Evaluating indicators of labour market capacity in New Zealand

The Reserve Bank of New Zealand sets monetary policy to achieve two operational objectives: to keep future annual inflation between 1 and 3 percent over the medium term (with a focus on the 2 percent mid-point) and to support maximum sustainable employment (MSE). The target inflation rate is observable data measured by the Consumers Price Index and produced by Stats NZ. However, the maximum sustainable level of employment is not directly measurable. The Reserve Bank has always monitored the labour market. Such analysis is important for understanding the transmission of monetary policy and avoiding unnecessary volatility in the real economy. The aspect which is new in the current environment is the concept of maximum sustainable employment as an operational objective. The analysis in this Note provides an initial consideration of this new part of the Reserve Bank’s mandate, allowing us to document our current thinking and learnings about the labour market. This Note evaluates how well measures of labour market slack are able to explain and forecast key variables – non-tradables inflation, wage inflation, and employment growth. The 44 measures explored in this paper capture aspects of the labour market that are covered in previous Reserve Bank publications, as well as aspects that are new to us. We evaluate the Reserve Bank’s more-traditional measures of capacity pressure. We also evaluate additional labour market indicators, including measures of underemployment, underutilisation, flows in and out of employment, and different dimensions of unemployment, including unemployment by region, age, and ethnicity. Our results show that labour market indicators that are particularly sensitive to business cycle fluctuations are better at forecasting employment, wages growth, and non-tradables inflation. These well-performing measures include Maori and youth unemployment rates, a reduced form Philips curve model, underutilisation, and the job finding rate. This exercise may give us some indication of which measures we should pay closer attention to when assessing where employment is compared to MSE. We still see value in keeping track of the full suite of labour market indicators. Different measures can be informative in different situations, and monetary policy formulation benefits from having a holistic view of the labour market over time. By consolidating all these indicators in one suite, we have a more detailed picture of the labour market.