The Labour Market is the second of the RBA’s two mandates and clearly important to the economic health of the country. In this piece we look at some of the developments in the labour market over the recent months and whether we’re arriving at a turning point.
Maintaining a strong Australian labour market is one of the RBA’s two explicit mandates. In fact, the RBA has three mandates, but only two of them can be measured. The RBA mandates are economic concepts rendered into legislation so the language is not always completely clear. The three mandates are:
- The stability of the currency of Australia.
- The maintenance of full employment in Australia.
- The economic prosperity and welfare of the people of Australia.
The first mandate is the inflation target, which is put into practice as trying to keep inflation between 2-3%. When inflation is low the value of the currency is stable. The third mandate is a general one, which is normally not specifically targeted, but is a summary of the other two. If the RBA could engineer the economy such that everyone had a job, but inflation was still low and stable, most would probably agree that the country was economically prosperous.
The second mandate is to encourage as much employment as can be safely achieved – precisely what that means and how the RBA is currently measuring up against this measure will be the focus of the remainder of this article.
What is Full Employment?
Full employment does not mean an unemployment rate of zero percent. Firstly, an unemployment rate of zero is not really possible, but even if it were, it wouldn’t be desirable. Most people would like to be able to choose the style of work, and the location of their work. Neither of those is possible if there is precisely the same number of people as jobs. Or, coming the other way, it would suggest that employers would need to take the available applicants for a position, even if the applicant didn’t have the right mix of skills.
Economics is at heart the analysis of trade-offs. Humans, at least in an economic understanding, are seen as reasonably selfish and wanting more of everything. However, the vast majority of economic decisions are not about one single variable, they are about trading off one positive and one negative outcome. The question is not “Do you want a higher salary?” – because everyone would answer yes. The question is instead “Do you want a higher salary for working 60 hours a week instead of 40?”. That’s a trade-off and a much more complicated decision.
For Central Banks, one key trade-off is regarding inflation and the labour market. The lower inflation becomes the more likely it becomes that employers will raise wages to attract talent. However, as some employers raise wages other employers are forced to match the salaries prevalent in the economy. But not all employers will be able to easily do so and some will respond by raising wages and also raising the prices of the goods and services they are selling. In this understanding a strong labour market will cause a rise in wages and a rise in inflation.
The RBA is mandated to keep inflation low and employment high. But the two targets are in tension because very high employment will lead to high inflation and a trade-off must be made. So rather than targeting “as many jobs as possible” or “a job for absolutely everyone at all times” the RBA instead targets “full employment” which the RBA defines as: “The current maximum level of employment that is consistent with low and stable inflation”.
Are we at Full Employment?
Over the last couple of years, the inflation rate in Australia has been very high, while the unemployment rate has been very low. It’s at least reasonable to ask if we are at, or past, the RBA’s definition of full employment. There are some strong indications that the answer is yes, Australia was, for a time, well past full employment.
The most obvious sign is in the vacancy data, which at the peak showed vacancies were fully 3.37% of the labour market. Or, to put it another way approximately one in every 30 jobs was vacant. That was materially more than during other “boom” periods.
Interestingly, although the number of vacancies rose, the unemployment seemed to hit a floor at about 3.5%. This doesn’t mean those 3.5% wouldn’t or couldn’t work, but that for some reason the available jobs and the available labour were not a match. That could be because of skills, location or other factors.
The real sign that Australia was past the peak in the labour market probably comes from the behaviour of something called a Beveridge Curve. This style of chart plots the unemployment rate against the vacancy rate at any given point in time. Note that this arrangement should have a diagonal relationship. When the labour market is strong the unemployment rate is low and the vacancy rate is high, but also vice versa. When the labour market is weak, the unemployment rate is high the vacancy rate is low.
The period around 2022 saw vacancies rise to a record level and the unemployment rate drop to a record level. But importantly the normal relationship (which had held for more than 20 years) was broken. Vacancies rose much higher than what the normal relationship suggests should have been true for the unemployment rate. Then, providing more evidence that we were at over full employment, from 2022 to 2024 the rate of vacancies dropped sharply without a rise in the unemployment rate.
That 2022-2024 behaviour violates the assumption of a diagonal relationship, but it makes sense if the period in 2022 was greater than full employment. If we assume that in 2022 there was a large number of vacant positions with no available workers to fill them then, over time, as new workers joined the workforce the new workers would slowly fill this backlog of vacancies and the vacancy rate would drop without a material change in the unemployment rate.
The recent odd behaviour does look as if it might be coming to an end, however. The vacancy rate seems to have fallen far enough now that we are, once again, approaching the space where the normal relationships hold. If that’s true, any further weakness in the labour market could see the unemployment rate rise quite quickly, even if it hasn’t risen much in the last two years.
But that’s only one definition of full employment. It focuses on the number of available jobs and number of available workers.
The RBA’s assumption was that when we were above full employment the rate of wage growth would be high. There’s been some increase in wages, but the rate of change of wages is actually currently only very marginally higher than inflation. Wage growth was lower than inflation for the vast majority of the last three years.
Wage growth is currently only quite near the rate of growth observed in the 2000-2012 period. So while the peak in 2022 does coincide with a material rise in the vacancy rate, wages growth does not look unnaturally high.
As an aside, the main reason wage growth is as high as 4.1% now is because the Fair Work Commission raised the minimum wage sharply in Q3 2023 causing a 1.3% increase in overall wages. If that hadn’t occurred the annual wage growth would likely be lower.
We await the coming Q3-24 wage data, scheduled for 13 November, eagerly.
So while there did appear to be a period where there were more vacant jobs than there were people to fill them, and that might be termed “full employment”, the current situation does not seem to unequivocally meet the RBA’s definition of full employment. There has not been a material rise in real wages. Now, the RBA doesn’t explicitly use wages as part of the definition the of full employment. But if wages are not reacting to the current tightness of the labour market then it’s hard to see why the labour market isn’t consistent with low and stable inflation.
What does the most recent data tell us about Full Employment?
The September labour force data, released on 17 October, showed a material rise in employment (up 64,100) and a fall in the unemployment rate to 4.1%. The previous result of 4.2% was also revised lower to 4.1%.
Most interestingly, the data also showed a rise in the participation rate to 67.2%, once again setting a new record.
The RBA’s definition of full employment being the level at which inflation starts to be impacted only works if the labour force cannot grow.
The most recent data suggests that the level of interest in working is rising above previous levels. That might be caused by the availability of jobs, or the cost-of-living crisis, or both. But either way, the recent data suggests that the risk of a wage break-out is ebbing away very quickly. We’ll know for sure when the next wages data is released.