Unemployment of 4.2% is a sign of RBA success, but it might not last. Here’s why

Today’s news that an extra 47,500 Australians found work in August while the unemployment rate held steady at 4.2% is a sign of success for both the government and Reserve Bank.

It’s a sign of success in dealing with the difficult task of bringing inflation down without too much economic damage.

Then Reserve Bank Governor Philip Lowe, in a speech shortly before he handed over the reins to Michele Bullock, said that success in this task would require navigating a narrow path.

To keep to the narrow path would mean

• inflation returns to the target band within a reasonable timeframe

• the economy continues to grow

• we hold on to as many of the gains in the labour market as we can.

Well, so far we’ve stayed on the narrow path - and that is a considerable achievement.

The main reason we’ve been able to stay on the path, up until now, is good decision-making by both the government in its handling of spending and taxation (so-called fiscal policy) and the Reserve Bank in its handling of interest rates (monetary policy).

This might seem a wild claim to make, and it is certainly contrary to the sorts of claims that are generally made.

But here are three key facts about policies and economic outcomes in Australia compared to the United States, United Kingdom and Canada that back it up.

Australia was less aggressive in raising rates

The first fact is that policymakers in Australia have been less aggressive in using interest rate increases to constrain activity in order to bring down inflation.

Australia started raising interest rates when inflation reached about the same level as the other countries, but increased them by much less, by 4.25 percentage points, compared for example to 5.25 points in the United States.

The second fact is that Australia’s more gentle approach to tightening does not seem to have led to an outsize increase in inflation after the tightening began.

Nor does it appear to have slowed the subsequent decrease in inflation.

The rate of inflation has fallen an average of 0.7 of a percentage point per quarter from its peak in Australia, 0.7 in Canada, 0.8 in the United States and 1.0 percentage point in the United Kingdom.

Australia’s approach kept unemployment low

The third fact is that, largely as a result, Australia has done better in preventing the rate of unemployment from climbing.

Australia’s unemployment rate has increased only 0.6 of a percentage point since interest rates were first hiked, whereas unemployment has risen 0.8 of a percentage point in the United States and 1.6 percentage points in Canada.

This achievement is made even more impressive by the fact many more Australians are making themselves available to work.

Australia’s so-called participation rate has climbed 0.7 percentage points since unemployment began rising, compared to 0.3 points in the United States and a fall of 0.2 points in the United Kingdom.

Of course it would have been better had unemployment not increased at all.

But the large rise in inflation in 2022 required a response. Deciding to head it off by increasing interest rates at the cost of some jobs was a reasonable call to make at the time.

Whether that is still the case is a different matter. Inflation has now fallen back below 4%. And when the inflation rate for the year to August is released next week, it may well be closer again to the Reserve Bank’s target band.

Our jobs market is weaker than it seems

Although the unemployment rate has so far only climbed from 3.5% to 4.2%, there are reasons to worry it will soon climb higher.

The average number of hours worked per month has climbed 24 million over the past year, an increase of 1.3%.

But much of this has been the result of an extraordinary boost in immigration boosting population growth.

In the year before COVID hit, the population grew by an average of just over 20,000 per month. Over the year to August, it grew 50,000 per month. This can’t be expected to continue, and the government’s proposed cap on international students is one of the measures that will slow it down.

Many new jobs are government-funded

As well, many of the extra hours worked are in largely government-funded jobs, in the industries the Bureau of Statistics calls education and training, health care and social assistance, and public administration and safety.

The number of people employed in childcare increased by 53,000 over the past two years and residential aged care by 47,000. In the “other social assistance” category (which includes disability care) employment has increased by 83,000.

Like high immigration, this can’t be expected to go on forever.

This graph shows the portion of the monthly change in hours worked that is accounted for by education, health care, social assistance, and public administration and safety jobs.

In recent months, they have accounted for more than 40% of the extra hours worked.

As the boost in largely government-funded jobs fades and the immigration rate slows, Australia’s labour market is likely to start to look worse.

Now is the time to start worrying about it. Jobs need again to come to the fore in setting monetary policy.

Not to do that risks undoing the good work so far, and pushing us off the narrow path, with a much larger labour market downturn than is desirable or necessary.