Our measures of labour market slack suggest that the official unemployment rate is significantly understating how much spare capacity there is at the moment and will probably continue to do so for a long time. This supports our view that even with a vaccine, interest rates will remain at rock bottom levels for many years.
- Our measures of labour market slack suggest that the official unemployment rate is significantly understating how much spare capacity there is at the moment and will probably continue to do so for a long time. This supports our view that even with a vaccine, interest rates will remain at rock bottom levels for many years.
- Given the record-breaking peak-to-trough 25% drop in GDP, the labour market appears to have been remarkably resilient. The official ILO unemployment rate has only risen from 4.0% in February to 4.8% in September, which, at face value, suggests there is not that much slack. Knowing the amount of labour market slack is crucial for having a good picture of the economy as it affects wages, inflation and whether the Bank of England will do more to support the economy, or eventually when it will start to tighten policy.
- We have created a “broad unemployment rate”, to use as a wider gauge of labour market slack. It takes into account the number of people who are officially unemployed, those who have been deemed inactive but want a job, the number of part-time workers who would like a full-time job and the number of people on the furlough scheme. Since 1993 this measure has tracked the official unemployment rate reasonably well. (See Chart 1.) But when the blue line in Chart 1 is above the black line, it implies that there is spare capacity in the labour market that isn’t being captured by the ILO unemployment rate and vice versa. For example, after of the Global Financial Crisis, the blue line remained above the black line, which was consistent with weak wage growth over that period. This broader measure of unemployment suggests that there is as much spare capacity in the labour market now as if the actual unemployment rate were 8.0%.
- We can also tackle the same problem by using hours worked. Normally, the average number of hours worked per week is relatively stable, but during recessions it tends to fall as people are required to work less. This is another way of measuring the amount of spare capacity as it captures those people who are still employed but are not working as much as they could and could be called “underemployed”.
- Chart 2 estimates the amount of underemployment by comparing the actual number of people in employment, the black line, with the number of people who would be needed to fulfil the total number of hours worked if average hours stayed at their pre-crisis level, the blue line, both expressed as a percentage of the workforce. So when the blue line dips below the black line it indicates that there is hidden slack in the labour market. For example, Chart 2 also suggests that there was plenty of slack in the labour market in the aftermath of the GFC. Before the COVID-19 crisis, about 96% of the workforce were employed. If average hours worked had stayed at 31.8, the same as in February, rather than falling to 28.5 in September, then it would only have needed about 85% of the workforce to fulfil the actual hours worked. (See Chart 2.)
- Of course, these measures always point to more slack during downturns. The crucial point is how they relate to the official measures of unemployment and hours worked. As it’s obvious that there is plenty of slack currently, the main benefit of these measures may come once the economy has recovered and it becomes less obvious how much slack there is. This will be crucial in determining how long monetary policy will remain loose for. Our suspicion is that there will be plenty of slack for a number of years yet.
Chart 1: Unemployment (% Workforce)
Chart 2: Employment (% Workforce)
Sources: Refinitiv, Capital Economics
Sources: Refinitiv, Capital Economics
Thomas Pugh, UK Economist, +44 (0)7568 378 042, firstname.lastname@example.org