Back to work
10 October 2017
It has been a long slog. The labour market fallout in the wake of the global financial crisis proved to be painful, pervasive and persistent. However, there are signals that after almost a decade, the healing process is close to completion. Our in-house indicator of labour market slack across developed markets tells this story well. The downturn opened significant spare capacity across labour markets, and it took years before economies started to chip away at this slack. Following consistent and relatively steady inroads, a wide range of developed market economies are now at, or approaching, labour market conditions similar to those prevailing before the crisis. This certainly looks true of the US, Canada, Australia and the UK. In the Eurozone, the German labour market looks tighter than in 2008, although Spain, France and Italy are all lagging. The story in emerging markets is more nuanced. Data quality issues in China make it difficult to estimate slack, but there have been signs that the acceleration in activity over the past year has clearly fed through to the labour market. There have been fewer signs of progress in Brazil and Russia, which are still in the early stages of recovery from deep recessions. However, we are seeing unemployment rates creep lower across a range of smaller emerging economies.
Against this backdrop, it is not a surprise that central banks are starting to turn an eye toward removing policy accommodation. However, there is a catch. Despite labour market progress we have yet to see concrete evidence that economies are producing inflation in line with central bank targets. There could be a straightforward explanation for this disconnect, such as transitory factors dampening inflation, or delays between closing labour market slack and building wage pressures. Alternatively, slack could be larger than we, and central banks, believe; or sector-specific structural factors could be a more permanent headwind to inflation. Most malign would be if firms and households had lost faith in central banks inflation targets following serial disappointments. This inflation puzzle will take time to decipher, but should not prevent central banks starting to adjust policy. However, it should make them cautious with regards to the speed at which they can withdraw. Data dependence will be the watchword for policy in 2018.