Australia: Has the natural rate of unemployment fallen? – Capital Economics

Australia’s unemployment rate may need to fall from 5.5% currently to around 4.0% before wage growth rises significantly and is partly due to the existing excess capacity not captured by the unemployment rate, but also as the natural rate of unemployment may be notably lower than most estimates of 5.0%, according to Kate Hickie, Research Analyst at Capital Economics.

Key Quotes

“In theory, wage growth should start to rise rapidly once the unemployment rate falls to the natural rate, which the RBA estimates is around 5%, as labour supply shortages force employers to pay higher wages. And some surveys suggest the unemployment rate could fall to 5.0% later this year.”

“In reality the high share of employees wanting to work longer, the “underemployed”, means that the unemployment rate will probably need to fall below 5.0% before capacity pressures start to bite. And there are a number of reasons to believe that the natural rate of unemployment may be lower than 5.0%.”

“Admittedly, it is conceivable that the changing structure of the economy has increased the natural rate as the end of the mining boom has created a pool of workers whose skills no longer match those required. But this upward influence appears to have been more than offset by other factors. First, the growing importance of the so-called “gig economy”, where the barriers to finding work tend to be lower, is exerting a downward influence on the natural rate.”

“Second, the ageing of the labour force is also having a downward impact as the greater skills and experience of older workers means they usually have a lower rate of unemployment. Third, the rising share of people with a tertiary education has probably reduced the natural rate as they tend to be more employable and are better able to adapt to changes in the labour market.”

“Fourth, technological changes have made the matching process between employers and job seekers easier and have also made it simpler for employees to work remotely, thereby reducing geographical mismatches. Finally, government policies to incentivise work have probably reduced the natural rate, although the downward pressure from this factor may now be fading.”

“So the natural rate of unemployment could be closer to 4.0% than the RBA’s current estimate of 5.0%, and it may still be falling. This means that wage growth will probably be lower for longer than most analysts, including the RBA, expect. This will weigh on underlying inflation and is a key reason why we doubt the RBA will raise interest rates from 1.5% until the second half of 2019.”