The RBA is too worried about expectations of persistently high inflation

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How much we should worry about inflation expectations is an empirical question: is this assumption confirmed by facts and figures?

In 2022, Dr. John Bluedorn and colleagues at the International Monetary Fund conducted a study of the historical evidence for wage-price spirals in developed economies and concluded that a jump in wage growth should not necessarily be seen as a sign that a wage-price spiral is underway.

Bluedorn outlined these findings at the Reserve Bank's annual research conference last September. His presentation was presented by Iain Ross, former president of the Fair Work Commission and now a member of the Reserve's board.

Ross (and leading labour economists such as Professor Jeff Borland of the University of Melbourne) readily agree that Australia experienced a wage-price spiral in the 1970s. But both men conclude that our circumstances 50 years later are “very different”, meaning that it should be possible to maintain steady wage growth without triggering a wage-price spiral.

In mid-2022, Borland listed three ways in which our current circumstances are different. First, upward pressure on wages on the supply side is limited by employers' ability to provide additional hours to part-time workers who would prefer to work more hours and to attract more people into the labor market.

Second, changes in the “institutional environment” since the 1970s have limited the scope for wage increases based on the principle of “comparative pay equity” – “These workers got a pay raise, so it’s only fair that we get the same.”

Third, the decline in union membership and a number of other factors have reduced workers' bargaining power and thus limited the level of wage increases that are likely to be achieved.

There is probably no one in the country better placed than Ross to explain how the institutional arrangements governing wage setting have changed over the decades. He told the conference that “these changes have been profound and have significantly reduced the likelihood of a wage-price spiral.”

The key difference was that in the 1970s and 1980s, institutional arrangements facilitated the transmission of wage increases negotiated at company level – usually by unions in the metalworking industry – to the respective industrial sector and ultimately to the entire workforce.

The current arrangements differ significantly in four important respects. First, the new “modern collective agreements” act as a minimum safety net and the circumstances under which minimum wages can be adjusted are limited. In fact, there is no scope to adjust minimum wages to the outcome of collective bargaining at company level.

Second, the Fair Work Act limits the general adjustment of all modern minimum wages to an annual wage review by the Fair Work Commission.

Third, company agreements must be approved by the Commission before they become legally binding. Agreements last for an average of three years. During this period, employees covered by the agreement cannot legally take industrial action to obtain further pay increases.

Fourth, the sanctions against participation in such industrial action are “easily accessible and effective”, says Ross.

Ross found that the percentage of all workers who belong to a union has dropped dramatically since the 1970s, from just over 50 percent to 12.5 percent. And in the private sector, it is 8.2 percent.

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The manufacturing sector and its unions played a central role in the wage-price spiral of the 1970s. Yet the share of manufacturing in total employment has fallen from 22 percent to 6 percent, while the share of union members in manufacturing has fallen from 57 percent to 10 percent.

While in the 1970s around 800 working days per 1,000 employees were lost due to industrial disputes, today this figure is virtually zero.

Ross said the current collective bargaining arrangements act as a shock absorber, limiting the bargaining ability of workers covered by a collective agreement. “There is no evidence to date that a wage-price spiral is developing under the current circumstances and current data suggest that such an outcome is unlikely,” he concluded.

My point is that there is no reason for the Reserve to live in fear of an impending deterioration in inflation expectations when the ability of workers and their unions to translate their expectations into higher wages is severely constrained. Given this, we should not allow impatience to get the inflation rate back to target to increase the risk of a recession, the depth and duration of which could significantly undermine our return to full employment.

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