Several factors can explain why US inflation is at decade-long highs; one of those is the tight labour market.
Generous COVID-related unemployment schemes have been cited as one possible reason for this tightness since, as the narrative goes, this may have discouraged some would-be workers from entering the labour market. We have found some evidence of this, reflected in the chart, which shows that the countries with higher excess savings since the start of the pandemic (a proxy for the generosity of fiscal support) have, on average, experienced larger declines in their labour participation rates. This would suggest that once these savings are spent, labour market participation rates will increase again, easing some of the tightness in the labour markets in those countries.
Another indicator supporting this hypothesis is the US Beveridge Curve. After some sharp swings in the early stages of the pandemic, it seemed to settle further to the right than pre-pandemic levels, suggesting that labour market frictions had increased. But in recent months it has shifted leftwards, suggesting that some of this friction is unwinding. All else equal, a further shift to the left should reflect an easing of the labour market mismatch, while remaining tight.
Other readings suggest that the US labour market remains very ‘hot’; the jobs balance from the Conference Board consumer confidence survey, readings from the National Federation of Independent Business (NFIB) small business survey, the jobs opening rate and quit rates are all either at, or close to, their highest levels in decades. Indeed, a sharp increase in the latter has corresponded with a pick up in wages, as reflected by the Employment Cost Index.
Although the headline payrolls figure came in below expectations, the US jobs report for December provided further evidence of the tight US labour market: the unemployment rate declined from 4.2% to 3.9%, while the U6 unemployment rate dropped from 7.7% to 7.3%, not far above its pre-pandemic level.
The bottom line is that factors such as COVID-related supply chain bottlenecks and higher energy prices have contributed to the sharp increase in inflation in the US. A risk is that labour market pressures, which have been building for some time, will be fuelled by an increase in inflation expectations from current price pressures. For the moment, however, that remains just a risk, and we expect US inflation to come down in the second half of the year, but to remain above target by December nonetheless.
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