In theory New Zealand has hit full employment.

At 3.9 per cent the unemployment rate is the lowest in 10 years and below the Government's four per cent target.

But what does that really mean? Not everyone has a job and many of those in work still struggle with job security and low wages.

Full employment - or the more technical term "maximum sustainable employment" - is essentially the lowest level of unemployment an economy can cope with before it starts cause problems with labour shortages curbing growth and wage growth pushing inflation too high.


That makes it an important value judgment.

It is a call that will be in the spotlight as the Reserve Bank looks to include it explicitly in its monetary policy settings next year.

Early last year Labour promised to reduce unemployment to four per cent in its first term.

The economy has achieved that sooner than expected but without much uplift in wage growth.

Perhaps that means the four per cent target is now too high.

But then what about business owners who are already complaining of skills shortages and rising costs.

A recent survey of the construction sector - by the Royal Institution of Chartered Surveyors - found that 84 per cent of respondents identified skills shortages as a factor holding back activity.

Overall low unemployment was a good problem to have, said NZIER principal economist Christina Leung.


Although labour shortages were starting to constrain growth and add costs in some sectors, it was preferable to a situation where there wasn't enough demand and people were losing their jobs, she said.

Leung noted that while we would all like to see higher wages, we need to see them driven productivity rather than just a tight labour supply if we want to avoid the inflation trap.

But she was hopeful that the tighter labour market might drive productivity growth over time if businesses were incentivised to invest in new technology and machinery in the absence of cheap labour.

Meanwhile we were definitely seeing the casualisation of the workforce with the rise of contract work and jobs like Uber driving, Leung said.

"This flexibility is a double-edged sword," she said.

It was great for people like students, who weren't so worried about job security, and it allowed employers to take more risks in hiring staff.

"However for workers seeking certainty of income, that casualisation is not as favourable," she said.

There were supply side solutions to labour shortages such as immigration, upskilling more people or finding more workers in under-represented demographics – such as older people.

But this required some longer-term thinking about what skills New Zealand really required.

Finance minister Grant Robertson has recognised this and put a lot of emphasis on a long-term strategy with establishment of the Future of Work Commission.

Meanwhile though the Reserve Bank faces an interesting call next year on where it sees the maximum sustainable rate of employment sitting in the context of its inflation challenges.

When employment was added to the Reserve Bank's monetary policy considerations it was generally assumed that it would put extra downward pressure on rates as policy would need stimulate employment growth.

But if the job market gets much tighter then, in theory, employment considerations could start to put upward pressure on interest rates.

It certainly seems unlikely (and undesirable) that we'd see the Reserve Bank enacting policy to try and create unemployment.

In the end the concept of full employment is a choice. It's a trade-off based on how much inflation pressure the Bank is prepared to tolerate.

So right now with core inflation low and wage inflation sluggish, it looks like we can afford to aim lower than four per cent unemployment.

Business owners may disagree. There is no doubt that the tight labour market in some sectors is creating serious problems and risks.

It's a complex dilemma.

"Maximum sustainable employment is determined by a wide range of economic factors beyond monetary policy," Reserve Bank Governor Adrian Orr said when the new Policy Targets Agreement was announced in March.

He and his team have clearly given this a lot of thought - next year we will see how they put it into practice.

And no doubt we'll all watch closely for signs of that long-overdue wage growth.