts expecting wages growth to decline had continued to fall.”
That is, wages growth isn’t going any higher than its current, abysmal level: 2.3%, according to the Wage Price Index. That looks grim for the RBA forecast of the WPI growing by 2.5% by the end of the this year. And WPI is the optimistic wage measurement. Average compensation per employee, one of the bank’s other favoured measures, was up by just 0.4% in the March quarter or 1.4% over the year.
Policymakers are visibly at a loss as to what to do about it. The government is simply refusing to acknowledge that there is any problem. Why should it? It just won an election that the opposition declared was a “referendum on wages”. Its business mates are loving not having to pay workers wage rises. The Productivity Commission recently listed 11 different ways of measuring wage stagnation and nine different theories about why it is happening, led by spare capacity.
But each passing quarter of poor wages growth — while wonderful for corporations, investors and wealthy retirees enjoying taxpayer-subsidised handouts for their franking credits — punches economic growth down, courtesy of its impact on household income. It’s already slowed growth to a crawl over the first three quarters of 2018-19. And as workers and consumers become habituated to it, they’ll pull in spending further. No wonder economists are tipping interest rates at 0.75% or even 0.5% soon.