Transcript of Question & Answer Session Why Productivity Matters

Thank you, Michael. name redacted. Really, really interesting topic. I was just wondering whether your analysis on productivity growth has also been incorporated into the model estimates of the neutral rate; whether there’s been a downward drift in the neutral rate because of very subdued labour productivity outcomes and how you’re thinking about that at the moment?

Yeah, yeah. A really good point, name redacted. So in estimating the neutral cash rate, an important determinant of that is productivity growth. So typically, the way you would think about that is higher productivity growth tends to be associated with higher returns to capital and, therefore, we need to add a higher neutral rate over time. So, our estimates that we use to come up with for the interest rate, some of them do take into account these sorts of effects, but we try and use different approaches to make it more robust.

But I think of all the unobserved things that we try and estimate, if you think of the neutral rate, or the NAIRU, things like that, I think it’s really the neutral rate is the one where it really is very, very imprecise. If I talk to my friends in Economic Research, and some parts of my own department, Economic Analysis, they do what they can to try and pin this thing down. But it’s very, very sensitive, the estimates of the neutral cash rate, to the point where, you know, it could be anything from one to four or something. So when you’re sort of getting closer, I think, of what to do with policy, that’s not particularly useful. But conceptually, yes, we do try and think about that.

name redacted . Michael, in the longer run, the sort of gap between wages growth and productivity growth, you know, feeds into, you know, price growth, inflation forecasts.

So, one of the features last week of the Reserve Bank’s inflation forecast in the Statement of Monetary Policy and their forecast in general was that somehow the Reserve Bank now doesn’t get back to the midpoint of the band. So in November, two and a half years out, you had 2.5 per cent as the inflation forecast, and that was associated with 3.1 per cent wages growth. So 3.1 per cent wages growth was enough to be at 2.5 per cent. But, you know, last week, two and a half years out, we only get to 2.7 per cent. So 3.1 per cent wages growth gives you 2.7, not 2.5.

So is there sort of a new assumption that productivity growth is slowing two and a half years out? Like, why does the Reserve Bank now have a gap of 0.6? I think that’s right. Sorry, 0.4 between 3.1 per cent wages growth and 2.7 per cent prices growth, two and a half years out? Whereas in November, you know, a much happier story we’re at the midpoint of the band because 3.1 per cent wages growth got you 2.5 per cent. So the 0.6 gap, which essentially is productivity, became a 0.4 per cent gap productivity. So productivity, what’s that, falling by one-third when it matters for all the monetary policy discussion?

So if you could talk about that issue, please?

Yeah, yeah. It’s a good point, name redacted. So, on that I’ll say a couple of things. So, one thing – we have our productivity assumption, our projection we use, so that was downgraded a bit in the near term in this round. In your references there to wages growth, you’re talking about sort of your WPI, Wage Price Index, type growth. Now, in assessing overall pressures of labour costs faced by firms, the measure, I think, that really matters for firms is that broader measure of unit labour costs. So that takes into account that this is the average earnings measure from the national accounts, that broader measure of wages. So that includes things like, you know, bonuses, overtime, but importantly it also picks up compositional change in the economy. So, people moving, for example, from high productivity to low productivity industries – the WPI won’t pick up much of that, or as much of that. That’ll get all picked up in the average earnings measures.

So, in terms of thinking about over the long run – and you can look at the data – so unit labour costs, which takes that, you know, average earnings per hour and adjusts it for productivity, so those broader measures of unit labour costs – if you look over the history of the inflation targeting period, so where inflation has averaged, you know, a touch over 2.5, growth in unit labour costs has also averaged a touch over 2.5. Right? So there is actually quite a strong long-run relationship between the broader measure of unit labour costs – and that’s the one that we use in inflation models, and conceptually I think that’s the right measure to use – so they actually do move together over time. So given the weak productivity outcomes and the broader movements in wages from that broader measure of average earnings, that inconsistency that you pointed out is not apparent when you look at the broader measures. But there’s a good point that you raise here.

(Inaudible).

Yeah, yeah. So we –

(Inaudible)

Yeah. So the point here is that wages growth, as measured by the WPI – so that’s a really good cyclical measure of wages. It gives you a good sense of where things are moving in the cycle, but it doesn’t capture a lot of things. Right? So we – you know, we’re not, we don’t hide what our views are on these other variables, and we talk about it quite generally when we start talking about inflation, we do talk about the broader measures of labour costs as well.

But it’s tricky as well, particularly in the short run, to your point, you know, the wages – the WPI measure – is sort of a smoother measure. When you get to these broader measures of average earnings and unit labour costs, they can be volatile – they are volatile, and then they can be revised as well. So that makes sort of getting a read in the near term – you know, that makes that tricky. So it could be, you know, that the WPI is actually giving, you know, a more accurate pulse, right, in that sort of recent disinflation, and that there’s some other issues in the broader measures of labour costs. Absolutely could be true.

(Inaudible)

So I’d characterise it a little bit different, name redacted. So in the sense that the – so you’re right on the wages, the WPI data, it’s pointing to some moderation in looking at wages growth.

(Inaudible).

Yeah, that’s right, over the second half.

(Inaudible).

And, well, if I go back a second, some of that unexpected stuff – in fact, most unexpected stuff for us – has been around public sector wages growth, where we know that there are some big agreements sort of in the pipeline and the timing of those will matter. So we could see quite a bit of volatility in public sector wages growth. But yes, there has been overall – wages growth did, overall, moderate, by the WPI, by more than we had anticipated. And some revisions to that data did show that sort of continued moderation, whereas the previous vintage of data had showed it had flatlined. To me, that actually, in terms of the lags with these things, the most recent data actually line up a bit better with, I think, how we think about wages growth, to the extent that the unemployment rate, basically, we thought, yeah, had been – unemployment had been going up a little bit, labour market conditions had been easing till sort of mid last year. Right?

Given the lags, you might still see some of that earlier easing had fed through to wages growth. Okay, so I think that’s actually broadly consistent. The big question now is, given that the unemployment rate has basically flatlined over the second half of last year and into early this year, and some other measures have even tightened – if you look at underemployment, what’s that going to do now for the forthcoming wages print?

So, could be that we get the further disinflation, as you’re inferring there, but maybe that sort of – the stalling in labour market easing might hold wages growth up. So, one to watch.

Thanks very much.

That’s all right. Next time.

Just before I finish –

It was a really good question about wool. Knowing I’m talking to – knowing I’m talking to Crookwell’s finest, two seconds – the role of commodity prices in productivity?

Yeah. So I think – yeah, name redacted, I’m from Crookwell, so we can talk about sheep till the cows come home. But I think the role of commodity prices is – name redacted, I think it goes back to that sort of terms of trade type effects. And, you know, some people have sort of suggested that – so when I said there’s, you know, both productivity and real income – and terms of trade movements can affect real income growth, some people have sort of said, "Well, maybe, you know, that the movements in the terms of trade when it was high, was it associated with lower productivity growth?" Well there’s a correlation there, but some of work done by others, including some of my colleagues, you know, if you look through that period, through the mid-2010s – sorry, mid-2000s to the 2010s – even if you take the mining sector out, or take WA and Queensland out, you still see in the data there’s sort of a deeper slowing in productivity growth. So, there could be something there, but we think there are bigger issues at play. And just before I finish, I want to thank my colleague, Angelina Bruno, who’s with us today, Kevin Lane and Jonathan Hambur, who each know a huge amount about productivity and helped a lot with preparing this. So, thank you, all of them.