Speech: RBA Governor Philip Lowe – The Labour Market and Monetary Policy

Economic Society of Australia (QLD) July 8, 2019

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.

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).

This sharp decline in unemployment has come as a welcome surprise. Back in February, we expected the unemployment rate to now be around 6½ 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 1½ 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.

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

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.

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