Is full employment closer than we think? (originally published 25th of May 2021)

Background

Between 2005 to 2008, unemployment fell from 5 per cent to 4 per cent, and inflation soon followed. However, in 2018 when unemployment only lowered to 5 per cent, we saw little inflation. This has given cause for the RBA and market commentators to speculate that the level of unemployment required for wage growth to emerge (i.e. full employment) has lowered somewhere in the 4 per cent realm, or even lower. This represents a change from historic norms, where a 5% unemployment rate was sufficient. A combination of rising underemployment and digital efficiencies in matching employees and employers, as well as enabling remote working, are both potential contributors to the lowering of the full employment rate of unemployment.

This thinking may have lulled central banks into dissuading inflation concerns as an unemployment rate in the mid 4’s is unlikely until 2023/2024. Emerging evidence may challenge this thinking.

COVID’s impact on labour markets

Kevin Warsh, former Federal Reserve governor, in a recent interview indicated that “COVID has fundamentally effected every job, every part of our economy, every bit of capital flows”[1].

This change in how the economy operates may have augmented labour skills desired by employers. Many of those who lost employment during COVID lack the skills to meet new employer requirements in other areas of the economy. Economists call this structural unemployment.

“The anecdotes of the last month or two I think are quite troubling. The Federal Reserve says that there are, I believe, 8.2 million Americans that were working pre-covid that aren’t working now and that they won’t be needing to change policy until those 8.2million people are back to work”[2] – Kevin Warsh.

In Australia, the Reserve Bank of Australia (RBA) sings from the same hymn sheet, as noted from their most recent policy statement in May.

“Labour market will need to be tight enough to generate wages growth that is materially higher than it is currently. This is unlikely to be until 2024 at the earliest”[3].

As discussed in the background, full employment, or non-accelerating inflation rate of unemployment (NAIRU), is thought to have lowered over the last ten years to below 5%, potentially an unemployment rate as low as 4.5%. This is well below the current unemployment rate of 5.5%.

However, should COVID have proven to be a catalyst for rapid structural change in labour market skill requirements, this may have also led to an increase in structural unemployment and an overall uplift in the full employment rate of unemployment (NAIRU).

Indications that this may be playing out are emerging in the US. There are a growing number of job openings that are simply not being filled. If rising job positions are not being filled, but there remains elevated unemployment, this begins to look a lot like persistent structural unemployment, nearing full employment.

In Australia, there is an inkling this might also be happening. There were 30,630 fewer jobs in April, but no change in the unemployment rate as labour force participation fell. Does falling participation signal that some labour market participants recognise their skills are mismatched with employer demand?

Anecdotally, we are already seeing labour shortages in the mining and hospitality sector, as well as wage pressures across the accounting and consulting industries. With skills-based immigration still at least a year off, this adds further weight that we may be much closer to the full employment rate of unemployment (NAIRU).

“If the Fed is making an error, then that error isn’t confined to the US[4]” – Kevin Warsh.

We may be a lot closer to full employment than central banks believe. The RBA has indicated it expects unemployment to be at 5% by the end of the year. If COVID has pushed NAIRU to an unemployment rate of 5%, then we wage growth will soon follow.

If this proves to be true, wage and inflation pressures will appear sooner than expected, vastly increasing the likelihood of interest rate rises well before 2024. If Central Banks are forced to recalibrate interest rate guidance, hold on to your socks, investment markets will be in for a wild ride.

By Matthew Vickers

Snowgum Financial Services

[1] https://open.spotify.com/episode/1m16R640zJjVgyGktb5KhK?si=782d153b1d9f495d (25:45 – 26:07)

[2] https://open.spotify.com/episode/1m16R640zJjVgyGktb5KhK?si=782d153b1d9f495d (26:14 – 26:21)

[3] Statement by Philip Lowe, Governor: Monetary Policy Decision | Media Releases | RBA

[4] https://open.spotify.com/episode/1m16R640zJjVgyGktb5KhK?si=782d153b1d9f495d (27:55-28:00)