The government is banking on optimistic wage growth forecasts to achieve its budget goals

Getty ImagesA festival goer wearing rose-coloured glasses.
  • Australia’s government is banking on faster wage growth to boost household spending, nominal GDP growth and national income levels.
  • It sees annual wage growth lifting to 3.25% in 2019/20, despite an expectation that unemployment will still remain at 5.25%.
  • Many believe unemployment will need to fall to 5% or below before wage pressures begin to lift.

When it comes to the outlook for Australian wage growth, few analysts are as optimistic as the Australian government.

Despite remaining near the lowest level on record, especially for private sector workers, the budget expects wage growth to accelerate sharply over the next few years, lifting from 2.08% at present to 3.25% by the 2019/20 fiscal year.

In the budget out years, wage growth is expected to accelerate further, rising to 3.5% in both the 2020/21 and 2021/22 fiscal years.

Source: Australian Treasury

As the government explains, this will be crucial in helping boost nominal GDP growth and, as a consequence, tax revenues, in the years ahead.

“Whilst wage growth remains subdued, it is expected to strengthen as growth in the economy strengthens to an above-potential pace and spare capacity in the labour market is absorbed,” it says.

“Higher wages and inflation will contribute to a rise in the level of nominal GDP over coming years.”

This is expected to help offset an expected decline in Australia’s terms of trade due to lower commodity prices.

“From 2018-19, the terms of trade are forecast to fall as prices of some key commodities are assumed to decline to more sustainable levels,” it says.

Nominal GDP is forecast to grow by 4.25% in 2017-18, 3.75% in 2018-19 and 4.75% in 2019-20.

As seen in the chart below, nominal GDP growth of such magnitude will be lower than the average seen over most of the post-GFC era.

Source: Australian Treasury

While commodity forecasting is notoriously difficult, it means much of the government’s budget projections are underpinned by higher wage growth.

The question now is whether the government’s forecasts for wage growth are a little too optimistic.

Based on recent evidence from both home and abroad, they are.

Like the Reserve Bank of Australia (RBA), Treasury sees Australian unemployment gradually declining in the years ahead, falling from 5.5% at present to 5.25% in the 2020/21.

Crucially, unemployment is not expected to reach Australia’s full employment level — widely regarded as around 5% — until the 2021/22 fiscal year.

Full employment, or Australia’s non-accelerating inflation rate of unemployment (NAIRU), is the point where wage pressures start to accelerate.

While 5% is often flagged as Australia’s NAIRU level, no one is really sure if it is any more given weak wage growth outcomes in other developed economies in recent years.

In its quarterly statement on monetary policy released last week, the RBA noted that there is “uncertainty around the level of the unemployment rate that is consistent with full employment”.

“If experience overseas is any guide, this level of the unemployment rate could turn out to be lower than previously assumed,” it said.

“The outlook for a pick-up in inflation depends on a gradual pick-up in wages growth.”

Like the RBA’s inflation forecasts, the same could be said for the government’s updated economic forecasts.

It expects that higher wage growth will help boost household consumption, and with it nominal and real GDP.

While commodity prices create both downside and upside risks to nominal GDP and national income levels, a lot is resting on stronger wage growth to achieve the government’s fiscal proejections.

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