Effects of the labor market on monetary policy

Nonfarm payrolls increased by 517,000 in January; strongest gain since July 2022.

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In economics and financial markets, history is a good guide to the past. Every economic situation and every financial market situation is different from the past. Former BIS head William White talks about economies as complex adaptive systems, which basically means that they are forever changing. Policymakers might expect policy changes to work in the way they have worked before; but they often don’t.

Financial markets might expect asset prices to react in a way that they have before; but they often don’t. Last Friday’s super-soaraway 517k gain in US payrolls for January shows us again what is very different about the current situation: the labor market poses the greatest risk to the "Goldilocks" economic and financial market landscape that investors so desperately want to see.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said: "We should not make too much of one figure, such as the 517k rise in January non-farm payrolls. Even if some factors, such as the return of striking government workers, artificially inflate the number, there is no doubt that the tightness of the labor market at this stage of a monetary tightening cycle and with the economy has no comparable historical precedent.

What’s more, it is not just the US; labor markets are tight in all advanced nations. And what’s even more disconcerting is that the Bank of England argued last week that some factors that seem to be draining the labor force, such as early retirees, are looking more like a permanent phenomenon than a temporary one.

"Policymakers have clearly not been in this position before, and that makes the scope for mistakes very high; presumably in terms of underestimating the amount of wage and price pressure that there could be even in the midst of recessions. Some might argue that countries can exist with both very tight labor markets and very low wage growth", said Mr. Steve Barrow.

After all that’s exactly what has happened in Japan for a long time. The Bank of Japan and the government have actually tried hard to lift wage growth without much success. However, what we have to bear in mind here is the very hefty bonus payments that make up Japanese workers’ income.

In the two bonus periods per year, December and June/July workers can expect to get around two months' salary each time. This gives firms a lot of leeway to absorb fluctuations in demand, and, because economic growth has generally been poor, these bonus payments have been quite meager (although they are picking up now). Bonuses are used in other G10 countries but these are much more geared toward certain sectors, particularly finance, and don’t have so much bearing on overall wage compensation across the economy.

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In other words, a tight labor market can force wages up, and, unlike the flexibility of bonuses, once wages go up, they stay up. The result is that policymakers in the likes of the US, euro zone, and UK are going to struggle to keep wage growth down, while Japanese policymakers continue to try to push wages up. Perhaps one argument that runs counter to this, but again falls into a historical trap, is that a continual decline in ization over many decades means that workers have less ability to push for big wage increases through industrial action.

However, if we look at the US, for instance, we’re currently seeing faster wage growth in non-ized sectors than ized ones. In other words, with labor markets this tight, workers don’t need s pushing for higher wage awards; they are able to do it on their own. All of this discussion shows quite clearly that the debate about inflation has moved on from goods price inflation – which is going down across countries – to service sector inflation, which is not because it is related to the labor market.

"Policymakers talk about inflation expectations being anchored, which has been able to hold down wages in the past. But again, the this has not been in the context of such tight labor markets. In short, it seems that central banks might have to keep pushing with rate hikes until they see some real traction in the labor market meaning, at a minimum, notable increases in unemployment rates", said Mr. Steve Barrow.