ONS Economic Review: the irrelevance of labour market ‘tightness’ to the inflation outlook

The higher the implied ‘tightness’ the lower the inflation reading

 

In the jargon, improvements in employment are regarded as a tightening of the labour market. As more people are employed and fewer unemployed, for economists the threat of inflation looms larger and larger. Policymakers then reach for the interest rate weapon.

Yet present conditions seem to stand such notions on their head. The labour market gains of the past years have come at the expense of lower wages, and the more plausible concern has been that of deflation.

As is widely understood headline inflation figures have been pushed below zero (to -0.1 per cent), in part by very steep falls in the price of oil, but disinflationary pressures go way beyond oil. In their Economic Review for June 2015, the Office for National Statistics (ONS) analyse in more detail the recent weakness in so-called core inflation (excluding energy, food, alcoholic beverages and tobacco– a measure thought to be a better guide to underlying pressures), observing that “core inflation has moved gently downwards since the end of 2011”.

Looking in turn at the contributions to core inflation, the ONS shows that of the 0.8 per cent recorded in April 2015, 0.4 percentage points are accounted for by housing prices and education. Given education is mainly explained by the administrative arrangements governing student fees and the expense of the housing market is well understood, this suggests that underlying inflationary pressures are not far from zero.

The conventional fear is that low inflation will lead to consumers postponing spending decisions as they wait for prices to fall. The ONS sees little evidence of this, with consumer demand growth little changed in recent quarters. That said they examine volume figures; under disinflationary conditions it may be more appropriate to look at sales values, where growth has slowed.

When it comes to the labour market, the ONS cannot help but fret about tightness. They construct a measure of the proportion of ‘new hires’ that are from other firms. This shows 54 per cent of such new hires in the year to 2015 Q1, “below its pre-downturn average, but the highest rate since early 2009”. The suggestion is that this “appears to reflect rising recruitment difficulties, suggesting employers have turned to labour from other firms as the supply of experienced labour among the unemployed and inactive has gradually fallen”.

A rising measure is one thing; an inflationary signal is something completely different. Plotting the ONS (monthly) measure against actual inflation outcomes (on the left hand chart below, using core CPI) shows this measure of ‘tightness’ meaningless in terms of inflation outcomes.

Labour market tightness and inflation (click to zoom)

Geoff Tily

In fact, the relationship is a negative one: the higher the implied ‘tightness’ the lower the inflation reading.

Such measures of tightness are not exclusive to the ONS. The Bank of England agents also derive a (quarterly) measure of ‘recruitment difficulties’ – this is shown against core inflation on the right hand chart. Again the match is an inverse one. (For those that care, the correlation for the ONS measure is -0.8 and the Bank measure is -0.7.)

Economists may have co-opted the word ‘tight’; but there are other definitions that might be more apt to present conditions: Informal: not willing to spend or give much money; mean.

Geoff Tily is a senior economist at the TUC

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