objectives. the connection with the second objective – full employment – is obvious. the rba is seeking to achieve the lowest rate of unemployment that can be sustained without inflation becoming an issue. in doing this, one of the questions we face is what constitutes full employment in a modern economy where work arrangements are much more flexible than they were in the past. i will return to this issue in a moment. the labour market is, of course, also central to the third objective in our mandate – our collective welfare. it is stating the obvious to say that for many australians, having a good job at a decent rate of pay is central to their economic prosperity. trends in the labour market also have a major bearing on inflation outcomes, so they are important for the first element of our mandate as well. over time, there is a close link between wages growth and inflation. and 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? this question is closely linked to the one about what constitutes full employment. so, it is natural that we focus on the labour market as the board makes its monthly decisions about interest rates. spare capacity with that background i would now like to discuss how we assess the degree of spare capacity in the australian labour market. i will do this from four perspectives : 1. the rates of unemployment and underemployment 2. the flexibility of labour supply 3. the effectiveness with which people are matched with job vacancies 4. trends in wages growth. unemployment and underemployment 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. even at full employment, some level of unemployment is to be expected as workers leave jobs and search for new ones. as my colleague luci ellis discussed last week, we don't directly observe the unemployment rate associated with full employment – we need to estimate it. [ 1 ] over recent times there has been a gradual accumulation of evidence which has led to lower estimates. while it is not possible to pin the number down exactly, the evidence is consistent with an estimate below 5 per cent, perhaps around 4½ per cent. given that the current unemployment rate is 5. 2 per cent, this suggests that there is still spare capacity in our labour market. the fact that the conventional estimate of spare capacity is based on the unemployment rate reflects an implicit

the labour market. 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. the matching of people with jobs a third perspective on spare capacity in the labour market can be gained from examining how well people looking for jobs are matched with the jobs that are available. looking at the labour market from this perspective, things look a little tighter than suggested by the other two perspectives that i have discussed. currently, almost 60 per cent of firms report that the availability of labour is either a minor or a major constraint on their business ( graph 7 ). this share is not as high as it was during the resources boom, but it is still quite high. reports from the rba's liaison program suggest that there are currently shortages of certain types of engineers, workers with specialised it skills and some tradespeople associated with public infrastructure work. businesses in regional areas are also more likely to report a greater degree of difficulty finding suitable labour. graph 7 one contributing factor here is an underinvestment in staff training. in the shadow of the global financial crisis many firms cut back training to reduce costs. we are now seeing some evidence of the adverse longer - term implications of this. as the labour market tightens further, i would hope that more firms are prepared to hire workers and provide the necessary training. another lens on job matching is the ratio of the number of unemployed people to the number of job vacancies ( graph 8 ). at present, there are fewer than three unemployed people for each vacancy. this compares with over 20 people for every vacancy in the early 1990s recession and five people for every vacancy in 2014. from this perspective the labour market looks reasonably tight. there is also some tentative evidence that, on average, unemployed workers are not as well matched to job vacancies as was the case in 2007, when the ratio of the two was at a similar level. graph 8 one such piece of evidence is that as the unemployment rate has come down over recent years, there has been little progress on reducing very long - term unemployment, defined as those who are unemployed for more than two years ( graph 9 ). addressing the causes of this chronic unemployment remains an important challenge for our community. more positively, the share of the labour force that has been unemployed between one and two years has trended down