How low can you go?

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One of the few bright spots in the global economy over recent years has been a relatively broad-based improvement in labour markets.

Between the end of 2014 and 2016 unemployment rates fell in 31 of the 39 advanced economies in the IMF economic outlook database.

Signs of an ongoing acceleration in global growth bode well for further progress. Data last week showed that the US economy continues to create new jobs at a decent clip, helping bring unemployment rates even lower.

Eurozone unemployment has also declined steadily over recent months and survey data suggest that firms’ hiring plans have rocketed to a nine-year high.

In Japan, the unemployment rate has been stable at low levels of late, although rising participation suggests that job creation is pulling workers into the labour market.

The UK bucks the trend slightly, with employment growth slower after the EU referendum. Data issues always make it hard to monitor labour-market performance in emerging markets. However, the composite Purchasing Managers’ Index suggests that job creation is running at a three-year high across this region.

Labour market dynamics will be important in determining how inflation evolves over coming years.

There have been few signs of pronounced inflationary pressures emanating from labour markets, even in those economies which have seemingly brought unemployment towards equilibrium rates (the non-accelerating inflation rate of unemployment (NAIRU) in ‘economist speak’).

There are a couple of explanations here. First, there could be more slack than appears at first glance. Both the Federal Reserve and the Bank of England recently downgraded their estimates of NAIRU following stubbornly subdued wage growth.

Moreover, spare capacity can be hidden from headline unemployment rates, making it important to focus on broader measures of labour utilisation and trends in labour force participation. Second, inflation has over many years shown signs of becoming less responsive to labour market fluctuations (again in economist terms: the Philips Curve has flattened).

Central banks will have to watch these dynamics closely when plotting a course for policy over coming years. Recent evidence suggests that inflationary pressures will build only slowly, although this should not provide an excuse for complacency.

By Jeremy Lawson, Chief Economist

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