Philip Lowe’s first speech as RBA Governor was on the topic of inflation and monetary policy. He showed just how powerful the impact of low income growth as been, with the wage price index (WPI) growing by just over 2 per cent over the past year, which is the slowest rate of increase since the series began in the late 1990s. Over recent years, there has been a decline in the frequency of wage increases and, when wage increases do occur, the average size is lower. This has profound impact on households loaded with high debt – yet this was NOT discussed.
The two measures shown are headline CPI inflation and the trimmed mean measure. We too have now joined the club of countries with headline inflation noticeably below the medium-term average, although we are a more recent member than many others. Headline inflation here is 1 per cent and measures of underlying inflation are running at around 1½ per cent.
These low inflation outcomes globally and in Australia are coexisting with low wage outcomes. In many industrialised countries, wage growth has been close to multi-decade lows and below what historical relationships with the unemployment rate would suggest.
The low inflation outcomes in the advanced economies reflect a combination of three factors – excess capacity, lower commodity prices and perceptions of reduced pricing power.
I would like to offer some reflections on these three factors from an Australian perspective.
First, excess capacity. While the Australian economy has performed better than many others over the past decade, we still have some spare capacity. Determining exactly how much is difficult, but Bank staff estimate that the current unemployment rate of 5.6 per cent is around ½ percentage point or a bit more above full employment. While this gap has narrowed over the past year, we do still have some spare capacity. Looking at broader measures of labour market utilisation reinforces this point. Over the past year, the Australian Bureau of Statistics’ (ABS) measure of underemployment has risen, not fallen, so that overall labour market underutilisation has been little changed. This largely reflects the fact that many of the people finding work recently have been employed in part-time jobs and report that they would like to work more hours.
The second factor is the decline in commodity prices. The most direct effect is the fall in petrol prices. Over the past two years, the price of petrol in Australia has declined by around 20 per cent. This has lowered the year-ended rate of headline inflation by almost 0.4 percentage points over each of these years. More broadly though, the decline in commodity prices has perhaps had a bigger effect in Australia than elsewhere, given that it has weighed on our aggregate income and thus demand. Over the past five years, the prices of Australia’s commodity exports have fallen by more than 50 per cent and Australia’s terms of trade have fallen by 35 per cent as a result, which is the main reason that growth in national income has been weak over recent years.
The third factor is the feeling of reduced pricing power, partly from greater competition.
One good example of this is in the retail sector, where the entry of foreign retailers has made a real difference in groceries and clothing. Over recent times, food price inflation has been unusually low and the prices of many goods have not risen as quickly as suggested by the conventional relationship with import prices.[1] Increased competition has forced existing retailers to find efficiencies to lower their cost bases and, in turn, their prices. Reflecting this, there has been a pick-up in the rate of productivity growth in the retail sector, which is good news for consumers. More broadly, though, many Australian workers are facing some of the insecurities that workers in other advanced economies are facing.
The effects of these three factors – excess capacity, lower commodity prices and reduced pricing power – are evident in the wage outcomes in Australia. In particular, the wage price index (WPI) has increased by just over 2 per cent over the past year, which is the slowest rate of increase since the series began in the late 1990s.
The Reserve Bank and the ABS have been working together to obtain some additional insight into what is happening here. Together we have looked at the wage increases for all the 18,000 individual jobs that the ABS uses to construct the WPI. The results are interesting. Over recent years, there has been a decline in the frequency of wage increases and, when wage increases do occur, the average size is lower. The decline in the average size of increases is largely due to a very sharp drop in the share of jobs where wages are increasing at what, by today’s standards, would be considered a rapid rate.
For example, six years ago, almost 40 per cent of the 18,000 individual jobs being tracked by the ABS received a wage increase in excess of 4 per cent. In contrast, over the past year, less than 10 per cent of jobs got this type of wage increase. And almost half of the individual jobs tracked by the ABS had a wage increase of between 2 and 3 per cent.
The low CPI and wage outcomes in Australia have seen some decline in inflation expectations, although not to the levels seen in many other countries. Consumer inflation expectations are lower than they were some years back, but are not at unprecedented levels. Market-based measures of long-term inflation expectations have also declined, but they remain consistent with the inflation target.
Looking to the future, we expect that the various factors holding inflation down will continue for a while yet. But this does not mean that we have drifted into a world of permanently lower inflation in Australia.
Domestic demand is expected to strengthen gradually as the drag on our economy from the decline in mining investment comes to an end. As this happens, the excess capacity, including in the labour market, is likely to be wound back. Some pick-up in wages and prices could then be expected. In addition, commodity prices, after having declined over the preceding four years, have increased this year. If sustained, this will boost national income and falls in petrol prices will no longer be having a significant effect on headline inflation. In terms of the downward pressure on prices and wages from increased competition, this is likely to continue for a while yet, but it is probable that this pressure will lessen at some point as domestic demand strengthens.
Putting all this together, our central forecast remains that inflation in Australia will gradually pick up over the next couple of years, although it is still likely to be closer to 2 per cent than 3 per cent by the end of this period.
