Third Atkinson Lecture - Economics

From the Labor Market to Inflation: the Missing Link

The Phillips curve, a short-run trade-off between the rates of unemployment and inflation, has been for decades a core organizing principle of macroeconomic research and of the practice of monetary policy.

Accordingly, the unemployment rate is viewed as a major determinant of "slack", a predictor of wage and, ultimately, price pressure from the demand side, that policy can arguably control. Unemployment is our main measure of the quantity of labor supply. But, in developed economies, at least half of all hires come from other firms, where job applicants are already employed.

Employer-to-Employer (EE) transitions are a primary engine of reallocation towards more productive and/or desirable jobs, which in turn can expand output and/or moderate the growth of labor costs, even if employment headcount is unchanged.

Mismatch between workers and their jobs is an engine of EE reallocation and another source of labor market slack, that is, an important dimension of the quality of labor supply. After controlling for labor demand, through either vacancies or the job-finding rates of the unemployed, EE transitions are a natural statistical measure of mismatch.As predicted by theory, in US data, high cyclical EE, relative to the current state of labor demand, signal labor market slack and weak pressure on labor costs, independently of the unemployment rate.

The 2020-2021 post-pandemic Great Resignation is a case in point. As workers switch jobs and mismatch is depleted, outside job offers become less and less likely to be accepted, and more likely to bid up real wages for stayers, thus labor costs, as observed since 2022.