For the past four years the Reserve Bank has been under instruction to set monetary policy with one eye on inflation and the other on supporting “maximum sustainable employment”.
But this year, it is in the awkward situation of believing it has overachieved on the latter objective.
The past six months has shown that the country can drive the official unemployment rate down to close to 3%.
Unemployment bottomed out at 3.2% between September and March which was lowest rate since comparable records began in 1986, and almost certainly the lowest rate since at least the 1970s.
In August, the Reserve Bank’s monetary policy committee confidently stated that employment was “well above its maximum sustainable level”.
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Chief economist Paul Conway says what it means by that is “the labour market is tight and an excess demand for workers is contributing to inflation”.
Simon Chapple, an adviser to Parliament’s finance and expenditure select committee, suggested in August that MPs on the committee challenged the Reserve Bank on its assumptions, however.
“If labour is in fact so scarce, how does the bank then explain ongoing and significant real wage declines, an indicator which suggests the opposite?”, he suggested they ask.
Chapple might seem to have a point.
Stats NZ reported in August that its raw measure of labour costs rose 5.1% in the three months to the end of June.
That remained significantly below the inflation rate of 7.3%.
A Reserve Bank chart show that by one measure that aims to adjust for changes in the skills and seniority of workers, real wages in the private sector were last observed declining at the fastest rate since at least 2005.
Crown accounts collated by the Treasury show corporate tax revenues in the year to the end of last June were on track to rise about 60% on two years ago.
That would suggest that, to date at least, it has been higher profits rather than a tighter labour market that has been the main driver of inflation.
Added to that, most economists are confident that even with unemployment last recorded at 3.3%, inflation is now past its peak with some, such as BNZ research head Stephen Toplis, forecasting the initial drop in inflation will be “marked”.
Assuming inflation is now falling, and perhaps falling fast, that would not seem to sit easily with an assessment that employment is above its maximum sustainable level.
But Conway says wage rises could be contributing to inflationary expectations without actually exceeding inflation, and the bank’s forecasting manager, Rebecca Williams, notes “wages tend to lag inflation”.
“We’re always looking forward,” Conway says.
“We’re not setting monetary policy for conditions ‘today’, we’re setting them for 18 months, two years down the track.”
There are some reasons to think wage rises could fall away quite rapidly, well before then, as the economy cools.
Evidence, at least internationally, suggests that workers are currently only achieving inflation-beating pay rises by changing jobs, and that wage rises paid to existing staff remain surprisingly well-contained.
The United States’ Pew Research Centre reported in July that the typical US worker who changed jobs in the year to the end of March saw their pay rise by 9.7% more than the rate of inflation, while the typical worker who stayed in their job saw their real wage decline by 1.7%.
Anecdotal evidence from recruiters suggests the same may be true in New Zealand.
That suggests any drop-off in hiring and labour market mobility that could be expected to precede any significant rise in unemployment could have an immediate, chilling impact on wage growth
But Conway is unperturbed, saying a cooling is what the bank wants to see happen.
“We’re not against wages going up; our catch-cry is all about improving the wellbeing of New Zealanders and the labour market is a big part of that.”
But that needs to be backed by productivity growth, he says.
“What we are leaning against is that possibility that we get into a wage-price spiral.”
However you spin it, the implication of the Reserve Bank’s latest monetary statement is that it believes it would be balancing its dual mandate better at the moment if there were fewer people in work.
The bank forecasts unemployment will steady climb back up to 5% by the end of 2025 as monetary policy tightens, economic growth slows and inflation drops back to the middle of its 1% to 3% target band.
“Yes, we are saying demand is too strong in our economy. That’s why we’ve got inflation at 7.3%. And that needs to slow down,” Conway says.
The employment gains of the past two years are not something that the Government appears likely to let slide without considerable regret.
Finance Minister Grant Robertson suggests that rather than merely being something transient – just a good number at a specific point in time – the low unemployment the country has recently enjoyed could have lasting societal and economic benefits.
“Getting people back into work after being out of the labour market for a while has long-term benefits for them, their family and the country,” Robertson says.
“Being in paid work helps take the pressure off their day-to-day living costs and gives people a sense of pride and belonging.
“They also gain valuable new skills and knowledge, and build relationships that are beneficial to the businesses they work for while enhancing their future employment prospects.”
But Robertson puts a brave face on forecasts that unemployment will gradually rise from its historically low level, pointing out that “does not necessarily mean that those who have found work after being out of employment for some time will be affected”.
“The Reserve Bank has operational independence over monetary policy and how it balances its dual mandate of price stability and maximum sustainable employment,” he also makes clear.
To the extent that wage rises driven by labour shortages in certain sectors of the economy are posing an ongoing inflation risk, is there a better method of controlling them than suppressing overall demand in the economy by raising the official cash rate?
That’s a question that appears to interest Conway, who acknowledges controlling monetary policy through the official cash rate (OCR) is a “very blunt tool”.
The Reserve Bank has more specific tools to target demand for credit in the housing market in the form of loan-to-value ratio controls in the mortgage market and soon, perhaps, debt-to-income ratios as well.
And the Government is understood to have responded to the evidence of rising profits among big businesses by escalating its consideration of competition policy.
It is conceivable that one upshot of the bank’s current review of monetary policy could be a recommendation that it places less reliance on big levers such as the OCR and quantitative easing, and more on more targeted interventions.
Conway says trying to use migration settings to stabilise the business cycle in specific sectors of the labour market would be challenging, given they probably have an even longer time lag between tweak and effect than monetary policy.
But Rebecca Williams says there are other agencies that are thinking through the options.
“Hopefully, that’s what the Ministry of Business, Innovation and Employment is looking at; that is what Treasury’s looking at.
“I don’t think these are tools that just need to come to the bank,” she says.
In keeping with that, Conway says that just because the Reserve Bank doesn’t currently view the 3.3% unemployment rate as “sustainable” doesn’t mean it could never do so.
“We could have a labour market that had a ‘neutral’ unemployment rate that was three-point-something if those structural aspects of the labour market were really humming, if skills mismatches weren’t a thing, and if flexible employment practices meant people were able to work more productively.
“That would be great and we would totally welcome that.”
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