Wage growth and labor market tightness

Research Question. Which measures of labor market tightness best predict nominal wage inflation, and do standard measures such as the unemployment rate and the vacancy-to-unemployment ratio capture the relevant slack? The paper also asks whether transitory productivity shocks affect wage growth, and whether the wage Phillips curve is nonlinear.

Motivation and Model. Standard measures of labor market tightness have had mixed performance since the COVID-19 pandemic: unemployment quickly returned to pre-pandemic levels while wage growth remained persistently elevated, motivating a search for superior indicators. The paper builds on the theoretical framework of Bloesch, Lee, and Weber (2024), a tractable New Keynesian DSGE model in which firms set wages and workers search on the job. In this model, labor market tightness is well-summarized by either (a) the quits rate or (b) vacancies per effective searcher (V/ES), where effective searchers include both employed and unemployed job seekers. Unemployment enters the model’s wage Phillips curve but with a coefficient close to zero, because changes in the unemployment share do not substantially shift the composition of searchers in a way that alters firms’ wage incentives. Transitory TFP shocks have theoretically ambiguous effects on nominal wage growth because the outcome depends on the central bank’s policy response.

Jeremy Pearce | Macro Paper Warehouse

Wage growth and labor market tightness