Can the economy reach full employment? Treasurer Josh Frydenberg's department thinks it can.(ABC News: Adam Kennedy)
Do you feel like the economy is heading towards full employment?
Apparently we are, ifyou believe the forecasts in last week's federal budget.
It's a questionable idea,but it's fascinating how we got here. It involveda massive amount of fiscal stimulus, loose monetary policy, and closed borders.
And it's raised real questions about theusual way of doingthings.
Have we everhadfull employment?
We've talked full employment before, but let's revisit someof the key ideas quickly, so we can see how different things are today.
Australia used to have a policy of genuine full employment.
It lastedfrom 1946 to 1975.
During that period, the unemployment rate was keptunder 2 per cent, on average.
And in that era, in 1960, theReserve Bank of Australia wascreated. Its foundingcharterreflectedthe spirit of those full employment days.
Now, the old full employment polices had obvious problems, because they were built around the male breadwinner model.
But they underpinned three decades of growth after World War II, with rising living standards and theexpansionof the middle class.
However, when Australia's economy was hit by stagflation in the 1970s, and the unemployment rate jumped to double digits,policymakers abandoned their old commitment to full employment amid the chaos.
They embraced a new theory that said higher levels of unemployment could benatural for prevailing conditions.
And they adopteda new definition: full employment would bethe level of unemployment that kept a lid on inflation (that is, whatever stoppedwages and prices growing too quickly).
The ugly term for that level of full employmentwas the NAIRU, or non-accelerating inflation rate of unemployment.
Under the NAIRU regime, the economy could apparently be in full employment when the unemployment rate was 4 per cent, or 6 per cent, or 8 per cent or higher.
It dependedon conditions.
And that's what full employment still meanstoday, when you hear policymakersreferring to it.
Now,the NAIRU concept hasalways had its critics.
And at the beginning of last year, Professor Ross Garnaut, a professorial research fellow in economics at the University of Melbourne, criticised its use as a policyguide.
He said it had condemned hundreds of thousands of Australians to involuntary unemployment.
He said thedecision to allow so many people to languish in unemployment in recent years, to suppress wages and inflation, as part of the country's broader economic policy settings, had immiserated people and cost the economy hundreds of billions of dollars in lost economic activity.
We should returnto genuine full employment, he said.
Healso pointed out that policymakers had repeatedly miscalculatedthe NAIRU anyway, and said they should stop guessing where full employment could be.
He said they should just drive unemployment down until wages picked up.
He estimated we could hit an unemployment rate of 3.5 per cent or lower — the lowest it's been since the 1970s — before that happened.
When he made those criticisms last year, the unemployment rate was6.4 per cent.
So, what's happened since then?
A switch in budget strategy
Quite a lot.
A couple of months after Professor Garnaut's critique, Treasurer Josh Frydenberg said he wanted to usehis next federal budget to prioritise pushing unemployment down.
He was talking aboutlast year's budget.
Mr Frydenberg said he wanted toprioritisegetting people into jobs, so hewasn't going to deliveran austerity budget bychasing a budget surplus.
It wasa radical departure from previous Coalition thinking.
He said Treasury and RBAofficials had come to believe that the unemployment rate would need to have a four in front of it before wage pressures began to build, so that's what he wanted to do.
But then he went further.
He co-opted the Keynesian argument thatif you concentrate on getting asmany people as possible working, the budget will repair itself over time.
It was brazen, because the Coalition had got into power in 2013 by arguing the exact opposite.
I want to come back to this point.
Full employment was not as full as first thought
A few weeks after Mr Frydenberg's budget volte-face last year, Treasury officials published a paper thatadmitted their estimateof the NAIRU had probably been wrong for the five years leading up to the pandemic in 2020.
They said theirmodel had suggested Australia's economy would be close to full employmentwhen the unemployment rate was roughly 5 per cent.
But they now thought the economy could probably havehandled a lower level of unemployment over those five years to 2020, say somewhere between4.5 per cent and 5 per cent.
It was some kind of progress.
For those five years, Australia's unemployment rate hadn't fallen below 5.1 per cent. Wages growth had slowed to record lows. Inflation didn't get above 2 per cent.
We were nowhere near full employment.
Butwould anunemployment rate of 4.5 per cent have been low enough to turnthose weak wage dynamics around?
Hardly.
That's why someeconomists welcomed Treasury's mea culpa, but said its updated NAIRU estimatewas still nonsensical.
Then unemployment falls quickly
At any rate, once Treasury officials convincedMr Frydenberg of the benefits of using fiscal policy, in last year's budget, to driveunemployment down hard, the economy was set on a certain path.
And during the next 12 months,Australia's labour market became far tighter than many predicted.
Due to a unique combination of massive fiscal stimulus, historically-loose monetary policy, closed international borders, and a widely-vaccinated population, the unemployment rate was driven down rapidly to 4 per cent.
And that's where it's sitting now:ata 13-year low.
It's seen the employment-to-population ratio, and the participation rate, both hitrecord highs.
Underemployment has fallen significantly.
And a senior economistat ANZ thinks the unemployment rate could even fall to3.3 per centby the end of this year.
Last week's budget
So, what about last week's federal budget?
Well, it included another new NAIRU estimate.
Apparently, Treasury officials now think the economy could be in full employment with an unemployment rate of 4.25 per cent.
So they've lowered the NAIRU again.
The unemployment rate has fallen faster and lower than previously expected, without generating substantial wage increases, thebudget papers said.
Theunderlying level of spare capacity and underemployment present in the economy may not have been captured in the previous NAIRU assumption.
Additionally, structural changes may have altered the wage and price setting dynamics in a way which was not fully reflected in earlier estimates.
Whoops.
But no matter.
Treasury isnow forecastingthe unemployment rate to fall to 3.75 per cent in the September quarter, and to remain there until the end of 2024-25. We're talking 1970s levels of unemployment.
And note that detail?
They're assumingthe unemployment rate willsit around 3.75 per cent for more than two years, while the NAIRU will be sitting at a higher level, at 4.25 per cent.
So, they're thinking the labour market will likely experienceover-full employment for more than two years.
Then, after 2024-25, they assume the unemployment rate will steadily transition back up to the NAIRU.
Itpushed potential output higher
Which brings us to the final section.
Remember how Mr Frydenberg said, before last year's budget, that he wanted to prioritise employment growth, and that it would drive budget repair over time?
Well, last week's budget provided some evidence of that strategy working.
It showed that, as the labour force has grown to a record size, and the unemployment rate has been driven down hard within that larger labour force, there are more people available to produce goods and services over the medium term.
That's resulted in a higher level of potential GDP by the end of the medium term.
Higher potential output largely reflects an increase in the size of the productive workforce associated with a permanently lower unemployment rate, the budget papers said.
So, instead of relying on high population growth to be a major driver of potential growth, which they've been doing in recent decades, we've been able to recover from the recession, and lift potential output again, by drawing down heavily on the pool of local unemployed people.
It's seen the number of unemployed people fall to levels last seen over a decade ago, along with higher-than-expected tax receipts and lower welfare payments.
It's another fascinating outcome of theexperiment we've beenrunning.
https://www.abc.net.au/news/2022-04-03/are-we-heading-towards-full-employment/100957058
