Unemployment must rise before inflation comes under control: Economists

Wednesday, 26 October 2022

The overall inflation rate gives a good measure of the bigger picture, but it’s just an average. Video first published August 30 2022.

New Zealand’s unemployment rate needs to increase to around 4.5% to stop adding pressure to inflation, ANZ’s economists say.

In an update on Wednesday, chief economist Sharon Zollner said she expected unemployment to rise to 5% over time. It is currently 3.3%.

The Reserve Bank is fighting inflation that remains at 30-year highs.

The official cash rate (OCR) has increased from a Covid low of 0.25% to 3.5% and is expected to go as high as 5% or 5.25%.

* Unemployment rate plunges to 3.4 per cent, matching record low in 2007

* Workforce reaching 'maximum sustainable employment'

Stuff Generic money, 10 cents, cost of living, inflation, nz coin

Zollner said New Zealand’s current business cycle was “special” because labour shortages had emerged here first, core inflation pressures rose here first and it was now more than a year since interest rates started to rise.

That situation had since been mirrored around the world.

“That’s put an unusually high degree of global attention on the outlook for this small, far-flung economy over the past year.”

She said there was strong interest in how the housing market, households and businesses coped with a sharp rise in interest rates.

“The canary in the coal mine is hanging in there.”

She said a sharp rise in unemployment would show how much “clear air” there was under what were still extremely overvalued house prices.

“That remains an important downside risk. But for now, the labour market remains extremely tight.”

Sharon Zollner says prices are too high but that doesn’t mean they can’t rise.

Job ads were very strong and employment intentions from firms were holding up the best of all the activity indicators, she said.

“The upshot is that it’s not obvious that the Reserve Bank has yet been successful in opening up spare capacity in the economy.”

She said average hourly earnings were up 7% in the year to June, only just behind the consumer price index (CPI) of 7.3% for the same period.

“Since then, CPI inflation has held high at 7.2% in the year to September, but wage growth is expected to have accelerated further. Not everyone will have had their purchasing power restored, but many have,” she said.

“We are forecasting the unemployment rate to rise to 5%, but not imminently, as we suspect that growth in the labour force from net migration will remain subdued for some time yet.”

She said movements in and out of the country were rising strongly, from a very low base. The Australian market was likely to pull workers in.

“Overall, we see the risks tilted towards unemployment staying low for longer than the Reserve Bank is forecasting. Overall, persistent core inflation and wage pressures mean that the Reserve Bank’s August MPS plan to stop hiking at about 4% and wait and see from there will be stymied, in our view. Rather, we see the OCR getting to 5% by February next year.”

Senior economist Miles Workman said ANZ estimated the non-accelerating inflation rate of unemployment was about 4.5%.

“That means unemployment around this level would be consistent with the labour market no longer adding to inflation pressures.”

Zollner said even a recession might not be enough to slow inflation, if it just meant a fall in output.

“To actually beat back inflation pressures, labour demand needs to fall. Rising unemployment is not a happy prospect for workers or for the housing market. But failing to get on top of inflation would lead to an economy that struggles to perform over the long term, with inflation eroding wealth and complicating long-term decision-making. What price are we willing to pay to avoid that?

“That’s a question that will be asked more and more as the damage from rising interest rates becomes less theoretical and more real.”