The research indicates that inflation, rather than being a consequence, played a pivotal role in shaping the 'fiery' job market.
The research indicates that inflation, rather than being a consequence, played a pivotal role in shaping the 'fiery' job market.
The Mass Departure was in full swing, leading to concerns about a "price-wage spiral", where wages and prices continuously rise and influence each other.
However, what seemed like a lively job market was actually a result, not the cause, of the recent rounds of inflation, as per new research that examined the effects of unpredicted price hikes on the labor market.
Perhaps it wasn't even a vibrant labor market: The increases in prices ate into people's earnings, forcing some workers to make extreme and expensive choices, such as job switching, according to the working paper, titled "A Theory of How Workers Adjust to Inflation". This in turn led to more vacancies, while layoffs and the overall unemployment rate remained historically low, creating the impression of a tight labor market.
"Periods of disruption in labor demand lead to upward pressure on real wages, which then impact output prices," explained co-author Erik Hurst, an economist and professor at the University of Chicago Booth School of Business. "During periods of increased labor demand, you will observe other signs of a lively labor market, such as real wages growing; employment increasing; the job-finding rate of the unemployed rising."
"None of those things happened in this period," he added.
Furthermore, real wages (adjusted for inflation) are approximately 4.4% lower than expected based on pre-pandemic trends, he stated.
Additionally, data from the Bureau of Labor Statistics revealed that real average hourly earnings decreased for 25 consecutive months from year to year. Although average hourly pay has surpassed inflation since May 2023, it hasn't yet returned to its pre-inflation level.
Inflation responsible for "costly" choices
When workers started losing money rapidly in early 2021, they likely took steps to prevent this, as per the paper, which Hurst co-authored with economists from Columbia University, the Federal Reserve Bank of Atlanta, and the University of Texas at Austin.
These potential responses included negotiating new wages within their current company, testing the waters of the job market by changing jobs, or leaving their company for unemployment if they felt their eroded wages were insufficient.
Each of these actions comes with additional costs, they noted.
Renegotiations may lead to less frequent wage changes in the future and may indicate a lack of commitment. Job searches have been shown to have direct monetary costs as well as indirect costs (stress, health, productivity), and unemployment can carry significant risks, including lost income and related consequences, as well as a deterioration of skills, research has shown.
"Part of the 'Great Shuffle' could have been due to inflation," Hurst said.
How the lively labor market influenced an extended halt
Despite this happening when the vacancy-to-unemployment rate reached historically high levels, it caused uncertainty among academics, economists, and key policymakers, according to the paper.
Notably, in November 2022 (six months after the Federal Reserve began increasing interest rates), Fed Chair Jerome Powell declared that "the overall picture is of an overheated labor market where demand exceeds supply."
It wasn't until two years later, when the labor market appeared to be quickly weakening, that the Fed finally began to lower interest rates via a large, half-point reduction.
"We know that policymakers were hesitant to act too soon, as they were concerned about potential inflationary pressures of the 'hot' labor market," Hurst said. "Therefore, understanding what's happening in a labor market will be beneficial for potential policy decisions."
This could involve paying closer attention to how wages are changing, who is leaving their jobs, who is being hired, and whether there are specific changes in how job seekers find work. This could all play a significant role in determining whether the labor market is causing inflation or if the opposite is true.
The recent inflation affected both the economy and businesses, leading some workers to make costly choices such as job switching due to eroding wages. The prolonged halt in lowering interest rates by the Fed was partly due to the perceived lively labor market, causing concern about potential inflationary pressures.