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Little inflation risk from falling jobless rate, says Wadhwani

THE IMPROVED performance of the jobs market could justify "testing the water" with interest rates by allowing unemployment to fall further, Sushil Wadhwani of the Monetary Policy Committee argued last night.

He said the unemployment rate below which a tight jobs market triggers inflation - the "non-accelerating inflation rate of unemployment" or Nairu - is lower now than at the start of the 1980s, although still higher than during the economic golden age of the 1960s.

It could fall more thanks to the increase in competition spurred by the Internet and to the Government's New Deal, which will eventually be extended to all unemployed adults, he said.

This did not mean the MPC could be complacent about inflation, Dr Wadwhani said, but there was a good case for allowing unemployment to continue falling. "One therefore looks for direct indicators of labour supply shortages, and evidence that they are placing upward pressure on pay," he said, adding that the current signs were mixed.

"Forthcoming developments in the labour market therefore continue to deserve careful monitoring," he told the Society of Business Economists in London last night.

The fact that economists had consistently overestimated likely joblessness, at the same time as getting inflation forecasts too high, was strong evidence of a fall in the Nairu since 1980. The average forecast for underlying inflation in the past seven years has been 0.4 percentage points too high, compared to an inflation target of 2.5 per cent, while unemployment had been overestimated by about 220,000 each year.

Dr Wadwhani said labour market deregulation reflected in declining union power, a reduced mismatch of skills between regions, and increased competition in product markets were the main reasons for the improved unemployment- inflation combination. Extended home ownership and perverse incentives created by housing benefit had worked in the other direction.