High on their own (estimates of) supply
Three lessons from the June labour force data: don’t put too much weight on one month’s data, triangulate across series, and take labour supply seriously.
- Monthly labour market data can be noisy, so it pays not to put too much weight on one month’s figures. Assessing trends over several periods is one way to cut through the noise, though this means you are partly using stale information. Measures that deal with outliers in current-period data are another.
- Also important is cross-checking using related data. Not only does this allow us to smooth through noise, but sometimes it reveals something about how we should interpret fluctuations in top-line data. This is clearly the case for current labour market data, which are behaving differently to the past, but exactly how we should expect when the labour market is roughly in balance.
- In any assessment, it is crucial to avoid excessive focus on demand-side frames of analysis. When demand and supply are roughly in balance, supply shocks and trends are at least as important as the demand-side factors that dominate when economic slack is significant. The RBA seems to be downplaying the role for short-term noise in supply in its labour market analysis, as well as taking a different view of supply trends than Treasury.
Recent labour market data highlight how important it is not to put too much weight on one month’s figures. As our colleague Ryan Wells flagged ahead of the April release, the timing of Easter dampened employment growth in the month, only to bounce back in May. Not everyone saw that coming. The June monthly number might also have a timing-related noise component to it, in the opposite direction.
Assessing trends over several periods is one way to cut through the noise, though this means you are partly using stale information. Removing outliers from the current period’s data is another, as with the trimmed mean and similar measures of underlying inflation. Also useful is triangulating across a whole dataset and related data. This is one reason why the richness and detail of the ABS’s labour market data are so valuable. It affords multiple ways to cross-check.
One way to cross-check is to use a different frame for the same concept. This could mean triangulating heads employment growth with growth in hours worked, or the ratio of employment to population instead of a simple growth rate. The ABS uses estimated population growth to scale up employment changes in the sample of people it surveys into an economy-wide figure. Because official population statistics are published with a lag, this scaling (and so reported employment growth) is prone to revision, especially when population growth is changing. And as one of my old bosses used to remind us, revisions to history are one of the main causes of a change in your view about the economy. The employment-to-population ratio is robust to this issue, and an important cross-check.
Even better cross-checks on employment growth can be found in measures of labour market slack. Unemployment, underemployment and job vacancies are currently a much clearer – and less noisy – through-line on the state of the labour market than employment growth has been lately. That was not the case a few months ago, when reported underemployment was surprisingly low. As another of my old bosses always reminded us, though, if the data look wrong, they probably are. Ryan highlighted in his preview of the June labour data that, after the May release, the ABS reported some systems errors that had resulted in underemployment being understated. The corrected data line up with the recent gentle upward trend in unemployment, and might be view-changing for some observers.
Fluctuating separately and together
The real benefits of cross-checks go beyond smoothing through noise. They reveal how we should interpret fluctuations in employment. Currently these are much more about labour supply than they are about labour demand. Each surprise on monthly employment lately has been accompanied by a broadly equivalent movement in labour force participation. Measures of slack such as unemployment have moved much less.
Indeed, these correlations in short-term dynamics are exactly what we should expect to see when the labour market is roughly in balance. For most of the past few decades, labour market slack has prevailed. Additional labour demand would therefore mostly draw from workers already seeking work. In that world, positive surprises on employment would mostly correlate with negative surprises on unemployment and related measures, and participation would move relatively less.
When the labour market is tighter than full employment, you would instead expect to see employment growth constrained by supply. Positive surprises on employment would only occur alongside a positive surprise on supply, that is, participation. Measures of slack such as unemployment would be flat to down in the face of such a move.
In an over-tight market, though, you would not expect to see an increase in both employment and participation also correlating with rises in unemployment, as we saw in June. The current pattern suggests supply and demand are roughly in balance, but with both subject to small fluctuations around rising trends. This means that sometimes employment, unemployment and participation all rise together, while sometimes they all fall together. Still other times unemployment breaks the other way, depending on which noise was larger in the month.
This pattern cuts against the traditional, demand-driven approach that pervades economic analysis in central banks and elsewhere. For example, in its May Statement on Monetary Policy, the RBA motivated its flat-to-down forecast for the participation rate as workers responding to dwindling job opportunities by withdrawing from active participation in the labour force. In that world, labour demand leads labour supply.
It seems a little odd to use a framing suited to a situation of labour market slack in your forecasts when you believe, as the RBA says it does, that the labour market is if anything tighter than full employment. This might be suggesting that it expects that its current forecasts of below-trend growth generate a reasonable amount of spare capacity quite soon. This is, after all, what it believes is needed to return inflation to target.
Bend to the trend
Perhaps more perplexing is how embedded a downbeat view of labour supply trends is in the RBA’s published forecasts. Recall that Australia, along with most other advanced economies, has seen a rising trend in labour force participation rates for several decades. Ageing populations actually encourage this: Japan, where demographic ageing is considerably more advanced, now has a participation rate that exceeds the US. For many years, though, ageing populations were assumed to shrink the workforce and lower participation rates. This assumption was built into the RBA’s forecasts for most of the 2010s and was the driving assumption behind Treasury’s Intergenerational Reports (IGRs) – and even the need for them.
More recently, Treasury appears to have thrown in the towel on the declining labour participation narrative. As Ryan highlighted back in May, this year’s budget incorporated a change in Treasury’s view, which now has a rising trend forecast for participation almost identical to our own forecasts. This contrasts with the flat profile assumed in MYEFO and flat-to-down trend in past IGRs. This puts their view of the outlook for labour supply at odds with the RBA’s.
To be fair, there is also a cyclical element to labour force participation. On top of the demand-leads-supply view that workers decide whether to search actively for work (and thus be recorded as unemployed as well as boosting their chances of getting a job) according to their perception of available opportunities, recent RBA research has shown how important cost-of-living pressures are for people’s decisions around participation and hours worked. These dynamics were less salient before the pandemic, when inflation and interest rates were low and stable.
These dynamics are especially evident for younger workers (age 15–24), where the boundaries between work and study are more permeable and flexible work more common. The chart pack accompanying Ryan’s note this week shows larger monthly swings in participation and underemployment for this age group than for older adults. But there is a demand-side element here, too, evident in trends by sex. In recent months, unemployment and underemployment rates have risen faster for female workers than for males. This is consistent with the relatively tougher times for consumer-facing businesses highlighted in our refreshed Westpac Business Signal report.
All of this points to the need to triangulate across data and adapt frameworks for a world that is roughly in balance but subject to considerable noise. Right now, the RBA appears to be using analytical frames suitable for a world of high slack, at the same time as believing there is no slack. If we are right about the longer-term trend in participation, the RBA may find itself back in that world before too long. But not in the near term. The risks of high inflation are front of mind now. Emerging slack will be more of a story late this year and early next year, and a consideration for the ultimate unwind of tight policy.
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