The advanced western economies have recovered rapidly from their sharp pandemic-induced recessions amid extraordinary levels of monetary and fiscal stimulus. Alongside the pickup in activity, the demand for labour has rebounded strongly, with vacancies near record highs in a number of economies. We have also seen a sharp pickup in inflation, which policymakers continue to describe as temporary. A key question is, whether tightness in labour markets could cause this inflation to become sustained.
Declines in employment and rises in unemployment were particularly marked in the US in the early stages of the pandemic, as the government focused on supporting incomes rather than jobs. The subsequent recovery of the US labour market has been robust, however. Since the trough, nonfarm employment has increased by over 18 million. The unemployment rate has fallen by over 10 percentage points from its peak and is only 1.1 percentage points above its pre-pandemic level (although the labour force participation rate remains over 1.5 percentage points lower than before the virus hit).
Survey evidence is pointing to a very tight US labour market. Jobs are plentiful according to households, but firms suggest they are struggling to fill positions. The removal of enhanced unemployment insurance does not appear to have made a major difference. The Beveridge curve also points to an increase in labour market tightness amid a rise in vacancies relative to unemployment. The shift to the right in the curve is also indicative of a deterioriation in matching efficiency.
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The US is not the only country where the labour market is tight. In the UK, the number of payrolled employees is now higher than before the pandemic; the unemployment rate on the Office for National Statistics Labour Force Survey measure is not much higher than in early 2020; and the number of job vacancies rose to a record level in the period from August to October 2021 (50% higher than in 2020 Q1). The UK’s Beveridge curve has also shifted substantially to the right.
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In terms of inflation, much hinges on whether tightness in labour markets proves temporary or more structural. If it is the latter, then higher rates of structural unemployment could fuel higher pay in an economy that is allowed to run hot and could result in inflation remaining at persistently elevated levels. Labour market tightness already appears to be contributing to significantly higher US wages. According to the Employment Cost Index, which adjusts for the quality of jobs created, the year-on-year increase in wages and salaries in 2021 Q3 was the fastest since 1985 Q3.
In our central scenario, these labour market mismatches should gradually dissipate and the Beveridge curves should shift back to the left and down. We are seeing some tentative signs of this occurring in the US. However, since it is not clear what has driven these mismatches, significant uncertainty surrounds such a call.
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Amid elevated inflation and rising wages, the US Federal Reserve recently announced a tapering of its asset purchases. At the current pace of tapering, the programme would end in June 2022. While it is not Fathom’s central scenario, if labour market mismatches were to lead to stickier inflation and were met with a material tightening of US monetary policy, equity markets could be vulnerable given their elevated valuations. There would also be a significant risk of a re-run of the 2013 ‘Taper Tantrum’ in emerging markets.
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