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Fighting inflation doesn’t directly cause unemployment – but that’s still the most likely outcome

You may have seen the news: in its attempts to tackle inflation, the Reserve Bank is going to increase unemployment. The idea can even seem to come right from the mouths of experts, including the bank’s governor, Adrian Orr. <a href="https://www.nzherald.co.nz/business/adrian-orr-beating-inflation-will-mean-higher-unemployment/WO3WLQQUGWEC5NVK3AQTR2BN5A/">Speaking recently</a> to an industry conference, he said: <blockquote> Returning to low inflation will, in the near term, constrain employment growth and lead to a rise in unemployment. </blockquote> Similar sentiments have been expressed by <a href="https://businessdesk.co.nz/article/opinion/inflation-taming-the-costs-are-becoming-more-visible">independent economists</a> and <a href="https://thespinoff.co.nz/business/31-10-2022/the-big-banks-just-cant-stop-winning">commentators</a>. But is it as simple as it might appear? What is the relationship between inflation and unemployment, and is it inevitable that reducing one will lead to an increase in the other? <blockquote class="twitter-tweet"> Unemployment rate holds steady at 3.3%, wages rise strongly - Stats NZ <a href="https://t.co/IQOPBaNYTn">https://t.co/IQOPBaNYTn</a> — RNZ News (@rnz_news) <a href="https://twitter.com/rnz_news/status/1587568087808999424?ref_src=twsrc%5Etfw">November 1, 2022</a></blockquote> Historic highs and lows Like other developed countries, New Zealand has been going through a period of historically high inflation. The latest figures, for the September quarter of 2022, show an annual <a href="https://www.stats.govt.nz/news/annual-inflation-at-7-2-percent/">rise of 7.2%</a>, only slightly lower than the 7.3% recorded for the June quarter. Inflation is the highest it has been since 1990. The story is similar across the OECD, where inflation averages <a href="https://www.oecd.org/economy/consumer-prices-oecd-updated-4-october-2022.htm">10.3%</a>, including <a href="https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/september2022">8.8%</a> in the UK and <a href="https://www.bls.gov/news.release/cpi.nr0.htm">8.2%</a> in the US. At the same time, New Zealand is experiencing a period of very low unemployment, with a <a href="https://www.stats.govt.nz/news/unemployment-rate-at-3-3-percent">rate of just 3.3%</a> for September 2022, following 3.2% in the June quarter. These are near-record lows, and the rate has not been below 4% since mid-2008. So, right now New Zealand is in a period of historically low unemployment and historically high inflation. At first glance, that might suggest that in order to return to low inflation, we may inevitably experience higher unemployment. The Phillips Curve The idea that inflation and unemployment have a negative relationship (when one increases, the other decreases, and vice versa) dates back to work by New Zealand’s most celebrated economist, <a href="https://en.wikipedia.org/wiki/William_Phillips_(economist)">A.W. (Bill) Phillips</a>. While working at the London School of Economics in the 1950s, Phillips wrote a <a href="https://onlinelibrary.wiley.com/doi/full/10.1111/j.1468-0335.1958.tb00003.x">famous paper</a> that used UK data from 1861 to 1957 and showed a negative relationship between unemployment and wage increases. Subsequent work by economics Nobel Prize winners <a href="https://www.econlib.org/library/Enc/bios/Samuelson.html">Paul Samuelson</a> and <a href="https://www.nobelprize.org/prizes/economic-sciences/1987/solow/facts/">Robert Solow</a> extended Phillips’ work to show a negative relationship between price inflation and unemployment. We now refer to this relationship as the “Phillips Curve”. However, even though this relationship between inflation and unemployment has been demonstrated with various data sources, and for various time periods for different countries, it is not a causal relationship. Lower inflation doesn’t by itself cause higher unemployment, even though they are related. To see why, it’s worth thinking about the mechanism that leads to the observed relationship. <blockquote class="twitter-tweet"> <a href="https://twitter.com/hashtag/LISTEN?src=hash&ref_src=twsrc%5Etfw">#LISTEN</a> 🔊 The Finance Minister says addressing inflation without increasing unemployment is a difficult balancing act. 📎 <a href="https://t.co/CfaopcqjGv">https://t.co/CfaopcqjGv</a> <a href="https://t.co/1gMNat2G99">pic.twitter.com/1gMNat2G99</a> — Morning Report (@NZMorningReport) <a href="https://twitter.com/NZMorningReport/status/1587893034351411200?ref_src=twsrc%5Etfw">November 2, 2022</a></blockquote> Collateral damage If the Reserve Bank raises the official cash rate, commercial banks follow by raising their interest rates. That makes borrowing more expensive. Higher interest rates mean banks will lend less money. With less money chasing goods and services in the economy, inflation will start to fall. Of course, this is what the Reserve Bank wants when it raises the cash rate. Its <a href="https://www.parliament.nz/en/pb/library-research-papers/research-papers/monetary-policy-and-the-policy-targets-agreement/">Policy Targets Agreement</a> with the government states that inflation must be kept between 1% and 3%. So when inflation is predicted to be higher, the bank acts to lower it. At the same time, higher interest rates increase mortgage payments, leaving households and consumers with less discretionary income, and so consumer spending falls. Along with reduced business spending, this reduces the amount of economic activity. Businesses therefore need fewer workers, and so employment falls. So, while the Reserve Bank raises interest rates to combat inflation, those higher interest rates also slow down the economy and increase unemployment. Higher unemployment is essentially collateral damage arising from reducing inflation. Great expectations That’s not the end of the story, though. After its 1960s heyday, the Phillips Curve was criticised by economists on theoretical grounds, and for its inability to explain the “stagflation” (high unemployment and high inflation) experienced in the 1970s. For example, <a href="https://www.econlib.org/library/Enc/bios/Friedman.html">Milton Friedman</a> argued there is actually no trade-off between inflation and unemployment, because workers and businesses take inflation into account when negotiating employment contracts. Workers’ and employers’ expectations about future inflation is key. Friedman argued that, because inflation is expected, workers will have already built it into their wage demands, and businesses won’t change the amount of workers they employ. Friedman’s argument would suggest that, aside from some short-term deviations, the economy will typically snap back to a “natural” rate of unemployment, with an inflation rate that only reflects workers’ and businesses’ expectations. Symptom or cause? Can we rely on this mechanism to avoid higher unemployment as the Reserve Bank increases interest rates to combat inflation? It seems unlikely. Workers would first have to expect the Reserve Bank’s actions will lower inflation, and respond by asking for smaller wage increases. Right now, however, consumer inflation expectations <a href="https://www.rbnz.govt.nz/statistics/series/households/household-inflation-expectations">remain high</a> and wage growth is at <a href="https://www.nzherald.co.nz/business/latest-job-numbers-out-unemployment-flatlining-near-record-lows/O4NDE3Y4W5GMHGDRDDS733LX7A/">record levels</a>. So, we can probably expect unemployment to move upwards as the Reserve Bank’s inflation battle continues. Not because lower inflation causes higher unemployment, but because worker and consumer expectations take time to reflect the likelihood of lower future inflation due to the Reserve Bank’s actions. And since workers negotiate only infrequently with employers, there is an inevitable lag between inflation expectations changing and this being reflected in wages. Alas, for ordinary households, there is no quick and easy way out of this situation. Writen by Michael P. Cameron. Republished with permission from <a href="https://theconversation.com/fighting-inflation-doesnt-directly-cause-unemployment-but-thats-still-the-most-likely-outcome-193617" target="_blank" rel="noopener">The Conversation</a>. Image: Getty Images<img src="https://counter.theconversation.com/content/193617/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1" />

Money & Banking

What happens when you free unemployed Australians from ‘mutual obligations’ and boost their benefits? We just found out

<div class="grid-ten large-grid-nine grid-last content-body content entry-content instapaper_body inline-promos"> During COVID-19 the government ran what turned out to be a giant real-world experiment into what happens when you boost someone’s unemployment benefits and free them of the “mutual obligation” to apply for jobs. On April 27 2020 the government as good as doubled the $565.70 per fortnight JobSeeker payment, lifting it by $550 per fortnight for what turned out to be six months. In September the boost dropped to $250 per fortnight, and in December to $150 per fortnight. Next Thursday the boost vanishes, although the base rate of JobSeeker will climb by a less-than substantial $50 a fortnight, leaving recipients $100 a fortnight worse off than they have been, $500 per fortnight worse off than back when JobSeeker doubled and back well below the poverty line. From Thursday April 1 they will also be subject to much more demanding work tests, having to show they have applied for a minimum of 15 jobs a month, climbing to 20 jobs a month from July 1. On top of that the government has announced: <ul> <li> a return to compulsory face-to-face meetings with Jobactive providers </li> <li> work-for-the-dole after six months of unemployment </li> <li> a dob-in line for employers to report jobseekers who seem not to be genuine </li> <li> increased auditing of job applications to ensure they are legitimate </li> </ul> They are the sort of “mutual obligations” that were scrapped while JobSeeker was doubled. Yet the government’s natural experiment where they doubled benefits and freed recipients of “mutual obligations” provides us with an opportunity to examine how a more generous approach affected recipients and whether, as the government says, a tougher approach is needed in order to compel people to work. During last year’s more generous approach, we conducted an online survey of JobSeeker recipients and found that (contrary to what appears to be the government’s expectation), it was helping get people into work. Freed of “mutual obligations”, many were able to devote time to reengaging with the workforce. As one respondent said, <blockquote> I was able to focus on getting myself back into the workforce. Yes, mutual obligation activities PREVENT people from being able to start a new business or re-enter the workforce as an employee </blockquote> And the extra income freed recipients to do things that would advance their employment prospects; either through study, through properly looking for work, or buying the tools needed to get work. One said <blockquote> I could buy things that helped me with employment — equipment for online work, a bicycle for travel, a proper phone" </blockquote> An Australia Institute review of unemployment payments and work incentives in 33 OECD countries found something similar — that higher payments correlate to lower unemployment. Another respondent said the suspended mutual obligation requirements made it easier to care for an elderly parent during pandemic and their recovery from major surgery. Another said she had been able to focus on her health needs and her children. People on social security are often accused of being dependent on welfare, but it’s often the economy and society that are dependent on their unpaid labour. Yet (except for during the worst of the pandemic) these people have been denied a safety net that ensures their survival. The inadequacy of payments goes to a major and enduring flaw in the Australian social security system — its inability to recognise all of the productive activities people undertake, including unpaid care largely undertaken by women. The decisions the government took during 2020 made a major difference to the lives of people outside the formal workforce. They enabled them to turn their attention away from day-to-day survival towards envisioning and realising a more financially and emotionally sustainable future for themselves and their dependants. The flow-on benefits, to all of us, ought to be substantial. The government ought to be very interested. If it was, it would examine the findings further, but they don’t seem to be on its radar. </div> <div class="grid-ten grid-prepend-two large-grid-nine grid-last content-topics topic-list"> Written by Elise Klein, Kay Cook and Susan Maury. This article first appeared on <a href="https://theconversation.com/what-happens-when-you-free-unemployed-australians-from-mutual-obligations-and-boost-their-benefits-we-just-found-out-157506">The Conversation</a>. </div>

Retirement Income

Why reducing unemployment should have been a focus for NZ's well-being budget

In its much awaited first <a href="https://www.budget.govt.nz/budget/2019/wellbeing/index.htm">well-being budget</a>, New Zealand’s coalition government missed a major trick in not making unemployment one of their central well-being priorities. As of March 2019, New Zealand’s unemployment rate was at 4.4% (not seasonally adjusted). The figure is slightly below the OECD average of 5.2%, and 12 OECD countries have lower rates. <a href="https://treasury.govt.nz/sites/default/files/2019-05/befu19.pdf">Treasury forecast</a> the rate to decline moderately to 4% this year and then to rise to 4.3% by 2023. While some might trumpet this as success, it is not good by New Zealand’s historical standards. Between 1956 and 1981, our unemployment was never above 2% and often below 1%. In the mid-1980s, the then 4% rate was considered unacceptably high and offered as a rationale for <a href="https://www.tandfonline.com/doi/pdf/10.1080/09538250120102750">the economic reforms of the time</a>. Low unemployment is central to well-being <a href="http://eprints.lse.ac.uk/47487/1/World%20happiness%20report%28lsero%29.pdf">Considerable</a> <a href="https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1475-4932.2007.00415">amounts</a> of <a href="https://onlinelibrary.wiley.com/doi/pdf/10.1111/1468-0335.00111">research</a> conclusively shows that when people become unemployed, their well-being, measured by their self-assessed life satisfaction, falls sharply. Should they remain without a job, the unemployed do not adapt to this new and traumatising experience. Their well-being remains low until they are re-employed. The research suggests that the main impact of unemployment on well-being is not through people’s lower income. Rather it likely hits people through the loss of social status, loss of life structure and purpose, and lack of a positive social context. In addition to being a direct cause of low well-being, unemployment is also strongly connected to other 2019 well-being budget priorities. Parental unemployment is a major cause of <a href="https://www.researchgate.net/publication/332879595_Child_Poverty_in_New_Zealand">child poverty</a>, which is one of five budget priorities. Unemployment is also likely to contribute to <a href="https://reader.elsevier.com/reader/sd/pii/S0001879109000037?token=F1CE3A7FAF3734BAC523AFE393C014E454B6D40020E05535CE29073467268AE2D31FA67BDF83382A859742E78834A598">mental health problems</a> and <a href="https://reader.elsevier.com/reader/sd/pii/S027795361530068X?token=65A8A824DF87339014265A2E7D27503221B3EDF7602E319EEEE5084FCF9A049DBB998792CFD33DDE8AF9082D706D2FB0">alcohol and drug problems</a>, another priority. A third budget priority is reducing income and employment gaps for Māori and Pacific people. Given these two groups are over-represented among the unemployed, lower overall unemployment would also contribute to achieving that priority. Do nothing approach to unemployment <a href="https://treasury.govt.nz/sites/default/files/2019-05/befu19.pdf">Treasury’s budget assessment</a> of the unemployment rate at which the economy is stable (strictly speaking their estimate of the Non-Accelerating Inflation Rate of Unemployment, or the NAIRU) is 4.25%. Following discussions with Treasury about the range of possible estimates around the 4.25% number, officials indicated they had no direct sense of its softness. But they did suggest that estimating the rate using different statistical models delivered quite different results. They didn’t state the size of these differences. The Treasury criteria for choosing a specific statistical model behind the budget’s stable unemployment rate was not discussed in budget documents. A cynic might suggest that proximity of the estimated stable rate to the actual current rate of unemployment – which generates a do-nothing policy conclusion – might have been on decision-makers’ minds when selecting the “best” model. Some indication of how different statistical models can generate quite different stable unemployment rates comes from <a href="https://www.rbnz.govt.nz/research-and-publications/analytical-notes/2018/an2018-04">recent work</a> at the Reserve Bank of New Zealand. The bank takes two approaches to estimating the stable unemployment rate – the results can differ at times by more than 2%. Consequently, it is difficult to take the precise 4.25% unemployment estimate, used to justify the do-nothing approach, seriously as a hard policy constraint. The well-being budget did contain <a href="https://budget.govt.nz/budget/2019/wellbeing/maori-pasifika/index.htm">some new but minor unemployment initiatives</a>. But they really amount to fiddling around the micro edges of a macro unemployment problem. Lower unemployment is achievable Even in today’s globalised trading economies, much lower unemployment rates than New Zealand’s current 4.4% are achievable. For example, the best OECD performer is currently the Czech Republic, with an unemployment rate of 2.1%. Japan is next at 2.4% and Iceland is at 2.7%. The questioning of the very notion of a stable unemployment rate, and the suggestion that macro policies can have significant impacts on unemployment, is also attracting <a href="https://pubs.aeaweb.org/doi/pdf/10.1257/jep.32.1.97">serious intellectual consideration internationally</a>. Top US economist Lawrence Summers recently <a href="https://www.bloomberg.com/news/articles/2018-06-18/summers-warns-biggest-economies-not-prepared-for-next-downturn">remarked</a>: [T]he issue that’s preoccupied monetary policy for the generation before the financial crisis – the avoidance of inflation – is no longer the top issue. Rather, for Summers, that top issue was “getting to full employment”. The government has missed an opportunity to use macroeconomic tools to test whether we can have a society which once again has low rates of unemployment, as we used to between 1938 and the early 1980s when they were between zero and 2%. From the <a href="https://nzhistory.govt.nz/social-security-act-passed">1938 Social Security Act</a> on we have had a welfare system designed to work best when high numbers of New Zealanders are in work. Despite all the changes to the working age welfare system since the 1970s, it still functions best when the unemployment rate is considerably lower than what we have settled for today. Full employment and low rates of unemployment were what <a href="https://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10425616">economist Wolfgang Rosenberg</a> described in the late 1970s as the fulcrum of our social welfare system. Perhaps much lower unemployment should once again be the fulcrum of what we might now call our social well-being system. To place it in such a position of prominence would be to inaugurate policies considerably more transformational than this coalition government has thus far delivered. Written by Simon Chapple. Republished with permission of <a href="https://theconversation.com/why-reducing-unemployment-should-have-been-a-focus-for-nzs-well-being-budget-118061">The Conversation.</a>

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Fighting inflation doesn’t directly cause unemployment – but that’s still the most likely outcome

What happens when you free unemployed Australians from ‘mutual obligations’ and boost their benefits? We just found out

Why reducing unemployment should have been a focus for NZ's well-being budget