Tolerate Unemployment, but Blame the Unemployed

The Contradictions of NAIRU Policy-Making in Australia
by David Richardson

For the last generation macroeconomic policy in Australia has been based on the assumption that unemployment must be maintained at a certain minimum level in order to restrain wages and prevent an outbreak of accelerating inflation. Now, after six years of record-low wage growth – which weakened even further in the latest ABS wage statistics – it is time for that policy to be abandoned.

In a comprehensive critique of unemployment and monetary policy in Australia, Senior Research Fellow David Richardson shows there is no stable statistical basis for the assumption that inflation will accelerate without end if unemployment falls below its so-called “natural” or “non-accelerating inflation rate” (NAIRU, commonly thought to be around 5%). And the economic and social costs of deliberately maintaining high unemployment are very large.

Richardson’s paper, Tolerate Unemployment, but Blame the Unemployed: The Contradictions of NAIRU Policy-Making in Australia, has been published today by the Centre for Future Work. The study was reported in the Sydney Morning Herald and other papers.

Among its major findings:

  • Officially recorded unemployment is only the tip of the iceberg of total underutilised labour in Australia. Counting underemployment, discouraged workers, and “marginally attached” workers, there are around 3 million Australians who would like to work (or would like more work) but can’t find it: far worse than the official unemployment estimate (currently around 700,000).
  • Recent disagreements between Treasury and the Reserve Bank of Australia over the precise level of the NAIRU (the former say it is 5%, the latter say it might be 4.5%) ignore the growing evidence that the core concept is invalid and unsupported by empirical evidence.
  • Numerical estimates of the NAIRU have been wildly inconsistent over time. This is partly because of a process called “hysteresis”: whereby the existence of even temporary or cyclical unemployment can create long-term barriers to employment that seem to inhibit subsequent job-creation. If policy-makers believe in an elevated NAIRU, and act to ensure that unemployment stays at or above that level, then it becomes a self-fulfilling prophecy – and economic performance is undermined for decades.
  • Monetary and fiscal policy should be shifted to aim to steadily reduce unemployment as low as, rather than targeting a certain minimum assumed NAIRU.
  • The economic benefits of reducing unemployment are enormous. Every one-percentage point reduction in unemployment results in 134,000 new jobs, $10 billion in additional output, and billions of dollars in additional fiscal revenue for governments.
  • There is an enormous contradiction between a macroeconomic policy that deliberately maintains unemployment, and a social policy that blames the failures of unemployed people (such as a supposed lack of “work ethic”) for their own hardship.
  • The long-term freeze in Newstart benefits (which have not changed in real terms since 199) should be abandoned, and benefit levels increased substantially. Since chronic unemployment is the outcome of deliberate policy, the least society can do is fairly compensate those who have been hurt by this policy.

Australia’s continuing record-low wage growth, and sluggish economic performance, make the need for a change in policy direction all the more urgent. Even within the constraints of the NAIRU policy, the RBA and the government have failed to meet their own stated objectives: for example, inflation has languished well below the official 2.5% target for over 5 consecutive years. It is time for a fundamental rethink of macroeconomic policy, which should be focused on restoring genuine full employment as the top priority.

Full report