“wage growth is weak and inflation is below its target range” for the Australian economy.

In February 20 this year, the International Monetary Fund (IMF) stated that “wage growth is weak and inflation is below its target range” for the Australian economy. What risks does a slow growth rate in wages pose to the Australian economy, and why are economists and governments so eager to see a general rise in wages for everyone?The following theories in Macroeconomics may be used to analyse this topic:Aggregate Demand and Aggregate SupplyUnemploymentInflationThe RBAUse of graphs and diagrams in your essay is highly encouraged, as this will display to the marker your understanding and ability to analyse a highly topical issue in Macroeconomics. When incorporating graphs into your essay, please adopt the following three critera: original (not a screenshot from your text) incorporating labels;correctly applied; andadds to your analysisAdditionally, this essay should be submitted in essay format, using Harvard style referencing. It is also expected that you include at least 5 sources in your essay. Suggested sources include Journal articles from the A, and websites, as long as they are reputable (major media sources, government websites (ABS, RBA, IMF etc)).WORD COUNT 1500 Words As an example, a suggested format for your essay is as followsï¼?IntroductionDiscussion of low wage growth in Australia (using appropriate data)Risks of low wage growthTheory 1Theory 2(Theory 3)ConclusionBibliography(Appendices)All work is individual only.Some sources that may help you! I need to atlas get a credit or distinction in this assessment https://www.smh.com.au/business/small-business/nin…https://www.ineteconomics.org/perspectives/blog/wi…https://www.economicshelp.org/blog/14299/labour-ma…http://www.news.com.au/finance/economy/australian-…http://www.news.com.au/finance/economy/interest-ra…http://www.news.com.au/finance/economy/interest-ra…
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Insights into Low Wage Growth
in Australia
James Bishop and Natasha Cassidy*
Recent low wage growth in Australia appears to be only partly explained by spare
capacity in the labour market, the decline in inflation outcomes and the decline in the
terms of trade from its 2011 peak. In this article, we present some tentative evidence that
the relationship between wage growth and labour market conditions may have changed,
and that this may help to explain recent low wage growth. Using job-level micro wage
data, we also find that, since 2012, wage increases have been less frequent and wage
growth outcomes have become much more similar across jobs.
Introduction
Over recent years, Bank forecasts for wage growth
have been persistently too strong (Graph 1). The
forecast errors have been largely the result of
there being more slack in the labour market than
anticipated and the decline in the terms of trade
being sharper than expected.1 However, even
after taking these factors into consideration, wage
growth has been surprisingly low. This raises the
possibility that the relationship between wage
growth and its determinants has changed, or
that there are other structural or cyclical factors
weighing on wage growth. Understanding the
drivers of recent wage outcomes is important
for assessing labour market conditions and
inflationary pressures in the economy. As wages
are the largest component of business costs, the
decline in wage growth has also contributed to
lower inflation outcomes over recent years than
expected.
* James Bishop completed this work in Economic Research Department
and Natasha Cassidy is from Economic Analysis Department. The
authors would like to thank David Rodgers for his assistance, as well as
the Prices Branch at the Australian Bureau of Statistics.
1 The Reserve Bank periodically reviews their economic forecasts. The
outcomes of the most recent forecast review are outlined in Kent C
(2016).
Graph 1
Wage Price Index Forecasts*
Year-ended
%
%
2011
4.0
4.0
2012
Actual
3.5
3.5
2013
2014 2015
3.0
3.0
2016
2.5
2.5
2017
2.0
2.0
1.5
*
2007
2011
2015
1.5
2019
February SMP forecasts
Sources: ABS; RBA
The analysis in this article will mainly focus on
wage growth as measured by the wage price
index (WPI). However, the Bank assesses a
range of available measures of labour costs to
provide insights into labour market conditions
and inflationary pressures in the economy. Each
measure captures a slightly different concept
of labour costs, although importantly they all
point to a slowing of earnings growth in recent
years (Graph 2). The main measures that the Bank
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Graph 2
Labour Costs Growth
Year-ended
%
8
%
8
AENA
6
AWOTE
4
6
4
2
2
0
0
%
5
%
5
Active EBA AAWIs*
4
4
3
3
WPI
2
2
1
1
0
2000
*
2004
2008
2012
2016
0
Average annualised wage increases
Sources: ABS; Department of Employment; RBA
follows are the WPI and average earnings from
the national accounts (AENA).
The WPI, which began in 1997, is designed to
measure changes in wage rates for a given
quantity and quality of labour. The index is
constructed by the Australian Bureau of Statistics
(ABS) by comparing the wage for a given job to
the previous quarter; adjustments are made to
exclude any changes in wages resulting from
changes in the nature of the job or the quality
of the work performed.2 It is constructed for a
fixed basket of jobs, so by design it should be
unaffected by changes to the composition of the
labour force.
AENA is a better indicator of inflationary
pressures in the economy than the WPI. This
is because it is wider in scope as it includes
non-wage costs, such as superannuation and
redundancy payments, and the impact of any
changes to the composition of the workforce.
This may include changes to the type of jobs
workers hold or slower-moving demographic
changes to the labour force. In practice, the
volatility in the AENA series can sometimes make
2 Although the WPI abstracts from pay increases due to improvements
in labour quality, it will be influenced by productivity improvements
arising from capital investment or technological innovation.
14
it difficult to separate out noise from signal. Other
measures of labour costs include the semiannual
average weekly ordinary-time earnings (AWOTE)
and wage increases in enterprise bargaining
agreements (EBAs).
The Bank has widely discussed the likely
determinants of the recent slowing in wage
growth. Jacobs and Rush (2015) argue that
spare capacity in the labour market, a decline
in inflation expectations, lower profitability
following the decline in the terms of trade, and
the need for the real exchange rate to adjust
to improve international competitiveness have
all contributed to lower wage growth. Firstly,
there has been more slack in the labour market
since 2008 and employees may be more willing
to accept lower wage growth given concerns
about future employment. The decline in
inflation outcomes and expectations in recent
years may have also contained wage growth.
Some employees are effectively bargaining over
â??realâ?? wages, with some wages either indexed or
heavily influenced by CPI outcomes.
The sharp rise and subsequent fall in the terms
of trade has also had a significant effect on wage
growth over the past decade. During the run-up
in the terms of trade, many firmsâ?? output prices
rose sharply, meaning they could afford to pay
higher wages while profits also increased. Mining
and mining-exposed firms needed to pay higher
wages to attract labour to increase output. Since
the peak in the terms of trade in 2011, firmsâ??
output prices have not grown as quickly and
wage growth has subsequently slowed. Finally,
the strong growth in wages during the large
run-up in the terms of trade outpaced that in
many comparable economies, resulting in a
decline in the international competitiveness
of Australian labour. However, since the terms
of trade have been declining, low growth of
wages has played the reverse role of improving
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international competitiveness, in conjunction
with the depreciation of the exchange rate.
A wage model which includes labour market
spare capacity, inflation expectations, a measure
of firmsâ?? output prices and a lag of wage growth,
cannot fully explain the decline in wage growth
over recent years.3 There are many possible
explanations for this. For example, it may be that
there is more slack in the labour market than the
unemployment rate would suggest, or that the
relationship between labour market slack and
wage growth has changed.
Spare Capacity in the Labour
Market
In this section, we delve further into the role
of spare capacity in the labour market. The
typical measure used in the Bankâ??s Phillip Curve
models of wage inflation is the unemployment
rate gap â?? that is, the difference between
the unemployment rate and the rate of
unemployment that is consistent with the
economy producing near its potential. The latter
unemployment rate, which is not observed
directly and has to be estimated, is associated
with a stable rate of inflation and is referred
to as the non-accelerating inflation rate of
unemployment (NAIRU). The estimate of the
NAIRU has fallen over recent years as a result of
weakness in unit labour costs (which is AENA
adjusted for productivity) and inflation.
The Bankâ??s estimate of the unemployment
gap suggests that spare capacity in the labour
market has declined a little more recently as
the unemployment rate has declined by more
than the estimate of the NAIRU; however,
wage growth has continued to moderate
(Graph 3). This is consistent with the experience
3 The Bank has recently modified the specification of the wages
Phillips Curve model that was outlined in Jacobs and Rush (2015).
See Appendix A for details of the model.
Graph 3
%
WPI Growth and the Unemployment Gap
Unemployment gap
(RHS)*
4.5
-1.0
4.0
-0.5
3.5
0.0
3.0
0.5
Year-ended growth in WPI
(LHS)
2.5
1.0
2.0
1.5
1.5
2000
*
2004
2008
2012
2016
2.0
The unemployment gap is inverted
Sources: ABS; RBA
of other advanced economies in recent years
that also have experienced modest wage growth
despite labour market conditions tightening.
This lends itself to a question of whether there
is more slack in the labour market than the
unemployment gap would suggest or whether
the relationship between wage growth and the
labour market has changed.
Another measure of spare capacity in the
labour market is the level of underutilisation
in the economy â?? which, in addition to the
level of unemployment, also captures the
level of underemployment in the economy. The
underemployment rate measures the number
of employed people who would like and are
available to work additional hours, expressed as a
share of the labour force. Between 2004 and 2014
the underemployment rate tended to move fairly
closely with the unemployment rate. However,
over recent years it has remained elevated while
the unemployment rate has declined (Graph 4).
Underemployment measured in terms of extra
hours of work desired has diverged by less than
this heads-based measure (RBA 2017).
Recent Bank analysis provides some
information on the characteristics of the
pool of underemployed workers. The bulk of
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Graph 4
Labour Underutilisation
Per cent of labour force
%
6
%
8
Unemployment rate
(LHS)
7
5
Underemployment rate
(RHS)*
6
4
3
2004
*
2007
2010
2013
2016
5
Full-time workers on reduced hours for economic reasons and
part-time workers who would like, and are available, to work more hours
Source: ABS
underemployed workers are part-time workers
who would like to work additional hours
(around 8 per cent of the labour force). The
second category of underemployed workers
are those who usually work full time, but are
working part time for economic reasons (less
than 1 per cent of the labour force). There are
a number of reasons for the elevated level
of the underemployment rate: the changing
composition of employment growth towards
industries with higher rates of part-time
employment and underemployment, along with
firms responding to economic conditions by
adjusting workersâ?? hours.
It is not clear how much labour underutilisation
might weigh on wage growth. The presence
of underemployed workers could dampen
wage growth given they offer additional labour
supply or may be more concerned about their
job security and have less bargaining power
to achieve higher wages.4 Unsurprisingly,
given the tight historical relationship between
unemployment and underemployment, we
have found little empirical evidence to suggest
that the level of underemployment in Australia
has affected wage growth separately to
unemployment. More recently, the divergent
trends in underemployment and unemployment
could account somewhat for wage growth
slowing by more than what is suggested by the
unemployment gap. As a result, trends in the
underemployment rate and other measures of
underutilisation will continue to be monitored.
It may also be the case that the relationship
between wage growth and spare capacity in
the labour market may be changing due to
structural changes in the labour market. It has
been posited in the international literature
that low wage growth may reflect a decline
in workersâ?? bargaining power. For example,
new arrangements, such as a restructuring
of work processes due to technological
progress, an increase in contract work, and
increased competitive pressure from growing
internationalisation of services trade, may
be weighing on wage growth. These factors,
alongside spare capacity in the labour market,
may be making workers feel less secure about
their jobs and, in turn, they may be less inclined
to push for larger wage increases. Such changes
to bargaining power are difficult to observe
and, as a result, the evidence of this occurring in
Australia is limited. Measures of job security, as
measured by householdsâ?? perceived probability
of losing their job in 12 monthsâ?? time or their
overall satisfaction with job security, are at low
levels (Graph 5). However, it appears these
indicators have tracked labour market conditions
fairly closely, suggesting that these job security
measures are not measuring anything separate
to traditional labour market indicators such as
unemployment.
4 It may also be the case that low wage growth may lead to higher
underemployment in that workers may desire more hours than
otherwise in order to boost income growth.
16
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Graph 5
Graph 6
Job Security and Wage Growth
Average subjective probabilities*
%
69
Finding a better or equivalent job if laid off
66
%
%
6
%
Losing job***
4
13
2
%
Voluntary leaving job
25
4
20
2
15
2004
2008
Quarterly*
Frequency**
%
Size***
2
10
%
%
4
WPI** (RHS)
63
Frequency and Size of Wage Changes
2012
*
Within the next 12 months
** Year-ended private sector wage price index growth
*** Indicator has been inverted
Sources: ABS; HILDA Release 15.0; RBA
0
2016
Trends in Wage Growth at the
Micro Level
Job-level WPI data can provide further evidence
on the determinants of wage growth. This
analysis is the result of a recent collaboration
between the Reserve Bank and the ABS using data
on wage growth for around 18 000 jobs (Bishop
2016). Using these job-level data, it is possible
to decompose aggregate wage growth into the
frequency and average size of wage changes.
Since 2012, both the average frequency and the
average size of wage changes have declined
(Graph 6). Overall, the declining size of wage
increases has contributed more than two-thirds of
the overall fall in wage growth since 2012, and the
reduction in the frequency of wage adjustments
has contributed the remainder. This pattern is
similar across public and private sector wages.
The frequency of wage adjustments is currently
at a low level; around one fifth of all wages are
adjusted each quarter compared to around
one quarter of all wages in 2012. This fall in the
average frequency could reflect more wage
freezes or longer delays in renegotiating wage
contracts, as wages are often frozen during the
26
4
22
3
18
2004
2010
2016
2004
2010
2016
*
Smoothed using a four-quarter trailing average
** Share of jobs with a wage change
*** Average percentage wage change, conditional on a wage change
Sources: ABS; RBA
negotiation period. It is also likely to reflect an
inability of many firms to cut wages. The fall
in the average frequency of wage adjustment
was also quite pronounced during the global
financial crisis; in part, this reflected the Australian
Fair Pay Commissionâ??s decision to freeze the
Federal Minimum Wage and award wages in
2009. The steady decline in the frequency of
wage changes since the early 2000s may reflect a
longer-run shift towards contracts that make less
frequent wage adjustments.
The average size of wage changes (conditional
on there being a wage change) has also fallen
since 2012. This is largely due to a reduction in
â??largeâ?? wage rises (more than 4 per cent); in fact,
this has had a very significant effect on overall
wage growth. The share of jobs that experienced
a wage change of over 4 per cent has fallen
from over one-third in the late 2000s to less than
10 per cent of jobs in 2016 (Graph 7). In addition,
the average size of these large wage changes has
declined to a little less than 6 per cent.
The declining share of large wage rises since 2012
has been apparent across all industries, though
the shift has been largest in mining and industries
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Graph 7
Graph 9
Wage Changes of Different Sizes
Share of jobs that experience a wage change*
%
2â??3%
More than 4%
40
%
40
3â??4%
30
Ï?
Dispersion in Wage Growth Across Jobs
Standard deviation of quarterly growth rate*
Ï?
2.5
2.5
2.0
2.0
1.5
1.5
30
0â??2%
20
20
10
10
Less than 0%
0
2000
*
2004
2008
2012
2016
0
exposed to mining, such as construction and
professional services (Graph 8). At the peak of the
mining investment boom in 2012, well over half
of mining jobs received a wage increase of more
than 4 per cent. These large wage increases were
required for labour to shift to the mining (and
mining-related) sector, and accordingly, there
was a high dispersion of wage growth across jobs
during that period (Graph 9).
The current low level of wage growth dispersion
might also suggest that the labour market
Graph 8
Share of Wage Rises
Larger than 4 Per cent
By industry
2012
2016
20
Sources: ABS; RBA
18
40
*
2004
2008
2012
1.0
2016
Smoothed using a four-quarter trailing average
Sources: ABS; RBA
Smoothed using a four-quarter trailing average
Sources: ABS; RBA
Mining
Manufacturing
Elec. gas etc
Construction
Wholesale
Retail trade
Accomm. & food svces
Transpt & postal
Info media
Fin & Ins svces
Rent hire & R/E svces
Prof scient & tech
Admin & supp svces
Public admin
Education
Health
Arts & rec svces
Other svces
0
1.0
2000
60
%
adjustment following the end of the mining
boom has run its course. However, relative wages
in the mining industry and mining-exposed
states are still significantly higher than they
were pre-boom, suggesting there may be more
adjustment to come (Graph 10). It is likely that
the adjustment to lower relative wages in mining
will be slower than during the run-up to the peak
in the terms of trade. This is because most firms
tend to be unwilling or unable to cut nominal
wages (known as â??downward nominal wage
rigidityâ??). Indeed, real wages have been fairly
unchanged over recent years (Graph 11).
The share of wage rises between 2â??3 per cent
has increased to now account for almost half of
all wage changes (Graph 7). This may indicate
some degree of anchoring to CPI outcomes
and/or the Bankâ??s inflation target. Decisions by
the Fair Work Commission, which sets awards
and minimum wage outcomes, are heavily
influenced by the CPI. A little over 20 per cent of
employees have their pay determined directly
by awards, and it is estimated pay outcomes
for a further 10â??15 per cent of employees
(covered by either enterprise agreements or
individual contracts) are indirectly influenced
by awards. Information from the Department of
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Graph 1 0
Relative Wage Price Index*
index
index
108
108
106
106
Mining**
104
102
104
102
Western Australia
and Queensland***
100
100
98
98
96
2002
*
2004
2006
2008
2010
2012
2014
2016
96
Aggregated by distribution of employers’ expenditure on wages;
seasonally adjusted; 2002 average = 100
** Wage price index in mining industry relative to non-mining industries
*** Wage price index in Western Australia and Queensland relative
to rest of Australia
Sources: ABS; RBA
Graph 1 1
Real Wage Price Index Growth
Year-ended
%
%
Deflated with
headline CPI
2
2
1
1
0
Deflated with
inflation expectations*
-1
*
2004
0
Deflated with
trimmed-mean
CPI inflation
2008
2012
-1
2016
Inflation expectations obtained from bond yields, union surveys and
market economist surveys
Sources: ABS; RBA; Workplace Research Centre; Yieldbroker
Employmentâ??s EBA database suggests ar …
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