Focus on rates as ‘full employment’ theory questioned

The Reserve Bank may be forced to continue to cut interest rates until the jobless rate plunges to as low as 3.5 per cent.

RBA assistant governor Luci Ellis in Melbourne. Picture: Aaron Francis.

The Reserve Bank may be forced to continue to cut interest rates until the jobless rate plunges to as low as 3.5 per cent, according to the central bank’s assistant governor, who argues the level of “full employment” able to be sustained by the economy could be far greater than economists believed.

Delivering the Freebairn Lecture in Public Policy in Melbourne, Luci Ellis said the central bank’s modelling showed there was a good chance “full employment” — the lowest level of unemployment without a breakout in inflation — was even lower than the recently revised estimate of 4.5 per cent.

The RBA board last week cut the official interest rate to a record low of 1.25 per cent in a bid to kickstart the economy, despite the jobless rate falling to its lowest point in a decade of about 5 per cent.

Although unemployment has touched historical lows in many developed nations, economists have been forced back to the drawing board amid a stagnation in wages growth in the aftermath of the GFC, which has helped usher in a period of weak inflation.

The RBA has a mandate to use its sole policy tool — the cash rate — to ensure inflation remains between 2 and 3 per cent and to target a suitable rate of full employment.

Ms Ellis said the RBA had overhauled its estimation of what constituted full employment, which is known as the non-accelerating inflation rate of unemployment, or NAIRU. That rate was now 4.5 per cent, down from 5.25 per cent a few years ago: “The model estimates there is a two-thirds chance the current NAIRU is between 4 and 5 per cent and a 95 per cent chance it is between 3.5 and 5.25 per cent.”

The central bank has long estimated a jobless rate of 5 per cent would see scarcity in the supply of workers, prompting firms to offer higher wages to attract the workers they needed.

But businesses are now using incentives such as gym memberships and flexible conditions to stop workers jumping ship to ­better-paying jobs, at the same time workers lack the confidence to demand pay rises, while changes in technology have automated jobs and brought down the cost of doing business.

“As the data have unfolded, it has become apparent the unemployment rate Australia can feasibly sustain is lower than it has been in at least the past 40 years,” Ms Ellis said.

“Could we look back in a few years and realise the NAIRU is even lower than we thought today? There’s no way to know for sure until we get there, but I can’t rule it out.

“If that turns out to be the case, that would be an excellent outcome. It would mean more people were in jobs. It would probably mean that the long-term unemployment rate has fallen further. Both of these factors would mean that fewer people were facing the kinds of disadvantage and economic exclusion that long-term unemployment can involve.”

Ms Ellis said having an economy where more Australians were in the workforce without the fear of sparking high rates of inflation would be a boon for “prosperity and welfare of the Australian people”, which the RBA is also mandated to achieve.

“If Australia truly can have lower unemployment — sustainably — policy should be used to try to get there. As the governor explained last week, that was one important consideration motivating the board’s recent decision to lower the cash rate,” Ms Ellis said.