By Michael Cameron*
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. Speaking recently to an industry conference, he said:
Returning to low inflation will, in the near term, constrain employment growth and lead to a rise in unemployment.
Similar sentiments have been expressed by independent economists and commentators.
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?
Unemployment rate holds steady at 3.3%, wages rise strongly - Stats NZ https://t.co/IQOPBaNYTn
— RNZ News (@rnz_news) November 1, 2022
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 rise of 7.2%, 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 10.3%, including 8.8% in the UK and 8.2% in the US.
At the same time, New Zealand is experiencing a period of very low unemployment, with a rate of just 3.3% 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.W. (Bill) Phillips.
While working at the London School of Economics in the 1950s, Phillips wrote a famous paper 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 Paul Samuelson and Robert Solow 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.
#LISTEN 🔊 The Finance Minister says addressing inflation without increasing unemployment is a difficult balancing act.
— Morning Report (@NZMorningReport) November 2, 2022
📎 https://t.co/CfaopcqjGv pic.twitter.com/1gMNat2G99
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 Policy Targets Agreement 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, Milton Friedman 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 remain high and wage growth is at record levels.
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.
*Michael P. Cameron, Associate Professor in Economics, University of Waikato. This article is republished from The Conversation under a Creative Commons license. Read the original article.
58 Comments
Sounds good to me.
Beats the conversations that we have been having for the last few years, all about:
- how landlords will just keep raising rents to shelter themselves from any kind of loss or pain
- how landlords are more clever and hardworking and generally better than tenants
- how landlords won't rent houses to people on benefits and/or think that renters shouldn't have children
- how clever landlords are, to be raking in 40%+ capital gains in the space of less than 2 years
- how stupid tenants are to be renting, and paying off a landlords mortgage.
The fact is that landlords have behaved like greedy, self absorbed, conscience deprived blood suckers. Rent to income ratios are the highest in the developed world. Even as interest rates fell, and capital values rose to give windfall gains to landlords, they STILL kept raising rents, squeezing more and more blood from renters. Renters are sick of being treated as "less than", as some kind of second class citizen.
Let them eat cake. Let the whole greedy, bloodsucking ponzi burn. We gonna have a big vampire squid bonfire... the modern version of the guillotine.
Capitalism dosen't work without risk. You've had the golden years of reward, reward, reward. Now you get to taste a bit of risk. And I say diddums.
I own a singular rental with my wife. It is rented for market rates. it's the home she owned prior to us getting together. (we're GenX before the 'ok boomer' comments start coming)
We have 95% equity across both properties (ours and the rental) . We've worked hard to 'de-risk' our investment portfolio by prioritising paying down debt on both.
I have no ambition to build a property empire, just to secure a solid future for my children by ensuring we have assets to pass on; for 2 decades we've used the clearly favourable NZ tax system which had incentivised property investment in this country to achieve this.
We've been a responsible landlord, that has also ended up in Tenancy Tribunal 8 times due to people smashing up the place, not paying rent etc..
I used the tools and the systems that were in front of me to try and get ahead. Now those tools and systems are 'unfair', and everyone who's used them is a scourge on society?
I thoroughly refute the comments that all landlords are blood sucking, virtue-signalling vampire-squids and need to suffer, and I definitely don't see myself as some sort of saviour.
Good effort mate. There are a lot of folk who demonize landlords on this site. Don't lose sleep with their comments. Some of them raise genuine issues others are just embittered and jealous.
If houses were to fall substantially, I wonder how many would consider becoming landlords, or deep down would like to if they had the financial clout?
Hmmm, I wonder how many of our articulate anti-landlord commentators are in their 40's with a useless Arts degree wondering why they are stuck on $90k/year and forever renting? Try getting a second job.
for 2 decades we've used the clearly favourable NZ tax system which had incentivised property investment in this country to achieve this.
In fairness, if we simply fix the perverse policies that are causing the housing bubble your children need not be dependent on your wealth. They will have a better chance under their own steam.
You could be a good person or a bad person, and it doesn't really matter. Either way, we are still better fixing policy issues that are causing the housing crisis, productivity problem, and only serving to extract wealth from following generations.
'productivity problem'.
While higher productivity can lead to better wages, productivity gains are usually at the benefit of the capital owner.
They're also related to $ per worker. Ireland's productivity has shot through the roof, but largely because it's a tax haven attracting head offices for corporate European arms. Did Ireland really become more productive?
If people want to benefit from higher productivity then they should look at different ways to improve the value of their time. Make more stuff, or produce less stuff but of higher value. If you can sell the stuff overseas, even betterer.
Hey, there could even be a financial website devoted to it. But instead, here we are, back in the common rooms at Auckland Uni.
Well played.
Logically, one of the best financial plays is acquiring an asset that also pays you an income.
Pretty hard to trust the share market.
TDs are bleh
KiwiSaver is harder to access if needed
Owning a business can be a way, but usually require some level of active involvement, or really good (and expensive) management.
No matter what you're doing, it's all precarious, and rarely easy.
Looking around it seems to me there must be a significant number of people that are unemployable. The beggars you see outside supermarkets and displaying crude cardboard signs at busy intersections for example. The addicts, criminals, many of the homeless sadly and the broken and mentally unwell.
The reality is that we have zero unemployment of high functioning employable people. This has been exacerbated by capable people quitting or retiring early. So with zero unemployment of capable people we likely have a severe deficit of potential employees.
We likely only get to a problematic (for employees) and significant unemployment level when it reaches around 10%.
That reinforces my argument as employers are forced to compromise due to the lack of ideal workers. You have to wonder about those young men that beg at intersections. Why aren't they seeking gainful employment? The pickings must be poor due to hardly anyone using cash these days too.
This must be a result of cultural conditioning. There are still large disparities between ethnic groups. Pakeha culture views work as almost a religious calling that their lives revolve around and gives them meaning. We live to work and sometimes make an effort to overcome that but largely fail. Outside of work our culture is extremely deficient and often deadly dull and reserved, revolving around the nuclear family. You only have to look at groups, that continue to be ethnically separated, relaxing at the beach to see who enjoys their spare time the most. Pakeha require work to make their spare time enjoyable with overseas vacations and toys like boats.
Drugs may be a symptom.
Biggest cause, imho, nutrition or rather malnutrition.
If I was in charge schools would have free lunches of barbequed meat and eggs, cheese and spring water. No fruit juices, fries, soft drinks or bread. This would appropriately feed growing brains and bodies and reduce appetite for unhealthy foods and other substances. Kids would love it too
You have to go back to England in the 1970's for that. Hot school lunches served on a plate and you sat at tables in the hall with an actual knife and fork. Morning tea was a bottle of milk and a straw. Woe betide you if you had to get up and go anywhere or got to the table late because I used to put peas on your seat. Ahhh good times, you think we have gone forwards as a society but reality is we have gone backyards in so many ways. I wouldn't swap being born in the 60's for anything.
When I watch a mother smoking I know it has nothing to do with the cost of housing. It’s priorities and what is important. I see it daily in manukau. The new Maori Health Authority is 2 doors up from Social Welfare. Kids sucking on a soft drink, Mums puffing away.
The problem there is a race and IQ + time preference problem. The science is well established on this stuff. You essentially aren't allowed to discuss this or acknowledge the problem these matters cause.
There is an interesting book called "The Son also rises" which essentially looked at church records for births, deaths and marriages over 1000 years in England and Scandenavia which showed that the 'upper class' nobles and 'middle class' tradesmen had more children which survived to adulthood, became downwardly mobile due to excessive children and essentially replaced the peasants over time with selection for higher IQ, lower time preference and higher work ethic. That this effectively made Northern Europeans into workaholic types which we see today.
No amount of cultural conditioning is going to fix that stuff, we have spent decades trying to resolve the gap with the assumption that humans are tabula rasa. It will never work and it will not change.
Intuitively it feels like the Bowling Alone phenomenon also applies to New Zealand here. In that much community participation that was previously common has been eroded or abandoned - perhaps driven in part by the need to work more and commute farther - and not replaced by new forms of community participation. Or worse, replaced by technology that started with reasonable intent but now embodies the worst of persuasive psychology.
Many people do seem to be limited to work and nuclear family, and have far less community than they once did. Some are trying, e.g. community gardens, men's sheds.
Many Asians see work as almost a religious calling too, in many cases much more than so-called "Pakehas". The productivity of some Asian countries such as South Korea are something that NZ cannot even compare with.
Anyway, for as long as there is enough wealth (and corresponding taxes) generated by these dumb "Pakehas" who do not know how to enjoy life, many from some other ethnical groups will afford to, and be happy to, relax at the beach or watch TV.
GDP per capita for NZ is $47,278 (23rd) while South Korea's is only $34,994 (32nd).
NZ appears to beat Korea in productivity and work fewer hours to achieve it:
Cross-country comparisons of labour productivity levels
There are still plenty whom, after the fiasco that was the last few years, are either burned out or simply tired for working and decide to travel around the country, take a break form employment. This and those retiring early with their gargantuan capital gains. These people are employable still but choose not to be, at least for a time, so I would have to disagree and say there can't be 0% unemployment for 'high functioning' employable people, or simply employable people at that. At present people can choose to take a break from the workforce and live off of savings if they are financially sensible to that point, and can line up another job with a solid salary increase due to worker shortage.
Stop and ask some of them?
I've been in 2 jobs in the public sector where KPIs on service/use/outcomes were also measured for ethnicity. Always amazed sitting around a table with lots of people talking for the māori perspective and reasons for the results rather than from the māori perspective. It was quite depressing to watch it in action.
This article seems to miss the point (or perhaps I'm missing the point of the article?). Low unemployment limits efforts to contain inflation because; workers are in a strong position to bargain for ever-increasing wages, often indexed to backward looking gauges of inflation, and people do not fear for their jobs to the extent that this flows through to constrained consumer demand. The latter will unwind first, the former takes more time and causes a degree of stickiness.
The building industry is coming to a screaming halt.
I told you we were heading for overshoot with housing, and here we are, yet out there are bulldozers shagging good farmland still and pretty ordinary houses, new but build with rubbish materals, fixtures and fittings on 300sqm in Hamilton, asking over a million, and seems like they must be getting close to it.
There are still huge numbers of developments in the pipeline, Hamilton has Peacockes for which a new river crossing has been built, another 3000 houses in Rotokauri, Sleepyhead development in Ohinewai, high rise in Drury, and I assume more elsewhere in the country.
Affordable housing still needed but most of what's been committed to is not that.
This is where the bulk of unemployment will come from. Hammer hands need to consider retraining as nurses and teachers
I was gonna retrain as a Finance Miniister and/Orr an over paid money grubber and I was gonna put all my eggs in one Basket and throw them at Royalties, not sensibly priced Housing for the Masses.
Living like a Royal and paying no Inheritance Taxes is just why some are Rich, Some are poor and some are in need of Nursing through the Health Sytem, if and it is a "Big If" they can find a little Abode to rest their weary upon.
Being as most Nurses are from other Countries as it is not a Favourite Kiwi Past time to spend hours slaving away for so little thanks and return.
And most of Nurses I have talked to whilst getting my Health Updates done over past 4 months are heading to Aussie for better pay and Cheaper Housing.
Not that I blame them....but Some in Power should look in the Mirror. It ai'nt all Rosy and they should stop fiddling the Books and create a well blessed Society, with sensible Accomodating.....Practices.
Cheaper to live, long and Benefit here....for sum....sorry some......these Words do get a little mixed up ...if truth be Told. And those who reap the Top Jobs are of course to blame, when the masses go Walkies to another Country to find a Lifestyle worth having...like the Natives have a pen chant for. voting in a Labourite wastrel and her croanies...not that a National Policy would change much...they have been fiddling and plying them selves with our Funds for years.
Gangs get a better deal than Nurses....sick does not cover what I thunk is wrong with our systematic failure to fix that with a :ittle More Education.....not ram raiding our Police and Health System into the grounds of a Drug Administered .........Bunch.
And most of Nurses I have talked to whilst getting my Health Updates done over past 4 months are heading to Aussie for better pay and Cheaper Housing.
It's only seeming likely to get worse too. Houses need to come down significantly in price or shortages of nurses, teachers, police etc. will grow.
Hopefully one of the major parties learns to grasp this. Not looking so, so far.
Higher unemployment is essentially collateral damage arising from reducing inflation.
Bullsh*t. It's an explicit part of the mechanism. As the article says (in the paragraphs above!); RBNZ's intent when they increase rates is to reduce economic activity, which leads to less employment, more competition for jobs (reducing pressure on wages), and, in theory, lower prices. As less people are employed, they have less money to spend, and economic activity reduces further. To argue that part of the intended causal chain is collateral damage is ridiculous. No wonder economics is in decline.
The world has always worked that way. Rich get richer. But then most rich people take the time to understand how money works, they take risks, study hard and work hard. And do the same for their kids.
I do believe that the rbnz has totally mismanaged the economy. And taken huge unnessessary risks and helped the bankers enrich theit shareholders way beyond moral decency. But the government the majority of the 'poor hard working kiwis' voted for.. has enabled all of this. And that governemnt still commamds their votes.
Importantly most 'poor working kiwis' all have the opportunity to get to the top themselves if they choose to study, work hard or to lead some well organised form of protest. Then they can try to enact change for their mates (when most get to the top that view changes btw as they wonder why those that didnt work hard should expect the same reward)
Half the problem today (probably always) is the lack of any motivation by the 'poor working kiwis' to improve their lot. There are tons of well paying jobs with employers desperate to pay well for skilled staff should the poor choose to upskill. But heck most of these poor hard working kiwis dont even bother to vote...
Seems a lot of passive acceptance of their lot.. with the most effort made being to complain on facebook. (Which is amusing as most rich dont have time or any inclination for social mediaexcept as a marketing tool to get more from the poor...)
:)
Elements of generic truth in here, however does not change the fact that policy has treated generations rather differently with regard to provision of affordable education and housing, undone in recent decades. There's plenty of reason for folk to be advocating for better policy treatment of younger generations - especially given they're still expected to fork out to look after the older generations who received more from policy.
But yes, they need to vote, and they likely need to vote outside the two largest parties, if they're to get change from recent exploitative policy.
(I do have questions vis-a-vis how in touch you are with poorer, younger folks' uptake of opportunity, however. See also: outward migration.)
Agreed .
I just dislike the victim mentality and labels like 'hard working poor kiwis' that actually encourage victim like behaviour and keep people down.
Maybe should use the term.. 'kiwis that chose not to study and work as hard as other kiwis and remain poor and who often do not leverage their entitlement to vote in order to improve their own situation' is more appropriate.
Accept many go overseas and so on which is awesome. Just would like to see as many as possible make something of themselves and drop any victimlike mentality that shackles them unfairly. I am an expat, in tech, have kids, etc.
Having a friend who worked for Kianga Ora at a moderately high level until recently, I can tell you a lot of it will go the way the mental health money for the Ministry of Health, up in smoke. Too many focus groups discussing each and every aspect of how to discuss a topic in a focus group, they have a high staff turnover for the last 2 years for a reason
Friedman is a lying stooge who sold a set of economics which is really not backed by any real evidence.
The demand supply curve never accounts for the power of suppliers to manipulate markets, and that the supplier defines the price landscape, because the organisational complexity of supplying is always much greater than demand. There is never any analysis of power in these established narratives of economics, which is at least partially why all they are so unable to predict anything properly.
The interest rate vs growth dynamic is not actually proven by evidence. The evidence essentially shows growth leads interest rates in the long term, interest rates below where they should be (Taylor Rule) incentivizes terrible speculation as we saw with the housing bubble. Interest rates do not lead growth, Richard Werner has a couple of papers on this demonstrating it.
Falsely believed that workers actually can negotiating with employers on this using 'perfect' information. This is obviously not true, employees only have power to negotiate if they are highly skilled or if you have a union and limited labour supply to demand it.
We need a new economics which is actually believable and models reality properly. I can never take these professional economists seriously when none of them seem to know the economy well enough to make themselves rich.
Could we be facing another missed opportunity like we did with correcting house prices at the start of the pandemic?
It appears that the Māori and Pacific unemployment rate is significantly higher than other groups:
Māori in the Labour Market - December 2020 Quarter
There are calls to increase participation of Māori and Pacific people in industry and manufacturing:
Thousands of Māori and Pacific workers needed to fill skills gap - report
If 9% are unemployed currently than these plans to increase unemployment are likely to make things much worse. It would be interesting to know what 2022 figures are however this seems strange:
The report’s authors found that while rates of employment among other ethnic groups now exceed pre-Covid levels, the pandemic has exacerbated inequities for Māori and Pacific peoples and their participation within the national manufacturing and engineering workforce is up to 25 per cent lower than prior to Covid-19.
Have they found employment in other sectors?
Sigh. The Phillips Curve dates back to a completely different monetary framework before the US defaulted on its debts in 1971 by breaking the link to the physical world via gold.
Mortgage payments have pretty much tripled. People have less money to spend. They can borrow less. Over time house building slows and then stops. Our entire "consumption driven" economy is based on expanding indebtedness via lending to house buyers. The whole economy is being forced to either become more productive or hyperinflate.
We have been following the path of Argentina, who currently have 83% inflation. The adjustment will not be painless. Thankfully we still have a working business model providing high nutrient food to the world. We have the option to run the country as a successful profitable business rather than as a shareholder diluting ponzi scheme.
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