Speech
The Labour Market and Monetary Policy
[*]
Philip Lowe
Governor
Economic Society of Australia (QLD)
Online - 8 July 2021
I would like to thank the Economic Society of Queensland for the invitation to speak today. I was
looking forward to my first trip to Brisbane in 18 months, but given the current lockdowns that will
have to wait for another day.
When I spoke at this lunch 2 years ago, I talked about the accumulation of evidence that Australia
could sustain an unemployment rate below 5 per cent without inflation becoming a problem. I also
raised the possibility that the Reserve Bank would soon cut the cash rate to help secure both lower
unemployment and inflation consistent with the target.
Since then, a lot has happened: a global pandemic and the biggest peacetime economic contraction
in our lifetimes; and not only did the RBA cut the cash rate, but we cut it as far as we reasonably
could and the RBA's balance sheet has nearly tripled to over $500 billion. So a lot has changed since
we last met.
Even so, I would like to return to the same 2 themes that I talked about 2 years ago: first, the
possibility of sustaining low rates of unemployment; and second, how the RBA's monetary policy
strategy is contributing to this.
I will begin with a brief update on recent labour market developments. I will then discuss the supply
side of the labour market and its implications for wage and inflation outcomes. And finally, I will turn
to the Reserve Bank Board's decisions earlier this week.
Recent developments
The recovery of the Australian labour market this year has been remarkable. The number of
Australians in a job has increased by over 250,000 since the turn of the year and the level of
employment is now 1 per cent above its pre-pandemic level. The unemployment rate has also fallen
sharply, and is now around the same rate as it was just before the pandemic (Graph 1).
Graph 1
Unemployment Rate
Seasonally adjusted, monthly
% %
7 7
6 6
5 5
4 4
2011 2013 2015 2017 2019 2021
Source: ABS
This sharp decline in unemployment has come as a welcome surprise. Back in February, we expected
the unemployment rate to now be around 61⁄2 per cent and not reach the low 5s until the second
half of 2023. Yet, here we are now. Labour force participation is near its record high,
underemployment is the lowest it has been in nearly a decade and job vacancies are at a record high
level. These outcomes point to the resilience of the Australian economy and the effectiveness of the
health and economic policy response.
One source of uncertainty for the near term is the recent outbreaks of the virus and the lockdowns.
We are watching developments carefully, but it is important to remember that Australia's experience
has been that, once an outbreak is contained and restrictions are lifted, the economy and jobs
bounce back quickly.
It is noteworthy that the positive surprises on jobs have not been matched with equivalent surprises
on wages and prices. The Wage Price Index (WPI) increased by just 11⁄2 per cent over the past year
and recent outcomes have been broadly in line with our earlier expectations (Graph 2). The same is
true for inflation.
Graph 2
Wage Price Index Growth*
% %
Year-ended
4 4
3 3
2 2
Quarterly
1 1
0 0
2001 2006 2011 2016 2021
*
Total hourly rates of pay excluding bonuses and commissions
Source: ABS
This combination of surprisingly positive employment growth and subdued wages growth had
become a familiar pattern before the pandemic. This is evident in the next couple of graphs. The first
shows the RBA's successive forecasts for growth in the WPI from 2014 (Graph 3). The picture is very
clear: wages growth was persistently lower than forecast. The next graph is similar, but shows
successive forecasts for the level of employment (Graph 4). The picture here is not quite as clear,
but employment growth has mostly been in line with, or exceeded, expectations, with the obvious
exception of last year.
Graph 3
Wage Price Index Forecasts*
Year-ended
% %
Actual
2014
3 3
2017 2019
2015
2016
2021
2018
2 2
2020
1 1
0 0
2013 2015 2017 2019 2021 2023
*
May SMP forecasts
Sources: ABS; RBA
Graph 4
Employment Forecasts*
Year-ended
'000 '000
2021
2019
13.0 13.0
2018
12.5 12.5
2016
2017
12.0 12.0
2020
2014
2015
11.5 11.5
Actual
11.0 11.0
2013 2015 2017 2019 2021 2023
*
May SMP forecasts
Sources: ABS; RBA
As you would expect, we have been seeking to understand this experience and its implications for
our policy settings.
One straightforward explanation is that the low wage growth encouraged firms to substitute labour
for capital, with the result being that employment grew quickly. The more important part of the
story, though, is that the strong growth in labour demand was closely matched by a strong increase
in labour supply. With both demand and supply rising, there was little need for the price - that is
wages - to move.
The supply side
There are 3 elements of the supply story that I would like to touch on:
the rise in labour force participation
the ability of firms to tap into overseas labour markets when workers are in short supply
in Australia
the trend rise in underemployment.
Labour force participation
Labour force participation has been trending up since the middle of the previous decade and is
currently around its record high (Graph 5). This upward trend was unexpected, coming after a
decade of broadly sideways movement and the ageing of the population. The increase has been
particularly large for women. There has also been a rise in participation by Australians older than 55
(Graph 6).
Graph 5
Participation Rate
Seasonally adjusted, monthly
% %
65 65
63 63
61 61
2001 2005 2009 2013 2017 2021
Source: ABS
Graph 6
Participation Rates*
Monthly
% %
Females Males and females, aged 55+
60 40
58 35
56 30
54 25
52 20
2003 2012 2021 2003 2012 2021
*
Female participation rate is seasonally adjusted; males and females,
aged 55+ series is non-seasonally adjusted
Source: ABS
This recent trend reflects a mix of factors, including: the wider availability of flexible and part-time
work; changes to child care arrangements; improved health outcomes for older Australians; and
changes in the pension age. It is possible that higher debt levels and the decline in asset values
during the financial crisis have also played a role.
The most important of these factors is the increased availability of flexible and part-time work, with
one in 3 workers now working part time. As hours of work have become more flexible, it has become
easier for people with caring responsibilities and older Australians to participate in the paid
workforce.
This change has coincided with another shift in the economy - that is, an increase in demand for
health services and social assistance, which has led to very strong growth in jobs in these areas.
Many of these jobs are able to be performed by people who are seeking part-time and flexible work.
So there has been a broadly parallel increase in labour demand and labour supply, and this has
lessened the upward pressure on wages.
Drawing on overseas labour markets
The second supply side factor is the ability that firms have had to draw on overseas workers when
skills or workers were in short supply in Australia. In some cases, firms hired workers from overseas
directly to fill specific gaps, but in other cases they hired people who were already in Australia for
other reasons, including to study and on working holidays.
It is useful to distinguish the effects of this ability to draw on overseas labour markets from the
impact of immigration more broadly. Immigration adds to both the supply of, and demand for,
labour: when immigrants work they supply labour and their consumption of goods and services adds
to the demand for labour. The precise balance between this extra labour supply and extra labour
demand is difficult to determine and depends upon the specific circumstances.
The picture, though, is clearer when firms are hiring workers to overcome bottlenecks and fill specific
gaps where workers are in short supply. This hiring dilutes the upward pressure on wages in these
hotspots and it is possible that there are spillovers to the rest of the labour market. This hiring can
also dilute the incentive for businesses to train workers to do the required job.
On the positive side of the ledger, hiring overseas workers to overcome bottlenecks allows firms to
hire the people they need to operate effectively, and to expand and invest. This benefit was clearly
evident during the resources boom, and there are a wide range of businesses and industries that
have benefited from hiring foreign workers. Without this ability, output in Australia would have been
lower.
At the time of the previous census (in 2016), there were around 430,000 people working in Australia
on temporary visas. In the food trades, these workers filled around 18 per cent of all jobs; and in the
hospitality sector, they filled 13 per cent of jobs (Graph 7). Most of these workers were on either
temporary visas for skilled workers or student visas. In contrast, in the farm sector it was more
common for workers to be on working holiday visas.
Graph 7
Temporary Migrant Employment
Share of employment by occupation and visa type, 2016
Food trades
Hospitality
Cleaning &
laundry
Food preparation
Factory processes
Farm, forestry &
garden
ICT professionals
Carers & aides
Sales workers
0 5 10 15 %
Temporary Work (Skilled) Student Other*
*
Includes Working Holiday Maker visas, other Temporary visas and Bridging visas
Sources: ABS; RBA
In conceptual terms, one can think of this ability to tap into the global labour market for workers that
are in short supply as flattening the supply curve for these workers. A flat supply curve means that a
shift in demand has only a small effect on prices, or in this case wages. In my view, this is one of the
factors that has contributed to wages being less sensitive to shifts in demand than was once the
case.
Underemployment
The third element of the labour supply story is underemployment.
When somebody is underemployed they are, by definition, willing to supply more labour, generally at
the prevailing wage. This means that when demand is strong, businesses are able to call on
underemployed workers to supply more hours without much upward pressure on wages. And then,
when demand is soft, hours can be scaled back.
Underemployment has become a much more prominent feature of the Australian labour market over
the past couple of decades. Today, over 7 per cent of the labour force report that they are
underemployed - more than double the rate in the 1980s (Graph 8). Most of these people work part
time and, on average, are looking for an extra 14 hours per week. In aggregate, these extra hours
amount to around 3 per cent of total hours available to be worked in the economy.
Graph 8
Underemployment Measures*
% %
10 10
Heads-based**
5 5
Hours-based***
0 0
1981 1989 1997 2005 2013 2021
*
Full-time workers on part-time hours for economic reasons and
part-time workers who would like, and are available, to work more hours
**
Share of the labour force
***
Share of potential hours
Sources: ABS; RBA
The rate of underemployment varies significantly across industries and is highly correlated with the
share of workers who work part time (Graph 9). For example, the underemployment rate in the
accommodation and food services sector is around 20 per cent, while in mining it is less than
1 per cent.
Graph 9
Underemployment by Industry
2019 average, share of industry employment
% %
20 20
15 15
10 10
5 5
0 0
food
Retail
& Mining
support
services
& Transport
recreation Education
Wholesale production
Agriculture
Healthcare
&
Construction
Accom
Admin
Arts
goods
business
Other
Other
Sources: ABS; RBA
The high rates of underemployment mean that hours of work have become an important margin of
adjustment in the Australian labour market. Hours can be scaled up and down when demand
changes, rather than the alternative of people being hired and fired. The benefits of this were
evident during the pandemic and the financial crisis more than a decade ago. Reflecting this, the
RBA has for some time been paying attention to both unemployment and underemployment when
assessing the degree of spare capacity in the labour market.
Cost control
Together, these 3 supply side factors help explain the labour market and wage outcomes over recent
times. Strong labour demand was met with a strong supply response. The result was that the price
of labour did not move much.
A related factor I have spoken about recently is the laser-like focus on cost control in Australian
[1]
business over the past decade or so. This focus has made firms wary of increasing wages, lest it
hurt their competitiveness in an environment where it is difficult to increase prices. Many have
instead relied on non-wage alternatives to attract and retain staff. Higher wages have often been
seen as a last resort, especially in an environment where the supply side of the labour market is so
flexible.
There has also been a shift by some firms towards variable, as opposed to fixed, remuneration. This
has the advantage to the business of avoiding a permanent increase in the cost base, but allowing
higher remuneration to be paid for a time. This change is evident in the WPI measure including
bonuses, which for most of the available history increased at the same rate as the measure
excluding bonuses (Graph 10). But in the second half of the previous decade, the measure including
bonuses increased at a faster rate as firms competed for workers.
Graph 10
Wage Price Index Growth
Year-ended
% %
4 4
3 3
Excluding bonuses and commissions
2 2
Including bonuses and commissions*
1 1
0 0
2001 2006 2011 2016 2021
*
Not seasonally adjusted
Source: ABS
The outlook
So what does this all mean for the future?
The big change on the supply side has been the closure of our international borders. This has
contributed to labour shortages in some areas given the strong pick-up in labour demand. In turn,
some workers have received sizeable wage increases. However, the spillover effects to the broader
labour market have been limited to date, and wage increases remain modest for most workers. Most
firms retain their strong focus on cost control, with many preferring to wait things out until the
borders open, and ration output in the meantime.
The impact of this change on the supply side is evident in the sharp jump in the number of job
vacancies, especially in the accommodation and food services sector (Graph 11). Whereas previously
some of these vacancies could have been filled by people on visas, this is now more difficult to do.
Since March 2020, the number of people in Australia on a visa with the right to work has fallen by
over 250,000, which is a significant decline.
Graph 11
Employment and Vacancies
in Accommodation & Food Services
Cumulative change since 2011
'000 '000
100 20
Employment
(LHS)
50 10
0 0
Vacancies*
(RHS)
-50 -10
-100 -20
-150 -30
2011 2013 2015 2017 2019 2021
*
Seasonally adjusted by the RBA
Sources: ABS; RBA
Given this experience, an important consideration for the outlook is how long the borders remain
closed.
One plausible scenario is that they open gradually over the period ahead, especially for workers with
skills that are in short supply. This would relieve some of the current pressure points in the labour
market. Alternatively, it is also possible that the borders remain closed for an extended period and
that the pressure points build further. If so, aggregate wages growth would pick up more quickly
than currently expected, but production and investment would be also be constrained.
In terms of domestic labour force participation, we are expecting further increases, but not a repeat
of the large increase since the middle of the previous decade. Increased job opportunities are
expected to continue to draw more people into the labour market. In addition, the more flexible work
arrangements that are a legacy of the pandemic make it easier for some people to participate in the
labour market. The reforms to child care should also help, although the ageing of the population
works in the other direction.
With all these moving parts, and the uncertainty about the future strength of labour demand, it is
challenging to determine exactly when the spare capacity in the labour market will be absorbed and,
hence, when we can expect a sustained lift in wages growth.
While it is hard to be sure, it is likely that the unemployment rate will need to be sustained in the low
4s for the Australian economy to be considered to be operating at full employment.
Underemployment will also need to decline further. To achieve this, a further period of strong
employment growth will be required.
One consideration here is that the closure of the borders is making it more difficult to match workers
with jobs, opening the possibility that more generalised labour shortages occur at a higher rate of
unemployment than we would have expected. Another source of uncertainty is the lack of historical
experience upon which to draw. In the past 4 decades, the only time that Australia has had an
unemployment rate close to 4 per cent was during the peak of the resources boom. So there is some
uncertainty about how aggregate wages will respond at lower rates of unemployment.
Given this lack of historical experience, 2 of my colleagues at the RBA - James Bishop and Emma
[2]
Greenland - have approached this issue from a different angle. In particular, they have examined
the relationship between the unemployment rate in nearly 300 individual local labour markets across
Australia and the average increase in labour income in these markets using data from the Australian
Taxation Office. The results are shown in Graph 12. The vertical axis shows how much growth in
income in a particular labour market varies from the average and the horizontal axis shows the
unemployment rate in each of the local labour markets.
Graph 12
Employee Income Growth and Unemployment
Based on 289 local labour markets for the period 1998/99-2017/18
ppt
1.5
Estimated
1.0
average)
relationship
growth*
0.5
overall
income
0.0
from
-0.5
Employee
(deviation
-1.0
-1.5
0 2 4 6 8 %
Unemployment rate
*
Average of all labour markets with a particular unemployment rate (to
the nearest 0.1 ppt) in a given year; the size of each dot is proportional
to the number of region-year observations at each level of
unemployment
Sources: ABS; National Skills Commission; RBA
These results suggest a clear relationship: the lower unemployment is, the higher is relative income
growth. This relationship is stronger when the unemployment rate in a local labour market dips
below 5 per cent and strongest when unemployment dips below 4 per cent.
While these results are subject to a range of qualifications, they suggest a couple of conclusions.
First, tighter labour markets do generate stronger wage increases - the laws of supply and demand
still work. And second, the relationship seems to be stronger at unemployment rates below
5 per cent.
These are important conclusions from a policy perspective, especially given the RBA's strategy is to
get the unemployment rate down so that wages growth picks up and inflation returns in a
sustainable way to the target range.
Monetary policy
This brings me to our monetary policy decisions earlier this week. At our meeting on Tuesday, the
Reserve Bank Board agreed to:
retain the April 2024 bond as the bond for the yield target and retain the target of
10 basis points
continue purchasing government bonds after the completion of the current bond purchase
program in early September. We will purchase $4 billion a week until at least mid
November
maintain the cash rate target at 10 basis points and the interest rate on Exchange
Settlement balances of zero per cent.
These measures will provide the continuing monetary support that the economy needs as it
transitions from the recovery phase to the expansion phase. They will help lower unemployment and
underemployment further and, in time, see inflation return to the 2 to 3 per cent target range. The
Board is committed to achieving the goals of full employment and inflation consistent with target.
The bond purchase program is helping us to make progress towards those goals. We decided to
continue purchasing bonds because we are still some way from reaching those goals. However, at
the same time we are responding to the stronger-than-expected economic recovery and the
improved outlook by adjusting the amount purchased each week. This is consistent with the
framework that we previously set out. Under that framework, bond purchases are reviewed in terms
of: their effectiveness; the decisions of other central banks; and, most importantly, the progress
towards our goals for inflation and employment.
We are seeking to provide as much guidance about future bond purchases as we reasonably can in
an uncertain world, while retaining the flexibility to respond in a timely way to changes in the state
of the economy and the outlook. So we will be reviewing the size of our bond purchases again at our
November meeting.
In terms of interest rates, the condition that the Board has set for an increase in the cash rate is that
inflation is sustainably within the 2 to 3 per cent range. It is not enough for inflation to be forecast in
this range. We want to see results before we change interest rates. The bond purchases will end
prior to any increase in the cash rate.
For inflation to be sustainably in the 2 to 3 per cent range, it is likely that wage growth will need to
exceed 3 per cent. That is on the basis that labour productivity continues to increase and that the
labour share of national income remains broadly steady. The current rate of wage growth is
materially less than 3 per cent. Partly for the reasons I have discussed, we still expect the lift in
aggregate wages growth will be gradual. We also expect that it will take until 2024 for inflation to be
sustainably within the 2 to 3 per cent target range.
I would like to close by reiterating the 2 points I made earlier in the week.
The first is that the condition for an increase in the cash rate depends upon the data, not the date; it
is based on inflation outcomes, not the calendar.
The second is that the step-down in the RBA's bond purchases from $5 billion to $4 billion a week
does not represent a withdrawal of support by the RBA. The evidence is that central bank bond
purchases have their impact through the total stock of bonds purchased, not the flow of those
purchases. By mid November, our cumulative purchases under the bond purchase program will have
amounted to $237 billion. We will hold a little more than 30 per cent of Australian government bonds
on issue and 15 per cent of state and territory bonds. This represents a substantial and ongoing
degree of support to the Australian economy. The adjustment in the rate of weekly purchases does
not change this.
Let me conclude on that note.
Thank you for listening. I am happy to answer your questions.
Endnotes
[*] I would like to thank Mark Chambers for assistance in the preparation of this talk.
[1] Lowe P (2021), 'From Recovery to Expansion', Keynote Address at the Australian Farm Institute Conference,
Toowoomba, 17 June.
[2] Bishop J & E Greenland (forthcoming), 'Is the Phillips Curve Still a Curve? Evidence from the Regions', RBA Research
Discussion Paper.
The materials on this webpage are subject to copyright and their use is subject to the terms and conditions set out in the Copyright
and Disclaimer Notice.
© Reserve Bank of Australia, 2001-2021. All rights reserved.
The Reserve Bank of Australia acknowledges the Aboriginal and Torres Strait Islander Peoples of Australia as the Traditional Custodians of this
land, and recognises their continuing connection to Country. We pay our respects to their Elders, past, present and emerging.