Reserve Bank’s path to a soft landing is very narrow indeed

The RBA has always interpreted its inflation target as being “flexible”, meaning the response to inflation was balanced with the impact of rates on employment. It has a dual, not duelling, mandate. And we now have a slightly clearer articulation of what the RBA has already done for three decades.

The RBA seems to be getting the gentle easing in labour market conditions it wants. But that easing may not be enough.

Given employment is central to the Reserve Bank’s decision-making, a first question is, how tight is the labour market?

The unemployment rate, having resembled a yo-yo for the past year, sits at 4 per cent, up from its near 50-year low of 3.5 per cent. But this is still below the RBA’s own estimate of the rate of unemployment consistent with stable inflation (the NAIRU or non-accelerating inflation rate of unemployment). This implies that the tight labour market is contributing to strong wage growth and above-target inflation.

However, the unemployment rate is no longer the best measure of labour market tightness. Back in the 1980s, four in five workers were full-time, a time when a home was affordable with a single full-time income. Counting the number of people who didn’t have a job was a reasonable measure of labour market slack.

But now almost half of people work part-time. Increased part-time work reflects changes in how businesses operate and labour laws, as well as people’s preferences.

Some part-time workers want more hours, and that exerts downward pressure on wage growth even though they are already employed. Some unemployed people want to work full-time but others are searching for part-time jobs.

Difficult trifecta

Just counting the number of people looking for work no longer captures labour spare capacity; the number of hours they want to work matters.

The Australian Bureau of Statistics publishes an hours-based labour underutilisation rate, which is the sum of an hours-based unemployment rate and underemployment (those employed wanting to work more hours). While the ABS publishes only a quarterly measure, the RBA uses unpublished ABS data to calculate a monthly underutilisation rate.

The ABS has made great strides to better serve statistics users, helping to underpin better analysis. Given the increasing importance of the underutilisation rate, a next improvement could be publishing a monthly estimate.

The second question is then, what does labour underutilisation tell us about the chances of a hike?

The RBA is trying to engineer a soft landing: increased spare labour but without a large increase in unemployment, as in the 1980s and 1990s recessions. Governor Michele Bullock has said the bank is focused on maintaining employment gains.

This suggests it wants an easing akin to that in 2012 (following the 2009-10 tightening of monetary policy), when unemployment increased but so did employment (population growth makes this add up).

Up to now, the increase in the hours-based unemployment rate has been smaller than in 2012. However, this rate has increased by more than in 2012, demonstrating that this margin of adjustment is now much more important. All up, the hours-based underutilisation rate is tracking in line with the 2012 slowdown: the RBA seems to be getting the gentle easing in labour market conditions it wants.

However, that gradual easing in labour tightness may not be enough. The governor has said the RBA expects the unemployment rate to increase up to their estimate of the NAIRU, 4.3 per cent.

But in 2012, the easing in wage growth came with the unemployment rate increasing above the NAIRU. That suggests further rate rises might be needed to moderate wages and inflation, making it harder for the RBA to land the trifecta of a gentle increase in labour spare capacity with employment still growing and inflation back at target. The RBA’s narrow path is very narrow indeed.