The US labor market is less tight than it looks

The US labor market is less tight than it looks

The Federal Reserve is raising interest rates to fight inflation and is looking at labor market metrics to see how it is doing. When the labor market is very unstable, when there are not many workers looking for work, inflation tends to increase. But conventional measures of the labor market slowdown aren’t perfect, and a new measure from LinkedIn researchers paints a very different picture: It suggests the labor market is much looser, meaning inflation may not be perfect. not be as high in the future as traditional measures indicate. .

The Federal Reserve raised interest rates another 0.75% last week, the latest in a series of rate hikes aimed at keeping inflation in check. The question hanging over the economy now is whether the Fed has gone too far or not far enough. The answer depends on the extent of the room for maneuver in the labor market. The Fed would like labor markets to be loose enough for wage growth to slow to a level consistent with its 2% inflation target. But how to assess the current degree of slack?

A new, broader measure of labor market tightness, which we created using data from LinkedIn, offers a new way to answer this question. And that suggests that labor markets are not as tight as other measures indicate. This, in turn, suggests that the Fed could risk raising rates too quickly.

The idea of ​​“underemployment” in the labor market refers to the insufficient demand for labor from employers in relation to the supply of available workers. When there are very few workers available, wages rise rapidly as companies raise wages to retain workers and hire new ones. As the cost of labor rises, companies in turn raise their prices to pass on their higher costs to consumers. Consumers then demand raises from their own employers so they can afford the higher cost of living, thus perpetuating the cycle of inflation. For this reason, economists consider that at least some amount of unemployment is necessary to maintain price stability. A little slack in the labor market is keeping inflation at bay.

To measure the labor market slowdown, economists have long relied on the number of job vacancies divided by the number of unemployed. The evidence suggests that this ratio outperforms the traditional unemployment rate when it comes to predicting inflation. A higher ratio of job vacancies to unemployment makes it harder for employers to find workers and easier for workers to find jobs, indicating that the labor market is tighter. The job-to-unemployment ratio is above 1.85 today, suggesting that there are almost two job openings for every unemployed person looking for work. This ratio is considerably higher than its pre-pandemic level and above the historical norm of around 0.7 since 2000.

But if the job creation/unemployment ratio indicates a very tight labor market, why is real wage growth still so timid? One of the potential reasons for this anomaly is that the labor market is not really that tight, i.e. standard measures of inactivity may not tell the whole story. There may be several reasons why the conventional measure may be a poor proxy for the degree of tightness in the labor market. For example, when looking to hire workers, employers often do more than post a job offer. They can change their hiring standards for a given position by adjusting the specific requirements of a particular position, or they can fill their positions faster by varying the amount of resources they devote to recruiting. Therefore, just looking at job postings can be problematic. Existing evidence suggests that the intensity with which employers fill job vacancies varies over the business cycle. In other words, employers tend to put the most effort into filling vacancies when the economy is expanding and less during periods of economic downturn and uncertainty.

Another reason why the traditional economic measure may not capture the true degree of labor market tightness is that the number of unemployed may be a poor indicator of the availability of workers to fill job vacancies. For example, many job applicants are already employed. Yet the standard metric does not take this into account. Thus, if there are a significant number of such workers, then the standard measure would overestimate the tightness of the labor market. Indeed, LinkedIn’s data on active job seekers suggests this is the case.

In the figure below, we plot the traditional measure of labor market tightness, the job vacancies to unemployment ratio (the green line). We also plot LinkedIn’s broader measure of tightness calculated using LinkedIn’s ratio of active job offers to active job seekers (the blue line). This more nuanced measure of active job postings takes into account the variation in recruiting efforts by employers and then compares the number of active job postings to the number of active job seekers on the platform. This broader perspective on the tightening labor market allows us to assess the health of the labor market more comprehensively than before. In October 2022, LinkedIn’s metric indicates that the ratio of active job postings to active applicants on LinkedIn was approximately 1.0, suggesting that there is a job available for every job seeker active in the United States.

LinkedIn’s job market tightness metric is calculated as the number of active jobs posted directly on LinkedIn divided by the total number of active applicants. Active applicants are members who submit at least one job application in a given month. We measure active vacancies as the stock of vacancies on the last working day of the month multiplied by a hiring intensity index. The idea behind hiring intensity is to measure how actively employers seek to fill vacancies. To quantify this, we follow the method developed by Steven J. Davis, R. Jason Faberman and John Haltiwanger (DFH) — the key idea is that a sluggish labor market makes it easier for employers to hire in general, so that it takes less recruiting effort to achieve the same hiring rate.

The analysis suggests that the labor market has not tightened as much during the pandemic as the classic ratio of vacancies to unemployment would imply.

What difference does it make, from a political point of view, if the labor market is less tight than it seems?

If standard measures of labor market slack don’t account for everyone actively looking for work, then less monetary tightening would be appropriate—in other words, interest rates don’t have to rise too quickly. . Fighting inflation can be like driving down a congested highway. Braking too hard can increase the risk of an accident and therefore can lead not only to a slowdown, but to an economic recession. By our estimate, as it stands, the US job market is still hot relative to the pre-pandemic benchmark, with LinkedIn job postings and quits still high and unemployment at its lowest levels. down. But monetary policy operates with a substantial lag. It takes time for monetary tightening to reduce demand. It is therefore not surprising that the recent tightening of the Fed has not yet had much impact on inflation. In this highly uncertain environment, it will be essential to find a balance between containing the potential threats of inflation and avoiding a disorderly tightening of financial conditions.

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