The correlation between labour market slack and the growth rate of negotiated wages is one of the key concepts in economics. It is also referred to as the wage Phillips curve, theorising that a tight labour market will, ceteris paribus, lead to higher wage increases. According to the theory, a labour market is tight if actual unemployment is below equilibrium unemployment, the level at which the labour market is neither overheating nor loose. Obviously, other factors are of relevance, such as labour productivity growth, inflation expectations, and trade unions’ preferences or other matters, such as employment, training and education.
It would appear that the relationship between the unemployment gap – the difference between actual unemployment and equilibrium unemployment – and wage trends weakened in the years following the outbreak of the credit crisis. Some economists even argue that this relationship no longer exists and refer to a flat Phillips curve. However, this may be because the unemployment rate is an inadequate measure for labour market slack in the post-crisis era, as discussed in a previous DNBulletin . For example, some people involuntarily became part-time workers while looking for a full-time job, whereas others were discouraged by the shortage of jobs and gave up job-hunting. As neither group is registered as unemployed, unemployment is a less accurate indicator of labour market slack if involuntary part-time work or the number of discouraged workers is high. In such circumstances, the unemployment rate overestimates the true amount of labour market tightness.
A new DNB analysis therefore examines whether the correlation between labour market slack and wage growth in the wake of the crisis can be revived using an alternative indicator for labour market slack. This indicator is based on a questionnaire by the European Commission which surveys businesses on whether or not they have difficulty in recruiting staff. The larger the number of businesses experiencing difficulties, the higher the value of the indicator and, hence, the tighter the labour market. According to the alternative indicator, there was more labour market slack than suggested by the unemployment gap in the post-crisis period (see Figure 1). It also shows that the labour market has tightened less markedly since the beginning of 2014 than the unemployment gap indicates.
Unemployment gap and alternative slack indicator
F four-quarter moving averages