World

Mon Apr 20

The RBA’s policy deliberately creates unemployment. So why do we treat the jobless so badly?

Written by: Warwick Smith, Honorary Fellow, School of Social and Political Sciences, The University of Melbourne

The Reserve Bank of Australia (RBA) will look at the latest unemployment figures ^[1] – 4.3%, roughly 650,000 people out of work – and see a labour market that is still “too tight”.

In other words, not enough people are unemployed for inflation to come down. Although that figure reflects almost none of the economic fallout from the war in the Middle East, it will strengthen the case for further interest rate hikes.

The logic of these expected rate hikes is to slow spending by pushing up mortgage repayments and, ultimately, pushing more people out of work. Those people will land in an employment services system that, as a 2023 parliamentary inquiry ^[2] found, treats them more like fraudsters than citizens who need help.

The fact the RBA is intentionally lifting the unemployment rate is rarely said out loud. However, Governor Michele Bullock came close in a speech in 2023 ^[3]:

If unemployment remains too low for too long, inflation expectations will rise, which will make it that much harder for the monetary authorities to bring inflation back down.

Our current inflation management framework is problematic in theory, in practice and in impact.

The theory on unemployment

At the heart of the RBA’s framework is a concept only an economist could come up with: the Non-Accelerating Inflation Rate of Unemployment, or NAIRU ^[4]. This is the theoretical lowest unemployment rate the economy can sustain before wages push up inflation.

The RBA considers a range of factors in its decisions, but the NAIRU is central to how it thinks about the labour market. The trouble is that nobody can directly observe the NAIRU; it must be inferred from models ^[5].

For years, the Reserve Bank estimated it was around 5%. Then unemployment fell well below that without triggering inflation, and the estimate was quietly revised down. As journalist Ross Gittins has observed ^[6], NAIRU models have consistently been set too high, leading policymakers to accept more unemployment than was necessary.

The NAIRU also treats the labour market as a single entity, which obscures important dynamics. In sectors like aged care, disability support and early childhood education, we face chronic labour shortages even while macro settings aim to increase overall unemployment. This tension suggests the problem is not simply excess demand, but how labour is distributed across the economy.

The Reserve Bank has a dual mandate ^[7]: price stability and full employment.

But the bank has made clear which takes priority. As Bullock has put it ^[8], low and stable inflation is “a prerequisite” for employment growth – so when the two objectives conflict, as they do now, unemployment comes second.

The blunt tool – interest rates

When inflation is above the central bank’s target of 2–3%, the RBA will typically respond by raising interest rates ^[9].

Since the explosion of household debt that began in the 1990s, this works mainly by squeezing mortgage holders, reducing their spending, weakening overall demand in the economy and – by design – increasing unemployment.

The current situation exposes the limits of this approach. The inflation now driving rate expectations is largely a global oil supply shock caused by conflict in the Middle East. Higher interest rates ^[10] can’t address the supply problem, but will cost jobs and add to mortgage stress.

The harsh treatment

If the system deliberately creates unemployment, you might expect it to treat the unemployed with some recognition of their role in the broader economic strategy.

The opposite is true. A 2023 parliamentary inquiry found more than 70% of participants had been subjected to payment suspensions ^[11] — the system’s penalty for failing to meet mutual obligation requirements. Yet there was no evidence that anything close to that proportion were not actively seeking work. The parliamentary committee described the system ^[12] as follows:

It’s harsh but true to say that Australia no longer has an effective coherent national employment services system; we have an inefficient, outsourced fragmented social security compliance management system that sometimes gets someone a job against all odds.

The assumption underpinning employment services – that unemployed people need to be monitored, impoverished and coerced – is in direct contradiction to an interest rate policy framework that requires a certain level of unemployment to control inflation.

What are the alternatives?

It is sometimes argued that this cruelty is regrettable but unavoidable – that there is no other way to manage inflation.

History and contemporary economics say otherwise.

From the end of the Second World War until the 1970s, Australian governments of both persuasions used fiscal policy, public investment and a range of other tools ^[13] in addition to interest rates to manage inflation.

Over this 25-year period, unemployment in Australia averaged 2%, a rate so low that “long-term unemployment” didn’t exist as a concept.

Today’s economy is different, but lessons can still be learned from the postwar boom years. Economists Ross Garnaut and Peter Dawkins recently argued ^[14] the best way to find the real floor for unemployment is not to rely on backward-looking models but to expand the economy’s productive capacity.

This means targeted investment in the areas where we face real constraints: training and retaining workers in care, health and education; building housing; accelerating the energy transition.

Inflation often happens when demand exceeds capacity. So expanding capacity in targeted areas of labour shortages won’t add to price pressures. It’s anti-inflationary.

Fiscal policy tools such as targeted public investment and well-designed tax reform can also address inflation without relying exclusively on the blunt instrument of interest rates.

Full employment should certainly be our goal. But if we are going to maintain a system that deliberately creates unemployment, the least we should do for those who bear the cost is income support that’s above the poverty line ^[15] and services that genuinely help. The current system is both ineffective and unnecessarily cruel.