Syllabus Topic
HSC Topic Three - Economic Issues
Unemployment
non-accelerating inflation rate of unemployment (NAIRU)
INTRODUCTION
In the complex landscape of economic policy and labor markets, understanding the Non-Accelerating Inflation Rate of Unemployment (NAIRU) is crucial for grasping the interplay between unemployment and inflation. NAIRU represents the level of unemployment at which inflation remains stable, meaning that inflation does not accelerate or decelerate. It is a key concept for policymakers and economists, as it helps determine the optimal unemployment rate to target to maintain stable prices while fostering economic growth.
ROLE OF NAIRU
The NAIRU indicates the lowest unemployment rate achievable without accelerating inflation. It helps measure the economy's 'spare capacity,' which refers to the extent to which economic resources are underused. Although NAIRU can't be directly observed, it can be estimated through related economic indicators.
'Spare capacity' occurs when aggregate demand is less than the economy's production capability. When this happens, businesses struggle to fill positions, leading to higher wages and subsequently higher prices for goods and services, which drives inflation. Conversely, when spare capacity increases, demand for workers falls, reducing wage growth and inflation.
The 'unemployment rate gap'—the difference between NAIRU and the actual unemployment rate—serves as a key indicator of spare capacity. Low inflation and wage growth suggest high spare capacity and an unemployment rate above NAIRU, while rising inflation and wages indicate low spare capacity and an unemployment rate below NAIRU. Policymakers, like the Reserve Bank, use NAIRU estimates to adjust monetary policy, aiming to balance full employment with stable inflation.
UNDERSTANDING NAIRU TRENDS - FULL EMPLOYMENT
If the unemployment rate is above the NAIRU, it means the economy isn't at full employment and inflationary pressures are low. To boost the economy, the Reserve Bank might lower interest rates or use unconventional policies to encourage spending, which increases aggregate demand and reduces spare capacity.
Conversely, if the unemployment rate is below the NAIRU, the economy is running at full capacity or beyond, causing upward pressure on inflation. To control inflation, the Reserve Bank might raise interest rates or withdraw policy support, which would help reduce aggregate demand and inflationary pressures.
In the short term, the Reserve Bank faces a trade-off: lowering interest rates can reduce unemployment but may increase inflation, while raising rates can control inflation but may increase unemployment. The short-run Phillips Curve illustrates this trade-off: if the economy is at a point where unemployment equals NAIRU and inflation is stable, stimulating the economy can lower unemployment but raise inflation. The greater the deviation from the NAIRU, the faster inflation tends to rise.
2024 TRENDS
In 2024, Australia’s NAIRU shaped by evolving monetary policy objectives and labor market conditions. Historically, Australia's monetary policy has aimed to balance price stability with full employment, targeting a consumer price inflation range of 2-3 percent. However, the definition of full employment lacked a precise numerical target until the 2023 Review of the Reserve Bank of Australia (RBA) clarified this in the updated Statement on the Conduct of Monetary Policy. This updated mandate emphasizes the RBA's commitment to regularly assess and communicate how labor market conditions align with sustained full employment.
The unemployment rate in Australia from December 2023 to June 2024 showed a gradual increase, with rates rising from 3.9% to 4.3%. This slow rise in unemployment reflects a more gradual easing of the labor market than initially anticipated. Despite stronger-than-expected labor market conditions, the adjustment process is ongoing, characterized by a decline in average hours worked and a decrease in job vacancies. As labor demand moderates, both employment growth and nominal wage growth are projected to slow down.
Wages in Australia grew by 4.1% in the year to the June quarter 2024, maintaining the same growth rate as in the March quarter. This level of wage growth has been consistently above 4.0% since late 2023, significantly higher than the long-run average of 2.4% per annum. This persistent wage growth, combined with moderate increases in unemployment, suggests that the economy is navigating a period where labor market conditions are adjusting, but inflationary pressures remain.
The RBA’s approach to managing NAIRU involves careful monitoring of these trends to ensure that inflation remains stable while working towards achieving full employment. The updated framework underlines the importance of the RBA’s role in assessing and responding to labor market conditions to align with its dual mandate of price stability and sustainable employment levels.
SOURCES
Investopedia: NAIRU
RBA: NAIRU Explained
RBA: Assessing Full Employment in Australia
RBA: Statement on Monetary Policy May 2024
AI Group: Factsheet- Wage Dynamics in Australia
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