If they want to defeat inflation, central bankers must cool the labor market. For two years, wage growth in the rich world has added to business costs and has continued to drive up prices. However, when they began to raise interest rates in order to slow the economy, policymakers hoped for an even more promising outcome: achieving a “soft landing,” which meant reducing inflation and doing so without massive job losses. That is asking a lot from an instrument as blunt as monetary policy.
Are they getting it? Federal Reserve officials will surely ask themselves that question when they meet on September 19 and 20. For now, the data indicates that, contrary to widespread expectations, labor markets from San Francisco to Sydney are cooperating.
Central banks began raising rates at a time when demand for labor was almost stronger than ever (see chart 1). Last year, the unemployment rate in the OECD club of rich countries (the percentage of the workforce that would like to have a job) was just below 5%, close to its all-time low. The excess demand for labor translated into an increase in unfilled positions, which reached an all-time high. Workers negotiated higher wages, knowing they had many options at their disposal.
The magnitude of the task that central bankers set for themselves is illustrated by history. According to research by Alex Domash and Larry Summers, both of Harvard University, there has never been a case in which the American vacancy rate has fallen substantially without a significant increase in unemployment. Last year, JPMorgan Chase’s Michael Feroli studied historical records and observed that “whenever the vacancy rate goes down a little, it goes down a lot, and the economy goes into recession.”
To assess developments in rich world labor markets, we gathered data from the OECD and Indeed, an advertising site, for 16 countries. In that group, employers have reduced vacancies by more than 20% on average since their peak, which is a historically rapid decline. Some countries, such as France, have recorded relatively modest declines of around 10%. In others, such as Canada, Japan and Switzerland, job vacancies have fallen by a quarter or more.
The decline in job openings is helping to cut wage growth. In the United States, the annual rate of wage growth has fallen from 6% at the end of 2022 to less than 5% today (see chart 2). Canadian wage growth is also falling rapidly. The situation is less clear in other countries; among other things, due to the poorer quality of salary data. In Germany and Italy, wage growth has likely stopped rising; In any case, there are still pockets of concern, such as in Great Britain, which could explain the expectation that the Bank of England, which also meets this week, will raise rates again.
For policy makers, this success would be somewhat clouded if it were accompanied by a sharp increase in unemployment. According to the general rules in the United States analyzed by Domash and Summers, in normal times a drop of more than 20% in job vacancies would be expected to be accompanied by an increase in unemployment of about three percentage points within a year.
In reality, a year or so after job offers began to decline, what seems to be happening is something else. The OECD unemployment rate has remained stable. Job growth, at 500,000 jobs a month across the rich world, is almost as fast as in the second half of last year. The employment rate of the working-age population (the proportion of people aged 16 to 64 who are in employment) has reached an all-time high in almost half of OECD countries. Even places known for high unemployment, such as Italy and Portugal, have found work for an unprecedented proportion of their working-age population.
Why do labor markets break the historical rule? One possibility is related to “the great resignation” that occurred during covid-19. In 2021, spooked by stories of employees leaving their jobs to create cryptocurrency companies and write novels, some entrepreneurs may have offered job offers as an insurance policy. Now, as fewer and fewer people quit their jobs, they are removing them again.
A second possibility is related to “preventive maintenance of personnel.” During the 2020 lockdowns, many companies laid off workers and then, when the economy reopened, had trouble rehiring them. You don’t want to make the same mistake twice. So today, even though the economy slows down and companies reduce their job offers, what they are trying to do is retain existing workers.
Central banks still have a pending task, because inflation remains uncomfortably high in many places. Even in the United States and Canada, demand for labor is high relative to supply. Across the rich world, wage growth is outstripping productivity growth, adding to the pressure. Domash and Summers could be right should unemployment rise in the coming months. Now, after two years of bad inflation data and warning after warning that their strategy was doomed to fail, policymakers have reason to hope.
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Translation: Juan Gabriel López Guix
