Is 4.7% unemployment really as good as it gets?; Bill English on the future of social investment; Rod Oram on NZ's productivity opportunity

RBNZ acting governor Grant Spencer argued more patience was needed - inflation will come back ... eventually. Photo Lynn Grieveson

In today's email we find a landmine for the incoming Reserve Bank governor to defuse.

1. Is 4.7% really as good as it gets?

Outgoing Governor Grant Spencer did as everyone expected yesterday by holding the Official Cash Rate and forecasting flat interest rates until late 2019, with only two hikes over the following two years.

But a detail revealed in a footnote in yesterday's Monetary Policy Statement (page 5) has put a figurative landmine just inside the Reserve Bank's front door for Adrian Orr to defuse when he arrives on March 27.

The Reserve Bank said its recent research suggested the Non Accelerating Inflation Rate of Unemployment (NAIRU) was around 4.7 percent, which means it thinks the economy is already at full employment. The charts above show the Reserve Bank's forecasts for unemployment and wages, showing it expects any further falls to simply fire up wage inflation.

This is controversial and flies in the face of the new Government's view that unemployment can and should be pushed lower than four percent without a damaging lift in inflation. It argues changes in the structure of the global and local economy that restrict wage inflation have effectively increased the economy's 'speed limit', and that it sees its role partly in offsetting those wage suppression effects through Government action such as pay equity deals and significant increases in the minimum wage.

The MPS was prepared before Wednesday's release of jobs and wages data showing the unemployment rate edged down to 4.5 percent in the December quarter without any major signs of wage inflation taking off, suggesting to many other economists that full employment is lower than the current level. Treasury estimated last year that the NAIRU had fallen to around 4.25 percent and could be as low as 4.0 percent.

Other economists have said the economy can sustainably handle an unemployment rate below 4.0 percent without generating too much inflation, particularly given core inflation has been under the 2.0 percent mid-point of the Reserve Bank's 1-3 percent target range for nearly nine years.

The 4.7 percent measure, which is expected to be detailed in an analytical note to be released in the next week or two, puts the Reserve Bank's existing economic models and economists on a collision course with the Government's target of getting unemployment below four percent.

The accuracy of the Reserve Bank's modelling is a live topic of discussion, given it has over-estimated inflation and under-estimated the productive capacity of the economy over the last five years. Most other economists have done the same as everyone struggles to comes to grips with an unusually long period of low interest inflation and low interest rates globally, and as globalisation and technology change the way many work and are paid. But the question will be whether the Reserve Bank's models have taken those changes (if they are real) into account.

2. 'Just be patient. It's coming'

Spencer and Head of Economics John McDermott stuck to their guns in the news conference and in the select committee hearing, arguing that more patience was required in the long wait for inflation and that the economy was operating at full capacity.

Spencer was asked in the select committee if there was room for the Reserve Bank to cut, but he was unmoved.

"Given the growth story and the capacity story there is going to be the question of when inflation is going to come back," said Spencer.

"We don't think it's a good thing to have policies that chop and change. We have a steady hand on the tiller, rather than having to negotiate each wave," he said.

Spencer also warned that rate cuts would undo the achievement of the last 18 months of moderating house price inflation.

"Any reduction in the interest rates could risk reigniting the housing market, causing debt-to-income ratios to increase. Household debt is very high at 168 percent of the average household income and we're just getting to a point where it's starting to come off," he said.

"The risk is that if we reduce interest rates more people will go out and get mortgages and that debt ratio might start to increase again."

3. 'Be ready for a 2 percent increase'

Even though he said a rate cut remained a possibility if the inflation did not arrive, Spencer was keen to echo (albeit faintly) the warning to home buyers that Graeme Wheeler gave in October 2013.

"They (borrowers and banks) have to be careful to make sure that debt servicing capacity is there at not just today's rates, but rates that are a bit higher," Spencer warned at a press conference.

When asked whether New Zealanders should be preparing for higher rates, Spencer replied that they should be.

"If you are borrowing you should be thinking if you can afford that mortgage at two percent higher than you are paying upfront. I'm not saying that two percent is where rates are going, but that's a typical buffer," Spencer told the news conference.

Spencer was cautious to not predict a certain level for mortgage rates or that they would rise by a definite amount. Wheeler warned in an unusual Op-Ed in the New Zealand Herald in October 2013 that: "we currently expect that the official cash rate could increase by 2 percent from 2014 to the beginning of 2016. This could result in interest rates on first mortgages of 7 to 8 percent."

That never happened.

Wheeler put up the Official Cash Rate by 100 basis to 3.5 percent in mid 2014, but had to lower it by the same amount the next year after the forecast inflation did not arrive. He subsequently had to cut rates even further to 1.75 percent through 2016.

4. Robertson sees Orr revisiting NAIRU

Finance Minister Grant Robertson told me this morning he had long held the view that the changing nature and structure of labour markets here and overseas meant the NAIRU levels talked about by the Reserve Bank needed to be revisited.

"History tells us it is possible to see unemployment fall below these levels without a major impact on inflation," he said.

The Government aimed to get unemployment below 4.0 percent, he said.

"I'm determined we'll get there," he said.

He expected both the Treasury and the Reserve Bank under Adrian Orr to do more work to understand how the changing nature of work was changing relationships between employment growth and inflation.

"I'm sure that the incoming Governor will focus on that, both in terms the changing objectives of the Act and in policy targets agreement," he said.

"There has been a long held and traditional view about the NAIRU at the Reserve Bank and I don't think there's any doubt that the new incoming Government will take another look at that."

"It's a very live issue."

"It's our long held view that we can do better without causing more inflation."

Robertson pointed to the figures in Wednesday's wage figures showing the under-utilisation rate had risen to 12.1 percent in the December quarter and remained significantly higher than before 2007.

He also pointed to modest wage growth in the December quarter figures and the conundrum seen around of the world of strong jobs growth without much wage growth.

"It's a quandary faced all over the world that it (wage growth) hasn't happened. It's a global issue while inflation remains as low as it is," he said.

"Bringing wages up is an important part of what we're working on."

Robertson said he wouldn't be telling the Reserve Bank what to do with interest rates or monetary policy when asked if it should be cutting interest rates to help get unemployment below four percent.

"What the Bank does is their call, but I'm keeping a close eye on where wages are going over the medium term," he said.

5. 'Let's do this and go for productivity'

Rod Oram argues in his regular Friday column for Newsroom Pro that there's never been a better time to build a high productivity and high wage economy.

He gives examples of where and how that could be done, but he also warns there's also a risk the current good times will allow complacency to lock in New Zealand's bad habits.

See his full column here first on Newsroom Pro. It will be published on Newsroom on Sunday.

6. Why Bill English is angry and frustrated

Bill English was just starting to roll out his social investment idea throughout Government when he lost power. His frustration at Labour's reluctance to wholeheartedly adopt the idea was evident in an interview he gave to Newsroom's Thomas Coughlan this week.

Far from being reflective or despondent after his electoral defeat, the former Prime Minister Bill English was actually steaming.

Social investment is close to his heart. It was English's baby - and he wants it back.

English is very defensive of the policy and refuses to brook criticism that it was difficult to understand or implemented without care for privacy concerns.

"It's just the Left don't like it," English says.

"Social investment is simply about making better decisions about how to change lives and making those decisions includes using data and evidence to decide what works and then when you've done it deciding if it worked," he said.

"Now the toolkit happens to be pretty sophisticated, but the alternative to that is flying blind."

See English's full interview with Thomas Coughlan here on Newsroom Pro, where it was first published yesterday.

Also a quick heads up to readers focused on telecommunications. Here's an excellent backgrounder from Tim Murphy this week on Newsroom about the policy debates and jockeying for position over the rollout of 5G mobile networks.

And also see Sam Sachdeva's report from David Parker's defence of the CPTPP last night at a public consultation event in Wellington.

7. One fun thing...

The launch of Elon Musk's SpaceX Heavy and the depositing of a Tesla convertible in orbit grabbed the headlines this week.

It also sparked some great Twitter humour, including this from Tom Sutcliffe:

"Terrible day. Parked my red Tesla convertible outside Cape Canaveral Space Center and I’m pretty sure it’s been towed."

Read the following thread for a good laugh.

8. This morning's political links