By Audrey Bismuth, Global Macro Researcher, La Française AM

Developed by New Zealand economist William Phillips in 1958, the Philips curve illustrates a negative empirical relationship between the rate of unemployment and inflation. The negative correlation between unemployment and inflation is conveyed through wages, whose variations tend to run alongside consumer prices. The bargaining power of employees increases if the available labour force is limited, i.e., if unemployment is low and tensions in productive capacities are high. However, this correlation has become more blurred in many countries since the 1990s. There are numerous reasons underpinning this trend.

After the major recession of 2008-2009, falling unemployment rates in the U.S. did not lead to a significant surge in wages. According to the Bureau of Labor Statistics (BLS), the unemployment rate fell from 10% to less than 4% before the Covid-19 pandemic, while the wage growth rate remained stable at around 2% over the 2009-2015 period before rising to 3% over the 2016-2019 period. This weaker negative relationship between unemployment and wages could point towards greater excesses in capacity than might be suggested by unemployment rates. In March 2018, in France, a study by the National Institute of Statistics and Economic Studies (Institut National de la Statistique et des Etudes Economiques, INSEE) indicated that the correlation coefficient between wage changes and unemployment in the United States was even positive between 2011 and 2015. This analysis concluded that “unemployment has an impact on wage fluctuations, but productivity remains a major long-term determinant”. Persistently weak output per hour worked may reduce corporate profitability and ultimately impact wage growth, as companies become less willing to grant wage increases in quick succession. In September 2017, research by the International Monetary Fund (IMF) also indicated that the increase in people frustrated with only working part time (i.e., people who would like to work more) and a higher use of temporary jobs were restricting wage growth. Other frequently cited reasons are increased automation, lower medium-term growth expectations, growth in the service sector and increased labour supply against a backdrop of globalization which has increased competition between companies, particularly following China's entry into the World Trade Organization (WTO) in the 2000s.

The Covid-19 pandemic has also altered the dynamics of employee relations within companies given the underlying developments in the global economy. The pandemic, alongside the subsequent massive stimulus packages, has accelerated the imbalance between supply and demand in the labour market. Currently, in the United States, there are 4.7 million more jobs available than there are people to fill them (Bureau of Labor Statistics, November 2022). This gap was 1 million people before 2019.

The growing number of employers having recruitment difficulties stems from the ever-increasing mismatch between the skills, interests and experience of job seekers and the positions that employers want to fill. According to Lightcast (December 2022), the US workforce has fallen by 2 million due to declining immigration, the early retirement of baby boomers and an ageing population (according to the Census Bureau, Americans over the age of 65 will make up 21% of the workforce by 2035). It is therefore likely to take time to replace them or bring them back to the job market, all the more so if we consider the significant transfer of wealth from the baby-boomers to Generation Y (millennials) estimated at 68 trillion dollars by a study carried out in October 2019 by Coldwell Banker. However, the substantial decline in excess savings accumulated during the pandemic, two-thirds of which have already been used up (once adjusted for inflation) according to Alpine Macro strategists, should lead Americans to return to the labour market. Moreover, it is young people and jobs with the lowest qualifications that are the source of wage growth and of keeping the unemployment rate at historically low levels. The number of active 20–24-year-olds remains 1.7 points below its pre-pandemic level and wages among 16–24-year-olds have jumped more than 12% according to the Atlanta Fed's wage tracker (January 2023), while wages increased by 6.3% overall. Moreover, improvements in labour market conditions are more beneficial to the lowest paid workers. Hence, their bargaining power is becoming stronger. The Atlanta Fed's wage tracker shows that wages for the lowest-skilled employees rose by 6.6% in January compared to a year earlier, while wages for the highest-skilled employees rose by 6.1%.

Although the negative correlation between unemployment and inflation is not necessarily clear all the time, the question remains over whether the aggressive increase in interest rates - the main tool of central banks in the fight against inflation - is entirely justified, as it could drag the global economy into recession and unnecessary job losses? Is a wage-price spiral, so feared by central bankers, likely to take hold?

In its October 2022 World Economic Outlook, the IMF's analysis of situations similar to 2021, when inflation was rising and wage growth was positive but real wages and the unemployment rate were stagnant or falling, was reassuring. The IMF showed that “given that inflationary shocks are originating outside the labour market, falling real wages are helping to slow inflation, and monetary policy is tightening more aggressively, the chances of persistent wage-price spirals emerging appear limited”. The latest report from the International Labour Organization (ILO) also noted that “in high-income countries, real wage growth has been lower than productivity growth since 2000. Whereas the sharp decline in labour productivity growth during 2020 momentarily reduced the gap, the erosion of real wages in the first half of 2022, combined with positive productivity growth, has once more increased the gap between productivity and wage growth”. This study states that in 2022, the gap between the growth in productivity and that of wages reached its highest point since the beginning of the 21st century, with productivity growth 12.6 percentage points above wage growth. It would therefore appear “to be scope in many countries for increasing wages without fear of generating a wage–price spiral”. Finally, economists point out that the decline in the working population will be a factor contributing to lower inflation over the long term. With lower income growth, consumer spending stands to fall, and the labour market should rebalance through a lower natural equilibrium unemployment rate (NAIRU, Non-Accelerating Inflation Rate of Unemployment, i.e., the lowest unemployment rate that can be sustained without causing inflation to rise). The NAIRU has declined gradually since the late 1980s, from 6.3% down to 4.4% as it currently stands. It should drop to 4.25% by 2032 according to the Congressional Budget Office.