The Reserve Bank says it cut interest rates earlier this month not because the economy was getting worse, but because it could get even better.

Key points: The RBA governor says "it is not unrealistic to expect a further reduction in the cash rate"

The RBA governor says "it is not unrealistic to expect a further reduction in the cash rate" The bank wants to get unemployment down towards 4.5pc, and also to reduce underemployment, in order to boost wage growth

The bank wants to get unemployment down towards 4.5pc, and also to reduce underemployment, in order to boost wage growth Workforce participation, women in the labour force, older Australians working and part-time work are all at or near record highs

The bank's governor also indicated it was prepared to cut rates again, saying there was a lot of room for the economy to improve and a 0.25-percentage-point rate cut was unlikely to do much to achieve that improvement.

Speaking at a luncheon in Adelaide, Philip Lowe said "it is not unrealistic to expect a further reduction in the cash rate as the board seeks to wind back spare capacity in the economy".

"This decision was not in response to a deterioration in the economic outlook since the previous update was published in early May. Rather, it reflected a judgement that we could do better than the path we looked to be on," he said.

When Dr Lowe speaks of spare capacity, he is mainly talking about people.

The bank now believes Australia's economy could sustain an unemployment rate closer to 4.5 per cent without seeing excessive wage increases — that is well down on the current level of 5.2 per cent.

However, Dr Lowe also said it was a mistake to focus on the unemployment rate, with the underutilisation rate now the key measure of labour market slack.

"The underutilisation rate is 8.1 per cent," Dr Lowe said, using the RBA's preferred measure that is based on hours worked, rather than number of people, which is how the ABS calculates it.

"This hours-based measure is preferable to heads-based measures of underutilisation that treats an unemployed person in the same way as a part-time worker seeking a few more hours.

"Unlike the unemployment rate, which has trended down over the past 20 years, the underemployment rate has been relatively stable."

Flexible labour market means unemployment can fall further

The Reserve Bank appears to attribute some of this to the increased flexibility in the labour market, with more part-time jobs available, increased participation by women and older Australians, and the capacity for skilled migrants and New Zealanders to plug some skills gaps when demand for workers is very strong.

"The female participation rate now stands at 61 per cent, up from 43 per cent in 1979," Dr Lowe observed.

"Australia's female participation rate is now above the OECD average, although it remains below that of a number of countries, including Canada and the Netherlands."

The participation rate is at record highs, mainly due to more women and older Australians in the labour force. ( Supplied: RBA )

That has resulted in many more people working part-time than used to be the case.

"In the 1960s, less than one in 10 workers worked part-time. Today, one in three of us works part-time. Almost one in two women work part-time and more than one in two younger workers work part-time."

Part-time jobs now make up close to a record share of total employment. ( Supplied: RBA )

"According to the ABS, around 3 million people work part-time because they want to, not because they can't find a full-time job. Most people who are working part-time do so because they are studying or have caring responsibilities, or for other personal reasons."

However, Dr Lowe acknowledged there were still many people who would like more work than they were getting.

"Having said that, around one quarter of people working part-time are not satisfied with the hours they are offered and would like to work more hours," he said.

"The share of part-time workers who are underemployed moves up and down from year to year, and the current share is above its average level over the past two decades."

More than a quarter of part-time workers want more hours than they currently get. ( Supplied: RBA )

That is despite reports from employers that they are struggling to find suitable people to fill positions.

"Currently, almost 60 per cent of firms report that the availability of labour is either a minor or a major constraint on their business. This share is not as high as it was during the resources boom, but it is still quite high," Dr Lowe observed.

The Reserve Bank says employers are finding it hard to get suitable workers. ( Supplied: RBA )

"At present, there are fewer than three unemployed people for each vacancy. This compares with over 20 people for every vacancy in the early 1990s recession and five people for every vacancy in 2014."

High debts may be pushing wages down

Dr Lowe said one factor behind this apparent contradiction between underutilised workers and labour shortages was a lack of skills training, meaning many people who would like more work were unsuitable for the jobs on offer.

"There is also some tentative evidence that, on average, unemployed workers are not as well matched to job vacancies as was the case in 2007, when the ratio of the two was at a similar level," he said.

Another potential reason, which would also go a long way to explaining low wages growth, is that people have become more reluctant to shift jobs because they have large debts and are concerned about being laid off if the economy turns down.

"This uncertainty means that if you have a job you want to keep it rather than take a risk with a new employer," Dr Lowe speculated.

"This might be especially so if you also have a large mortgage. So it is possible that the high level of household debt is also affecting labour market dynamics."