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RBA reveals the real cost of unemployment

James Mitchell
25 August 2021 2 minute readShare
RBA reveals the real cost of unemployment

The central bank has been able to quantify the effect that unemployment has on spending as the COVID-19 pandemic continues to cast uncertainty over the Australian economy.

In its latest research discussion paper, “Job Loss, Subjective Expectations and Household Spending”, the Reserve Bank of Australia found that employed workers have some ability to predict whether they will lose their jobs in the year ahead. However, they typically overestimate the probability of job loss.

“These systematic overestimations vary with the business cycle, with workers typically overestimating job loss during economic downturns and in the period just prior to the COVID-19 pandemic. Unemployed workers also underestimate the duration of the unemployment spell,” the research paper noted.

Not surprisingly, household spending falls significantly at the onset of unemployment. Reserve Bank modelling found that a household’s total annual expenditure falls by 9 per cent in the year that the head of the household is unemployed.

The modelling also found that total consumption takes two years to return to pre-unemployment levels.

“Households also reduce spending by similar amounts regardless of whether the job loss is expected or not,” the RBA noted. “However, households do cut back more on their spending if they expect a period of unemployment to persist. The effect of unemployment on spending is particularly strong for households that are liquidity constrained and during economic downturns.”

In contrast, the Reserve Bank only found limited evidence that concerns about future job loss affect spending for those workers that do not become unemployed.

“For policymakers, our research quantifies the effect of unemployment on spending, a previously unexplored aspect of unemployment in the Australian literature,” the RBA concluded.

“Our findings highlight the cost of unemployment to households and underscore the importance of macroeconomic policies that keep unemployment low. Our finding that households reduce spending by more the longer they remain unemployed may imply a role for policies designed to reduce unemployment duration.”

Unemployment drops below 5 per cent

Australia’s jobless rate fell below 5 per cent in June to 4.9 per cent before falling further to 4.6 per cent in July.

However, the RBA members noted in their August monetary policy meeting that outbreaks of the Delta variant and accompanying lockdowns had introduced a high degree of uncertainty to the outlook for the second half of 2021.

“Members observed that economic activity and employment were expected to decline in the September quarter,” the bank said.

Improvements in labour market conditions were expected to reverse temporarily in the September quarter as a result of the lockdowns in Greater Sydney and other parts of the country. The restrictions on activity were expected to result in a substantial decline in average hours worked.

The RBA stated that labour force participation was also expected to decline for a period as people delayed searching for work while restrictions on mobility remain in place, as had been seen during previous lockdowns.

“Some employment losses were expected, although a fall in labour force participation was anticipated to limit the increase in the unemployment rate. The high level of job vacancies and increased fiscal support would also help limit job losses,” the paper said.

However, much would depend on health outcomes and the duration of the lockdowns. Looking further ahead, RBA members noted that the eventual lifting of restrictions and underlying strength in economic conditions are expected to result in the labour market recovery regaining momentum.

“In the baseline scenario, the unemployment rate was forecast to decline to around 4.5 per cent by the end of 2022 and to 4 per cent by the end of 2023, which was lower than previously forecast,” the RBA said.

The Reserve Bank noted that, in the preceding half-century, this was a level that had been reached only briefly during the mining investment boom and in the early 1970s, when the structure of the economy had been very different.

RBA reveals the real cost of unemployment
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James Mitchell

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