Is the Phillips Curve Still a Curve? Evidence from the Regions

Abstract

The way in which wages respond to very low rates of unemployment remains a key source of uncertainty in Australia, partly due to the lack of historical evidence to draw upon. To help fill this gap, we study data on unemployment rates and wages growth across local labour markets over the past 20 years. The considerable variation in economic conditions across local labour markets allows us to infer the strength of the relationship between unemployment and wages growth (i.e. the wage Phillips curve) at very low unemployment rates that are rarely seen at the national level. We find strong evidence that the wage Phillips curve is indeed a curve, rather than a straight line. When the unemployment rate exceeds 7½ per cent, the Phillips curve is flat and wages growth is unresponsive to changes in unemployment. Wages growth then becomes increasingly responsive to changes in the unemployment rate as the unemployment rate falls to lower and lower levels, most notably below 4 per cent. These findings have implications for monetary policy, particularly at the current juncture given the Reserve Bank of Australia's central forecast for the unemployment rate to fall to multi-decade lows in the next few years.