Monetary policy is one way of helping the economy get on a better path, but fiscal and structural policy is also necessary, Reserve Bank of Australia Governor Philip Lowe told a CEDA audience in Adelaide.
“As you are aware, the Reserve Bank Board reduced the cash rate to 1.25per cent at its meeting earlier this month. This was the first adjustment in nearly three years,” he said.
“This decision was not in response to a deterioration in the economic outlook since the previous update was published in early May. Rather, it reflected a judgement that we could do better than the path that we looked to be on.
“Monetary policy is one way of helping get us on to a better path. The decision earlier this month will assist us here. It will support the economy through its effect on the exchange rate, lowering the cost of finance and boosting disposable incomes. In turn, this will support employment growth and inflation.
“It would however be unrealistic to expect that lowering interest rates by a quarter of a percentage point will materially shift the path we look to be on.
“The most recent data – including the GDP and labour market data – do not suggest we are making any inroads into the economy's spare capacity. Given this, the possibility of lower interest rates remains on the table.
“It is not unrealistic to expect a further reduction in the cash rate as the Board seeks to wind back spare capacity in the economy and deliver inflation outcomes in line with the medium-term target.
“It is important though to recognise that monetary policy is not the only option, and there are limitations to what can be achieved. As a country we should also be looking at other ways to get closer to full employment.
“One option is fiscal policy, including through spending on infrastructure. Another is structural policies that support firms expanding, investing, innovating and employing people. Both of these options need to be kept in mind as the various arms of public policy seek to maximise the economic prosperity of the people of Australia.
“The central scenario for Australia’s economy is quite reasonable.
“We’re expecting household income to pick up, not just because of the interest rate cuts, but because of the government handing back some of its tax revenue. We see infrastructure investment taking place, the terms of trade are rising again, resource sector investment is going to be positive next year after being negative for five years in a row and a housing market adjustment is coming hopefully as well.
“If it turns out to be weaker than expected, we still have the capacity to lower interest rates.”
Mr Lowe addressed Australia’s labour market and discussed spare capacity in the market.
“The conventional measure of spare capacity in the labour market is the gap between the actual unemployment rate and the unemployment rate associated with full employment,” he said.
“The fact that the conventional estimate of spare capacity is based on the unemployment rate reflects an implicit assumption that if you have a job you are pretty much fully employed.
“In decades past, this might have been a reasonable assumption. But it is not a realistic assumption in today's modern flexible labour market, so we need a broader measure of spare capacity.
“As more and more of us have worked part time, it has become increasingly common to be both employed and to work fewer hours than you want to work.
“In the 1960s, less than one in 10 workers worked part time. Today, one in three of us works part time. Almost one in two women work part time, and more than one in two younger workers work part time. These are big changes.
“Around one-quarter of people working part time are not satisfied with the hours they are working offered and they would like to work more hours. We can think of these people as underemployed.
“The share of part-time workers who are underemployed moves up and down from year to year, and the current share is above its average level over the past two decades.
“One of the successes of the Australian labour market is that we have been able to accommodate this desire for part-time work and flexibility.
“Flexibility in labour supply is evident in the substantial rise in labour force participation. Today, the participation rate currently stands at 66 per cent, which is the highest on record.
“Reflecting this, the share of the working-age population in Australia with a job is currently around the record high it reached at the peak of the resources boom. This is a significant achievement.
“There are two groups for which the rise in participation has been particularly pronounced: women and older Australians. The female participation rate now stands at around 61 per cent, up from 43 per cent in the late 1970s. Australia's female participation rate is now above the average of the OECD, although it remains below that of a number of countries, including Canada and the Netherlands.
“The participation rate of older workers has also increased over recent decades as health outcomes have improved and changes have been made to retirement income policies. These changes are contributing to higher participation by older Australians.”
Discussing wage growth, Mr Lowe said a critical influence on wage outcomes is the balance between supply and demand in the labour market; or in other words, how much spare capacity is there in the labour market at a given point in time?
“One reason why wage growth is weak is because there is still spare capacity in the economy,” he said.
“I think that’s probably at least of the explanation, but the other half is structural. And the structural thing that I see is increased perceptions of competition. Everyone feels like there is more competition out there.
“Why do we all feel there is more competition? I think it is globalisation and technology…it widens the marker and increases the range of competitors.
“Firms are reluctant to put up their prices, they want to keep their costs under control, so they don’t want to give wage increases and workers are nervous.
“It’s affecting both the price and wage dynamics in Australia and actually right around the world. It’s the primary reason why inflation is low everywhere – this perception of competition – and I don’t think it is going to go away anytime soon.”
Mr Lowe also discussed the impact of temporary skilled migration on the labour market.
“While migrants add to both demand and supply in the economy, they can be a particularly important source of capacity for resolving pinch-points where skill shortages exist,” he said.
“When the demand for labour is strong, more people enter the jobs market or delay leaving. This rise in participation is a positive development. But it is one of the factors that has meant that strong demand for labour has not put much upward pressure on wages over recent times.”
Temporary migration: CEDA research report
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