Free Exchange in The Economist had an article which looked at the change in terminology used by Janet Yellen chairman of the Federal Reserve. In a recent statement she alluded to the US economy near maximum employment and that rate rises could ensue. However only 69% of American adults have a job.
Full employment has normally been the concept that has been used to describe a situation where there is no cyclical or deficient-demand unemployment, but unemployment does exist as allowances must be made for frictional unemployment and seasonal factors – also referred to as the natural rate of unemployment or Non-Accelerating Inflation Rate of Unemployment (NAIRU). If a central bank wishes to stimulate demand below this level there is the concern that inflation will increase therefore they take a guess as to what is the natural rate of unemployment – the lowest rate of unemployment where prices don’t accelerate. Maximum unemployment is the same in that it refers to the labour market being as tight as it can be without increasing prices. Natural rates in the US have varied – around 5.3% in 1950 and then peaking at 6.3% in the stagflation period before falling 4.9% in 2008 and then rising to 5.1% after the GFC, see graph below.
NRU and its causes
The NRU mainly depends on the level of frictional unemployment – defined as those who are in between jobs. This number can vary as at different times of the business cycle as there can be a delay in matching those looking for work with the vacancies themselves – a mismatch sometimes referred to as Structural Unemployment. The increase in frictional unemployment in the 1970’s and 80’s was largely due to the decline in manufacturing jobs with the advent of automation and more right wing policies (Reagan and Thatcher). Workers would stay unemployed in the hope that good high paid manufacturing jobs would reappear.
Unions can also influence the NRU with protecting workers jobs and pushing up wages so that employers find it too costly to employ more labour. However the fall in the 1990’s could be due to the advent of technology in the hiring process and the growth of part-time jobs which assisted those workers facing a career change.
Another influence on the NRU is wage growth as with the higher wages you attract more of the labour force to engage in actively looking for work.
A central bank will have to use trial and error to make a decision on how much spare capacity there is in an economy. Only when prices start to increase do they have an idea how capacity is running.
Quality not Quantity
As alluded to by The Economist the goal of full employment must consider the quality of jobs as well. With the acceleration of technology over labour, maximum employment should consider more than capacity constraints or inflationary pressure.
Rather, governments need to consider the options available to workers: not just how easily they can find jobs they want, but also how readily they can refuse jobs they do not. By lifting obstacles to job changes and giving workers a social safety net that enables them to refuse the crummiest jobs, societies can foster employment that is not just full, but fulfilling.
Sources: The Economist 28th January 2017, St Louis Federal Reserve – Natural Rate of Unemployment
I have being going over the theory behind the output gap and here is an explanation – written a few years ago. Probably not so applicable to the economic environment today
Just as Messrs Friedman and Phelps had predicted, the level of inflation associated with a given level of unemployment rose through the 1970s, and policymakers had to abandon the Phillips curve. Today there is a broad consensus that monetary policy should focus on holding down inflation. But this does not mean, as is often claimed, that central banks are “inflation nutters”, cruelly indifferent towards unemployment.
If there is no long-term trade-off, low inflation does not permanently choke growth. Moreover, by keeping inflation low and stable, a central bank, in effect, stabilises output and jobs. In the graph below the straight line represents the growth in output that the economy can sustain over the long run; the wavy line represents actual output. When the economy is producing below potential (ie, unemployment is above the NAIRU), at point A, inflation will fall until the “output gap” is eliminated. When output is above potential, at point B, inflation will rise for as long as demand is above capacity. If inflation is falling (point A), then a central bank will cut interest rates, helping to boost growth in output and jobs; when inflation is rising (point B), it will raise interest rates, dampening down growth. Thus if monetary policy focuses on keeping inflation low and stable, it will automatically help to stabilise employment and growth.
Stephen Toplis at the BNZ produced an interesting graph showing the Non Accelerating Inflation Rate of Unemployment – NAIRU. With the increasing amount of structural unemployment in the New Zealand economy caused by a mismatch – Skills of unemployed v Skills required in the labour market – the NAIRU is around 5%. This means that an unemployment level of 6.7% is worringly tight and a level below 5% could be inflationary. This is likely to result in upward pressure on wages which will erode corporate profitability given that output growth will be constrained.
Although the recent figures for the rate of unemployment in New Zealand have increased from 6.4% to 6.7% there are some interesting statistics with regards to participation rates and employment rates.
The employment rate increased 64.2% of the total working-age population, from 63.9%. The BNZ highlighted the following:
1. The unemployment rate hasn’t been affected too greatly during the last 4 years as NZ nears the bottom of the economic cycle;
2. NZ employment rate has settled well above that seen following the 1998 recession and significantly above that which was experienced following the early-1990s recession;
3. New Zealand’s early-1990s employment rate is about where a lot of the troubled developed-world economies now find themselves – Greece, Spain, and even the US. See graph below;
4. New Zealand, in contrast now has one of the highest employment rates in the world (testimony to its relatively high participation rate, coupled with a high rate of placement into jobs).
With firms indicating that it is their intention to take on more staff the BNZ estimate that the unemployment rate will be:
6.2% Dec 2012
5.6% Dec 2013
The recent special report in The Economist looked at the altering structure of the labour market worldwide. Obviously globalisation and technology have brought big changes in the nature of work, and levels of unemployment will remain high in the developed world as developing countries see their numbers employed being boosted.
Edmund Phelps, Nobel Economist, thinks that the US natural rate of unemployment in the medium term is realistically around 7.5% which is significantly higher than a few years ago. Remember the natural rate occurs when inflation is correctly anticipated – this level of unemployment results when the economy is at full employment.
Michael Spence, another Nobel prize-winning economist, agrees that technology is hitting jobs in America and other rich countries, but argues that globalisation is the more potent factor. Some 98% of the 27m net new jobs created in America between 1990 and 2008 were in the non-tradable sector of the economy, which remains relatively untouched by globalisation, and especially in government and health care. Lowering this natural rate will require the following:
1. changing education to ensure that people enter work equipped with the sort of skills required so that there is no mismatch
2. adjusting the tax system – incentivise work
3. modernising the welfare safety net – encourage those to find work
4. encourage entrepreneurship and innovation.
This is easier said than done.
This has increased dramatically in many countries – 58% in Ireland, 40% in both Spain and Japan, and 30% in the US, see graph below.
The concern with these figures is that the longer poeple are out of work the less likely there are able to find future employment. There are two reasons for this:
1. Their skills get out-dated very quickly and this is especially prevalent in the current labour market as technology is starting to takeover many procedural white-collar jobs.
2. Motivationally they find it hard to engage in the process of lookign for work and this is esepecially prevalent once a person is on a generous welfare benefit.
According to The Economist:
Long-term unemployment often turns into permanent unemployment, so governments should aim to keep people in work, even if that sometimes means continuing to pay them benefits as they work.
The BNZ Economy Watch today talked of the labour market pressures that might be facing New Zealand over the next year – this is especially prevalent if the country is going to meet the needs of a more bouyant economy. What is interesting to notice is the actual unemployment figures during the recent recession compared with those from earlier downturns:
2010 – Unemployment 7%
1998 – Unemployment 7.9%
1991 – Unemployment 11.2%
This suggest that in 2010 the labour was already very tight going into the recession and had fallen to 3.4% which is well below what is considered New Zealand’s NAIRU (Non-Accelerating Inflation Rate of Unemployment) of 5.0% – earlier this year I did a post on the Austalian NAIRU – Aussies – cruising along nicely but watch for the NAIRU. So it could be said that the first stages of the recession were just reducing the excess demand in the labour market and even when in recession employers reported difficulties in finding skilled labour. See graph below
The BNZ is concerned that the labour supply is insufficient and has the potential to result in a combination of constrained economic expansion, rising unit labour costs and increasing inflationary pressures more generally.
The current youth unemployment rate (those aged 15 to 19) is a staggering 27.5%. Moreover, the next age group up (ages 20 to 24) has an unemployment rate of 13.5%. See graph at the bottom of the post.
If the youth unemployed are the main pool of labour available to call on for economic growth then there may be issues in finding the necessary skills. At that point, however, the data becomes “curiouser and curiouser” when one looks even more closely at its composition. Despite the relative surge in the youth unemployment rate the proportion of unemployed who are youths actually falls. What this means is that youth employment fell and rather than unemployment rising folk simply left the labour force altogether. And boy did employment fall. Stephen Toplis BNZ
The labour market still appears to be very tight and this will ultimately lower New Zealand’s growth potential. This means that lower growth rates will impact on inflationary pressures as labour becomes more scarce and therefore this may lead to an increase in interest rates and the NZ$. Not really what New Zealand needs at this present time.
As on expectations the RBNZ held the OCR at 2.5% today. However Alan Bollard did suggest that tightening is anticipated in December but don’t be surprised if it is a 50 basis points increase as the bank is wary of inflationary expectations. The cash rate is expected to peak at 4.75% by the end of 2012 which means a further increase by 175 basis points.
According to the Bank of New Zealand the RBNZ’s inflation view are weighted to the upside. In particular, we note that “the Bank’s policy outlook relies on three key assumptions.
These are that:
– construction cost inflation will be subdued relative to its mid 2000s peak;
– households will continue to focus on reducing debt;
– recent increases in surveyed inflation expectations will be short lived”.
However, the labour market is also worthy of note. The Reserve Bank is forecasting the unemployment rate to fall to 4.5% which one would suspect is below or close to the non-accelerating inflation rate of unemployment – NAIRU. This could add inflationary pressures to the economy. According to Stephen Toplis of the BNZ:
Moreover, the RBNZ falls into the trap of assuming that the current 6.6% unemployment rate will act to suppress inflation near term. But this misses the point that the current youth (those aged 15 to 19) unemployment rate is 27.5%! The next age group is high too. The current unemployment rate of those aged 25 and over is just 4.6%. This is the group from which most skilled labour comes from. It is stretched already so we believe the risk of wage inflation is probably higher than the RBNZ expects.