Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Are Watching the Labor Market Tightness
Transcript
- Lucas: So the Federal Reserve has been watching a lot of indicators this year — the PCE deflator, the employment cost index, the neutral rate debate we did a few episodes back. But one metric that keeps coming up in the minutes and in public speeches is something called labor market tightness. Luna: And tightness in this context isn't just 'there are a lot of job openings,' right? It's a specific ratio. Lucas: Exactly. The standard measure is the number of job vacancies divided by the number of unemployed workers. So if you have two job openings for every one person looking for work, that ratio is two. As of the most recent JOLTS data — that's the Job Openings and Labor Turnover Survey — the ratio in the US is about 1.2. That's down from the peak of 2-to-1 in early 2022, but it's still above the pre-pandemic level of roughly 1.2 as well, actually it was around 1.2 in 2019. So it's come back to that range. Luna: Right, so the Fed is watching whether it goes below 1.2, which would signal a looser market than pre-pandemic. What does that mean for policy? Lucas: Well, the tightness ratio matters because it's a leading indicator for wage growth. When vacancies are abundant relative to unemployed workers, workers have bargaining power. They can quit and find a new job more easily, which forces employers to raise wages to retain staff. And wage growth feeds into services inflation — the sticky part of the inflation picture. Lucas: If the ratio stays at 1.2 or above, the Fed worries that wage growth might not slow enough to get inflation sustainably to 2 percent. If it falls below 1.0 — meaning there are more unemployed workers than vacancies — then the labor market is clearly loosening, and wage pressures ease. But the risk is that a sharp drop might signal a recession. Luna: So it's a balancing act. The Fed wants the ratio to normalize, but not too fast. And this is where the Beveridge curve comes in, right? Lucas: Yes. The Beveridge curve plots the vacancy rate against the unemployment rate. Normally, as unemployment falls, vacancies rise, and vice versa. The curve shifts outward when there's structural mismatch — when employers can't find workers with the right skills, so they have lots of openings even with moderate unemployment. Lucas: During the pandemic, the Beveridge curve shifted way out. That mismatch was a big reason the tightness ratio got so high. What's interesting now is that the curve seems to be shifting back in — unemployment has stayed low, but vacancies have fallen. That suggests the labor market is rebalancing without a big jump in unemployment. That's the soft landing scenario. Luna: But some economists argue the curve might not fully return to the pre-pandemic position. There could be a 'new normal' with slightly higher structural tightness due to demographic shifts — fewer young workers entering the labor force, more retirements. Lucas: That's a real possibility. And central banks in other countries are grappling with the same question. The Bank of England publishes its own vacancy to unemployment ratio using ONS data. As of mid-2026, the UK ratio is around 1.1, down from a peak of 1.8 in 2022. The ECB watches a composite indicator of labor market tightness that includes vacancy rates, hiring rates, and wage tracker data. Luna: And the ECB's version is interesting because the euro area has more institutional variation — different labor laws, different collective bargaining structures. So one measure doesn't fit all. Lucas: Right. For example, Germany's labor market has been tighter than Italy's for years. So the ECB tends to look at country-level data and then aggregate. But the principle is the same: tightness feeds into wages, wages feed into inflation. Luna: One thing I find fascinating is how central bankers talk about this. Chair Powell has said the Fed is watching the 'rebalancing' of the labor market. That phrase implies they want it to happen gradually. Lucas: Yeah, and that's precisely why the tightness ratio is so useful. It's a single number that summarizes the balance. And it's forward-looking in a way that, say, the unemployment rate alone isn't. You can have low unemployment but still have upward wage pressure if vacancies are high. Lucas: Look at the current situation: unemployment is at 3.9 percent, which is low by historical standards. But if the tightness ratio were 1.5 instead of 1.2, the Fed would be much more worried about wage inflation. The fact that it's come down without a spike in joblessness is encouraging. Luna: Although, some critics say the JOLTS data is noisy. The response rate has been declining, and there are large revisions sometimes. So how much weight do central banks really put on it? Lucas: It's a fair point. The Fed uses JOLTS but also cross-checks with other sources — the Conference Board's help-wanted index, Indeed's job postings data, and the Quits rate. The quits rate is another indicator of tightness: if people are quitting voluntarily, they're confident they can find another job. That rate has fallen from 3.0 percent in 2022 to about 2.3 percent now, which is consistent with a cooling but still-tight market. Luna: So the suite of indicators gives a consistent picture. That's reassuring. Lucas: It is. And it's worth noting that the Bank of Japan has started paying more attention to labor market tightness too, as they try to normalize policy after years of deflation. Japan's unemployment is very low, but their tightness ratio is actually lower than the US because of structural factors like labor hoarding. Luna: Right, different economies have different 'natural' tightness levels. So central banks can't just target a specific number; they have to interpret it in context. Lucas: Exactly. And that's why the debate over the neutral rate — which we covered in episode 113 — ties into this. If the labor market is structurally tighter, the neutral rate might be higher, because wage growth will be persistently higher. The two conversations are connected. Luna: So for listeners trying to make sense of Fed policy, the tightness ratio is one of the clearest numbers to track. Where can they find it? Lucas: The Bureau of Labor Statistics publishes JOLTS data monthly, usually on the first Tuesday of the month. The vacancy to unemployment ratio is just a division of two series — total vacancies divided by total unemployed. FRED, the St. Louis Fed's database, has a series for it. It's updated each month. Luna: And if someone wants a quick check, the Atlanta Fed publishes a 'labor market spider chart' that includes tightness. It's pretty accessible. Lucas: Good point. And we'll link to that in the show notes — or at least, you can find it by searching 'Atlanta Fed labor market spider chart'. Lucas: You know, a couple of dollars a month is genuinely what keeps these episodes going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. It helps us keep the show ad-free and focused on the details. Luna: Yeah, it really does make a difference. And we appreciate every single one. Lucas: Alright, back to tightness. One more nuance: the composition of vacancies matters. Are the jobs high-skill or low-skill? Are they in services or manufacturing? The aggregate ratio masks a lot. Luna: Can you give an example? Lucas: Sure. In 2023 and 2024, the leisure and hospitality sector had a very high vacancy rate — people didn't want to return to those jobs after the pandemic. That skewed the overall ratio higher. But that sector has since normalized. Meanwhile, healthcare and construction remain tight. So the Fed looks at sector-level data too. Luna: Does that mean the aggregate ratio might be misleading right now? Lucas: Not misleading, but it requires interpretation. If tightness is concentrated in sectors that are less sensitive to interest rates — like healthcare, which is driven by demographics — then monetary policy might have a harder time cooling wage growth there. That's another reason the Fed is cautious. Luna: So the takeaway for our listeners: labor market tightness is a key metric to watch. It's not just about jobs numbers; it's about the balance between supply and demand for workers, which directly influences inflation. Lucas: And as of mid-2026, that balance has improved but not fully normalized. The Fed is likely to keep rates where they are until they see more progress. And the next JOLTS release, due in early August, will be closely watched. Luna: We'll be watching too. Thanks, Lucas. Lucas: Thanks, Luna. And thanks to our listeners for sticking with us through the details.