In today's email we asked whether the economy is getting closer to its increasingly hard to define "speed limit".
1. Why we're not at full employment yet
Unemployment's fall to a nine-year low of 4.5 percent begs the question for interest rate setters and watchers: has the economy revved so hard that it is about to generate inflation?
The New Zealand economy performed better than many expected during and after the change of Government in late October. But has it performed so well that the Reserve Bank needs to put up interest rates to contain inflation?
Economists say not yet, but the economy is getting closer to its hard-to-find speed limit. Some think the forces of globalisation, new technology, de-unionisation and low consumer price inflation have effectively increased that speed limit over the last decade.
They say it could allow the Reserve Bank to run the engine faster with lower interest rates, particularly if its new Governor forces its economists to look harder in the economy's engine room to understand why it has run faster for longer with low inflation generally and wage inflation in particular. NZ Super Fund CEO Adrian Orr is not due to start until March 26, but one of the first items on his to-do list will be to find the new speed limit. This morning's Monetary Policy Statement is expected to be a tame affair with no change in either the Official Cash Rate or the bank's interest rate outlook (for no change until well into next year).
Labour force figures for the December quarter that were released yesterday showed the economy in a 'Goldilocks' mode, where it grew jobs at a faster-than-expected rate, but without pushing up wage inflation. The economy was not too hot and not too cold. It was just right.
The unemployment rate fell to a nine-year low of 4.5 percent in the December quarter from 4.6 percent in the September quarter and employment grew 12,000 or 0.5 percent in the quarter. That was more than expected despite lower business confidence and fears by some that the economy slowed around the election.
However, wage growth was relatively modest and broadly in line with expectations, reducing the risks that inflation and interest rates would rise sooner and faster than expected. Economists have been predicting a break out in wage inflation for years, but it failed to appear yet again in the December quarter.
The closely-watched Labour Cost Index measure of quarterly wage inflation in the private sector fell to 0.4 percent in the December quarter from 0.7 percent in the September quarter. Economists had expected growth of around 0.5 percent. Annual LCI private sector wage inflation was unchanged at 1.9 percent and slightly below the market’s expectation of around 2.0 percent. The overall Labour Cost Index for both the private and public sectors and including overtime rose just 1.8 percent for the year. Without the July 1 start of the $2 billion pay equity settlement for aged care support workers, the increase would have been just 1.6 percent.
The economy has been growing for seven years and would usually be generating inflation at this point in the cycle and with unemployment well below five percent.
2. Double digit under-employment
A closer look at yesterday's figures showed there remains some slack in the labour market, with one sign being the surprisingly low wage inflation and a stubbornly high under-utilisation rate, which includes people who are working part-time and want more hours. (Chart above by ANZ)
That rate rose from 12.0 percent to 12.1 percent as the number of people saying they were under-employed rose 7,000 to 122,000. The total number of under-utilised workers rose 6,000 to 343,000.
“This measure is just as important as the unemployment rate,” Labour Market Statistics Senior Manager Jason Attewell said.
Statistics New Zealand’s comments highlighted the amount of slack still left in the labour market before the economy hits its so-called ‘full employment’ or inflation-creating level known as the Non-Accelerating Inflation rate of Unemployment or NAIRU. This is the speed limit that central bankers and economists often refer to when talking about the productive capacity in the economy, although there is more than labour in the economy.
Treasury has forecast the NAIRU is around 4.25 percent, but the Reserve Bank has consistently said it cannot measure it precisely and that the economy is operating near its full capacity. Unemployment fell to 3.3 percent in December of 2007 during the previous Labour Government, but most economists saw that level as inflation generating and above the ‘speed limit’ of the economy. The debate over whether the economy is operating at full employment is even more important this year as the Government reviews the Reserve Bank with the aim of maximising employment.
3. Adrian Orr will have to work it out
ASB Senior Economist Mark Smith sees unemployment falling below four percent later this year without generating too much more inflation.
"There are quite a few factors out there that are holding down aggregate wage inflation and we saw that again today. It's certainly become a lot better. You can run that labour market tighter before you see wages start to pick up," he said.
"There are some structural changes going on. If you look at globalisation, that's one where you're competing not only against other workers in New Zealand, but also globally. That's holding down wages. You've also got very low headline inflation, which with indexation is helping holding down wage inflation."
Technology and the increasing use of 'gig economy' and 'zero hours' work arrangements were also factors, economists said.
"Not only is the pool so much larger, but there's also increasing casualistion of the labour market, particularly in services, which has been a growing part of the economy," Smith said.
He expected Orr to review why core inflation had been below the Reserve Bank's mid-point target of two percent for nine years.
"There'll be some pretty fundamental questions asked about the operation of monetary policy, and whether it's been done to achieve your inflation mandate."
Westpac Senior Economist Michael Gordon said even the low level of real wage inflation (adjusted for consumer price inflation) was puzzling.
"Even real wage growth has been on the low side of what we would expect, given the improvement in the unemployment rate and what businesses are saying about the difficulty of finding workers," Gordon said.
4. Maybe the NAIRU is a dead idea
One idea to explain the higher speed limit (ie a lower unemployment rate) is that the NAIRU or speed limit is past its use-by date completely.
This is mildly heretical for New Zealand economists, given the idea of a trade-off between lower unemployment and higher inflation is a foundational idea in modern macro-economics and a key tool in the inflation-targeting toolkit. It also came out of research by New Zealand's most famous economist, Bill Phillips, who came up with the Phillips Curve to explain this trade-off. What if there was no longer much of a curve and the relationship has broken down?
CTU Economist Bill Rosenberg said the NAIRU may no longer be a functional theory.
"There's a lot of talk in both policy and theoretical circles about it not being stable, and that the theoretical relationship between wages and inflation and unemployment has gone haywire," Rosenberg said.
He said New Zealand should be aiming to get unemployment well under four percent and more towards the 3.3 percent seen a decade ago.
"Treasury has lowered its stable rate of unemployment measure to 4.25 percent, but I think we could get lower than that without causing any significant inflation problems."
Rosenberg was sceptical about whether the NAIRU was ever there, or whether it was used as an excuse to stop legitimate wage increases.
"During the 90s and 2000s, monetary policy functioned to cut off wage increases even when the economy could well have afforded them," he said.
"We could quite easily get down to the mid 3 percent area. We got down to 3.3 percent in 2007 without any great concerns."
That point would be challenged by other economists, given core inflation rose over 3.0 percent in 2007 and early 2008, forcing sharp increases in the Official Cash Rate. Core inflation has since fallen to around 1.4 percent over the last six years.
5. A great doubling of the labour force
Rosenberg argued a range of factors were artificially suppressing wage inflation, including low union coverage in the private sector. Union coverage has fallen from over 60 percent in the early 1980s to 18.7 percent this year, with private sector coverage below 10 percent.
"A large part of it is we've got dysfunctional wage setting systems that leave it up to individuals to bargain with their employer, and that's where a huge imbalance in bargaining power comes through," he said.
"For most people, they're too worried about not only not getting a job or losing their job, but also their future career prospects, to really push on wages. There's very weak pressures from our bargaining institutions.
"On top of that we've got very significant net immigration, which takes pressure off employers offering higher pay, and there's still the threat of offshoring, which is going on constantly."
The biggest factor has been the increasing globalisation of the labour market since the early 1990s, as economies such as Eastern Europe, China and India entered the global trading system, and as technology changes have made it easier for previously closed domestic labour markets to be opened up beyond their borders. Berkeley economist Richard Freeman described 'The Great Doubling' of the global labour force in a now-famous paper published in 2006.
Examples include the likes of Facebook, Google, Uber, Amazon, Netflix and Airbnb allowing consumers to get products and services for much lower prices than when they had to use local producers. These companies often use technology to do work previously done by workers in offices, and can often much lower prices and better service.
The best recent example for this reporter is for business telecommunications services. I am based in the Parliamentary Press Gallery and our phones are about to shifted from a local telecommunications company's plans to Skype for Business, which is owned by Microsoft.
6. Sugar-free carrots and sticks
Newsroom's new gallery reporter Thomas Coughlan reports this morning that the verdict on the tempting idea of a sugar tax is coming in: they don't work as well as many hoped.
So the Government wants to nudge the industry to voluntarily cutting the sugar content of food and drink, but may use the stick of regulation if necessary.
The Government is working with food and drink manufacturers on new voluntary measures to reduce the sugar content of their products, but is leaving open the option of harder regulation if that doesn't work. A sugar tax looks even more remote as the evidence mounts that they don't work and after an official report to the Health Ministry said they were not effective.
Health Minister David Clark told Thomas after receiving the report that the Labour-led Government had no plans for a sugar tax and was instead focused on voluntary sugar reductions.
"Currently breakfast cereals have high health ratings because they've got fibre in them even though they've got really high sugar," Clark said.
He said the first task of the Government was to talk to the industry about some voluntary measures that might be introduced to improve the quality of their food.
Clark said he would expect the industry to voluntarily reduce the content of sugar in their food and to have a wider conversation about sugar substitutes, as well as plainer labelling.
Asked whether allowing the industry to regulate itself was a soft touch, he responded that he preferred an approach where the industry was not the "recipient of regulation that they will then try and work their way around. It's pointless and you don't get an outcome."
He did offer that regulation would be threatened if the industry did not make sufficient moves on its own.
"If that path isn't credible then we're also not afraid to regulate. I'm being clear upfront about that."
Clark said that he had not announced a time-frame for talking to the industry, but it would begin before the end of this parliament.
See Thomas' full piece on the topic on Newsroom Pro, including the evidence around sugar taxes and the arguments in favour of better labelling.
7. Two fun things...
This video of the back of Donald Trump's head as he walks up the stairs to Air Force One on a windy day is revealing in a looking-through-your-fingers-and- grimace kind of way.
And while we're on the subject of Donald Trump's vanity, his latest demand for a military parade in Washington generated this hilarious piece of fake news commentary on the event.
8. This morning's political links
(These are provided in the morning subscriber email)