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2017-10-12Macro `n Cheese

When Doves Cry

This week Roger takes a look at the labor markets of the United States, Euro Area, and United Kingdom.

When it comes to the labor markets of the United States, the Euro Area, and United Kingdom divided opinions within the various monetary policy boards, are emerging. Particularly within the FED and the ECB. It seems that the less stern members are raising their voices (again), pointing primarily to low wage growth.

Macrobond chart

Graph 1: Wage growth is low

But a swift glance at the above chart reveals that while this proposition holds true for the US and UK, the Euro Area is at least approaching its pre-crisis averages (from below). In addition to large negative deviations from pre-crisis trends, the more recent developments in wages are also pointing in the wrong direction for the US and UK economies.

On that note, the argumentation runs more or less along the same line in all central banks; the deep recession has left a scar on the “true” inflation expectations why employers are not pushing up margins and employees are not demanding higher wages, despite the advances made on labor markets over the past decade. Speaking of which, many of the softer-speaking members confer to a still considerable amount of labor market slack exerting continued downward pressure on wages and, therefore, on inflation.

Now, wouldn’t it be interesting to make a comparative study on the amount of labor market slack across these three economies? – Well, a starting point could be a box in the ECB-bulletin from this spring1. In this box the ECB tried to create a measure similar to the U6-measure2 of the unemployment rate that the US Bureau of Labor Statistics produces. For the Euro Area it looks like this:

Macrobond chart

Graph 2: Labor market slack in the Euro Area

Since we have the exact same definitions across the European Union (now there’s an under-appreciated Brexit counter-argument) we can do this for the UK too. Here, it is much harder to detect any excess labor supply. To the contrary, all expanded measures of the unemployment rate are lower today than before the crisis erupted.


2Which the BLS defines as: The total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force.

Macrobond chart

Graph 3: Labor market slack in the UK

Admittedly, our simple exercise might not cover all type of slack, and the Americans have of course been busy providing their own take on measures of labor market slack – over and above the different ‘U’-measures:

Macrobond chart

Graph 4: Labor market slack in the US, American style

The labor market indicators seen here come from a rather interesting article by Hornstein et al (2014) at the Richmond FED3. As can be seen, the only measure that indicates a larger amount of labor reserves is the more traditional U6-measure. All the other indicators are actually showing that the labor market is well in line with the experiences just before the crisis erupted, and when wage pressures were considerably higher. However, in a feeble attempt to harmonize the labor market slack indicators I tried to calculate an “ECB-version” as well, and it looks something like this (suggestions on improvements are very welcome).


Macrobond chart

Graph 5: Data-mining some slack

Now that’s more like it! Of course, you would need a dismal scientist to conjure up something to fit your dovish argument. According to this measure, the softer members of the FED might be up to something after all, even though this also suggests a matching set of problems (which we have already covered in a previous post). That said, the amount of slack found here is still quite low and does not leave much room for measurement (and methodological) errors (of which I am certain there are plenty).

All in all, after some digging, we managed to find indications of excess labor in the Euro Area and (perhaps also) in the US, pointing to subdued wage pressures for some time yet4. In the UK, should the Phillips-relationship reappear in form, it should not be long before wage and inflation pressures rise again. the amount of slack Summing up our discussion above is easiest to do in a graph:

4That reminds me of that ‘pent-up wage deflation’ paper from a few years ago (that I really liked):

Macrobond chart

Graph 6: If there is any slack, it’s mainly in the Euro Area

To conclude, and to be honest, I don’t think it will be any measure of excess labor supply that eventually explains the puzzle of low inflation. I find the “new-normal” arguments, put forward by the academia over the past years, much more appealing, which were nicely illustrated in chapter two of the IMF:s latest World Economic Outlook5. What has me worried by that despondent outlook is not so much the fact that the IMF has now resigned from coming up with perky policy ideas for bringing the world economy back to pre-crisis trends, but rather what this will imply for fiscal policy’s ability to economically repress (inflate) away some of the liabilities coming due over the coming years and decades.


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We don’t usually have views and opinions about economic and financial states of affairs, (not ones that we express publicly as a company, anyway). We do believe, however, that people can and do appreciate a variety of perspectives. What you’ve just read is the perspective of our resident chief economist. While we think he’s very smart, Macrobond Financial does not expressly endorse the views he presents here. And, as the old adage goes, you shouldn’t believe everything you read (not without finding the data, performing a few analyses and presenting it in a nice chart). We want to make it clear that we are not offering this information as investment advice. That being said, if you have the application you can easily check everything that’s mentioned here, and decide for yourself. If you don’t have the application, now you have a great reason to get it.