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Among mounting talks of stagflation and the risk of shifts in inflation regimes, we update our comparison of US and Euro labour markets now that Covid is under control and the US pandemic unemployment benefits, accused of discouraging potential workers from accepting jobs, have expired. Latest data confirm the divergence of the two economies: while in Euro countries the reversion towards the pre-Covid pattern carries on, in the US the Beveridge curve remains outward shifted, implying the persistence of an equilibrium where high unemployment and vacancies coexist. This dynamic signals the strong frictions that the US labour market is facing: firstly, more potential workers are looking for jobs and more employers are looking for employees, indicating that the matching process is stalling, and secondly the curve has become dangerously steep in latest months, which means that the labour shortage keeps worsening even accounting for the new post-covid market frictions. It should be noted that such attritions cannot simply be justified by the recovery: as emphasized by September nonfarm payrolls, which added only 194k jobs after 1 million in June and July and 370k in August, employment remains well below trend, implying frictions seem to be more a consequence of economic policies, rather than a sign of an economy running at full potential.
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In the US and the Eurozone, job markets are missing respectively 5.7% and 3.9% of potential employment, but the relatively better performance of the Euro Area is explained by the implementation of job retention schemes, since in terms of aggregate hours worked the US has shown a faster recovery.
To better grasp how the two recoveries differ we implement a decomposition of supply & demand of labour shocks based on changes in hours and wages[1]. The model indicates that, while in the Eurozone workers’ labour supply has been the main driver, the opposite was true for the US, where the demand of labour by firms has almost systematically outweighed workers supply shocks. This stresses the different narrative in the two economic areas: in the United States the decisive factor remains that firms are struggling to fill vacancies, while in Europe workers who had temporarily abandoned the labour force in the initial phases of the pandemics have been driving the recovery by returning on the job market.
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Putting together the hints offered by the Beveridge Curve and the Shocks Decomposition the result points towards an overheating US job market due to frictions in the supply of labour, while the Euro Area one would be growing at a more sustainable rate. Supporting such thesis, annualizing wage changes shows how US ones are running at a significantly higher pace compared to pre-pandemic years, while in Europe labour cost growth is still subdued[2].
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The implication of a growing cost of labour – the main factor of production for the average firm – is higher producer prices: since the beginning of 2020 the United States have cumulated a wedge of 2.2% in the index of industrial prices with respect to the Euro Area.
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Up to now the main driver of higher PPI seems to have been the price of commodities. But recently in the US the correlation of the labour component has reached the one of raw materials, while in Europe labour cost is slowing[3].
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Overall, once again there seems to be a decoupling between the two economic areas: while in the US the labour market keeps showing significant and consistent signs of overheating, in the Euro Area we are witnessing a more sustainable recovery. What should be cause for concern is that this continues to be true even after the recent phase-out of the Covid relief package, which has been presented as a candidate rationale for the frictions in the US market, discouraging potential workers from reentering in the job market. High matching frictions, slower employment recovery, accelerating wages, and higher production prices all point towards alarming constrains in the labour market. While part of the pressure on producer prices is clearly justified by higher commodity prices, the fact that the Eurozone did not show such strong signs of job market disruptions, displaying a more orderly recovery, should sound a note of warning. In the end, while the risk of a wage-price spiral is at the moment non-existent in Europe, the danger should not be completely disregarded in the US. Although the jury is still out on the transitory vs permanent inflation debate, with one side pointing to the CPI consistently above 5% and the other claiming MoM annualized core CPI is back down to 2%, if we focus on the labour market then the expected upcoming Fed tapering might be welcome, though monetary policy alone can do little to remove bottlenecks and cool down the US labour market.
[1] See Brinca et al. (2020) for SVAR shock decomposition methodology.
[2] Differences in labour productivity growth are not wide enough to justify the gap between labour costs.
[3] Commodities prices as proxied by the IMF Primary Commodity Price Index; Labour Cost as proxied by LCI for Eurozone, Total Compensation for US.
