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Author(s): William Mitchell, Joan Muysken and Riccardo Welters
Title: The changing nature of inflation control in Australia
No: 13-05
Year: 2013

Abstract:

ヒIt is clear that the official unemployment data significantly underestimates the extent of labour market slack in the Australian labour market. Since the 1991 recession, underemployment has risen dramatically in Australia, a trend common in most OECD countries. Figure 1 shows the evolution of underemployment in Australia since 1978. The defining event in this evolution was the major recession in 1991 which saw an acceleration of part-time work as full-time jobs were scrapped but moreover an increasing proportion of the part-time offering sub-optimal hours of work. The sharp spike in 2009 was thwarted by the fiscal stimulus that the federal government introduced early in that year. However, a new level appears to have been established as the Australian labour market has endured very low employment growth since 2011. This growth has been biased towards part-time work.

Mitchell and Muysken (2008b) analysed why inflation fell in Australia in the period leading up to the financial crisis despite sustained and strong employment growth and falling unemployment. The underlying proposition outlined was that the rise in underemployment since the early 1990s changed the wage setting process in the labour market and employers use this slack as a means of disciplining wages growth and adjusting to the flux and uncertainty of the business cycle. They concluded that the Phillips curve relationship had altered and within-firm slack had become an additional disciplinary force on inflation.

While the standard Phillips curve approach predicts a statistically significant, negative coefficient on the official unemployment rate (a proxy for excess demand), the hysteresis model suggests that state dependence is positively related to unemployment duration and at some point the long-term unemployed cease to exert any threat to those currently employed. Consequently, they do not discipline the wage demands of those in work and do not influence inflation. The hidden unemployed are even more distant from the wage setting process. So we might expect that short-term unemployment is a better excess demand proxy in the inflation adjustment function.

While the short-term unemployed may be proximate enough to the wage setting process to influence price movements, there is another significant and even more proximate source of surplus labour available to employers to condition wage bargaining ¬タモ the underemployed. The underemployed represent an untapped pool of potential working hours that can be clearly redistributed among a smaller pool of persons in a relatively costless fashion if employers wish. It is thus reasonable to hypothesise that the underemployed pose a viable threat to those in full-time work who might be better placed to set the wage norms in the economy.

Thus within-firm excess supply of labour factors may now exert a significant disciplining force to the wage determination process in addition to, or as an alternative, to the traditional external excess supply forces such as the unemployment rate. It is plausible that while the short-term unemployed may still pose a more latent threat than the long-term unemployed, the underemployed are also likely to be considered an effective surplus labour pool. In that case we might expect downward pressure on price inflation to emerge from both sources of excess labour.

Subsequently, Mitchell and Muysken (2010) developed a model to help understand how firms adjust full- and part-time employment to meet the flux and uncertainty of the demand conditions they face. The paper applied the model to the Australian labour market and found that there were disproportionate declines in full-time employment during the recessions in 1982, 1992 and 2009 as a result of the decline in aggregate demand. However, there was also evidence that part of the decline in full-time employment was related to firms replacing full-time jobs with part-time employment. Further, each recession induced an increasingly stronger underemployment of labour, manifesting itself in an increasing share of part-time workers wanting to work more hours. The 1991 recession, Australia¬タルs worst since the Great Depression, was notable in this regard.

In this paper, we extend both papers using data to June 2013, which incorporates the adjustments that have been associated with the financial crisis and subsequent fiscal stimulus and fiscal retrenchment. We show that low unemployment does not indicate that the economy is close to full capacity. This also alters the concept of fiscal space, which we define as the spare real productivity capacity at any point in time, rather than use meaningless financial ratios relating to the size of the deficit or the public debt ratio.

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