Some wisdom today from Ross Gittins:
It is true that a fall in the dollar leads to a rise in the prices of internationally tradeable goods and services.
It is also true that the fall in the nominal exchange rate has to be accompanied by a fall in the real exchange rate (the nominal rate adjusted for our inflation rate relative to those of our trading partners) if it is to cause a lasting improvement in the price competitiveness of our trade-exposed industries.
What doesn’t follow is that the real exchange rate can fall only if real wages fall. For a start, it doesn’t require wages to grow no faster than the inflation rate for that rate to be unchanged.
All that’s need is for wages to grow no faster than the inflation rate plus the trend rate of improvement in the productivity of labour (often taken to be 1.5 per cent a year).
Thus are the benefits of productivity improvement spread around the economy in the form of rising real wages (and, thanks to indexation, rising real pensions) without adding to inflation. As it loved reminding us, this is just what happened throughout the Howard government’s term.
It follows that real wages would need to fall only to the extent that the increase in inflation caused by the fall in the dollar exceeded the trend rate of productivity improvement. (Of course, the need for slower wage growth would also be reduced to the extent that our trading partners’ inflation rate happened to be higher than ours.)
Exactly right and why productivity growth is so vital in the period ahead. It is by far the least egregious way to close the gap between our standards of living and competitiveness that is currently yawning in the real effective exchange rate:
