Jobs, not inflation, key to rates policy

Garry Shilson-Josling, Economist
(Australian Associated Press)

The Reserve Bank frames its commentary on interest rates in terms of its two-to-three per cent inflation target rather than employment – but there’s no doubt the outlook for employment will call the shots.

That’s because in an economy like Australia’s, with a reasonably free labour market, it’s not really possible to achieve an inflation target if the unemployment rate that is too low or two high.

With unemployment too low, wages growth accelerates and pushes prices up, creating a vicious upward spiral in inflation.

But if the economy is too weak and unemployment is too high as a result, wages growth will slow down and the smaller rises in business costs will in turn feed through into inflation that’s below target.

That’s the predicament the RBA – and Australia – is in now.

Slower wages growth can give employers a bit less of an incentive to lay their workers off, but it’s a double-edged sword, as the RBA acknowledged in its quarterly monetary policy statement on Friday.

“While the protracted period of low wage growth has allowed for more employment than otherwise, it has also constrained growth in nominal household income in recent years.”

Combined with the slower growth in the number of people actually earning a wage, that puts a lid on consumer spending.

To illustrate that, over the past 25 years, household disposable income grew an average of 5.8 per cent a year and household consumption spending grew 5.7 per cent.

Over shorter time frames the gap between income and spending growth can vary, but the variation tends to even out over time.

That’s because over the long haul what really drives – and limits – household spending is not consumer confidence or fine judgments about the appropriate level of saving or borrowing, but how much money households actually have to spend.

The RBA – like central banks around the world – is trying to boost spending by cutting interest rates to the bone.

A big part of that strategy is to encourage investment rather than consumer spending.

But even that strategy has run into limits.

Whether it’s real estate, shares bonds or any other asset, prices have risen faster than the earnings the assets generate, making it harder to justify even more borrowing to fund even more investment.

And consumers are limiting their growth in debt-driven spending – wisely, as it turns out, given the sluggish growth in the incomes they’ll have to pay down the debt.

The result in Australia will be more sluggish growth and, as the RBA itself admits, limited prospects for the jobless rate to fall over the coming two or three years.

That’s why the money market has factored in the likelihood of another interest rate cut , most likely some time early next year.

And it’s why, if that cut is made, the market will very possibly be looking toward another.


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