What are the links between job vacancies, unemployment and inflation?

Unemployment in the UK has been historically low since the start of 2022, despite rising interest rates and falling numbers of job vacancies. A key question for monetary and fiscal policy-makers is whether this trend will continue into the future.

The UK’s rate of unemployment has been historically low since Covid-19. It stood at 4.2% in the three months to December 2021, having fallen from a pandemic-high of 5.3% at the start of that year (in the three months to January 2021).

From December 2021, the unemployment rate has continued to fall, hitting 3.6% in July 2022, the lowest level recorded since 1974.

Figure 1: The UK rate of unemployment since 2014

Source: Office for National Statistics (ONS)

The period from December 2021 to August 2023 was also characterised by hikes in the Bank of England’s policy interest rate from 0.25% to 5.25%, where it remained until July 2024 (before being reduced to 4.75% by early December).

Typically, higher interest rates are associated with higher unemployment. As consumer demand falls and investment becomes more costly, firms reduce their hiring activities. This means that unemployed people are competing over fewer job openings and subsequently the rate of unemployment rises.

Data suggest that higher interest rates slowed down hiring with job vacancies falling from a record 1.30 million in May 2022 to 0.87 million in July 2024. But the unemployment rate remained low and stable during this period.

Why has the unemployment rate remained low despite falling vacancies?

We can use an economic relationship called the Beveridge curve to explain part of the low unemployment rate. The Beveridge curve describes the observation that as unemployment rises, vacancies tend to fall – and vice versa.

This relationship provides evidence for the story that when firms reduce their hiring activity, people find it harder to get jobs, which corresponds with an increase in the rate of unemployment.

The Beveridge curve shifted following the pandemic as people reassessed their job preferences. Over 2021/22, many workers quit their jobs to find remote work opportunities and a better work-life balance. Data from the ONS show that the share of workers citing resignation as the reason for switching jobs peaked at 50.3% in 2022, much higher than the pre-pandemic average of 33.0%. This period of job quitting has become known as the ‘’great resignation’.

Changes in job preferences are not the only explanation of post-pandemic job mobility. Another is that there was a ‘great unbunching’. Vacancies boomed in late 2021 after having been suppressed during the pandemic, and workers seized this opportunity to reallocate to better jobs.

All else equal, the increase in competition for vacancies – due to either of these trends – would lead to a decrease in the probability of the unemployed finding a job. As Figure 2 shows, this can be represented by an outward shift in the Beveridge curve, such that for a given vacancy rate, we would anticipate a higher rate of unemployment (Haskel, 2024).

Figure 2: The effect of the great resignation on the Beveridge curve

Source: ONS and author’s calculations

Of course, the shift in the Beveridge curve alone cannot explain the historically low unemployment rates observed since 2022. This highlights the key role of labour demand in the post-pandemic labour market.

The great resignation saw an increase in job postings as those who quit left behind labour shortages, and employed workers searched for new jobs. Figure 3 illustrates how higher demand for workers after Covid-19 actually led to a falling rate of unemployment in 2022.

Figure 3: The labour market before Covid-19 and during the great resignation

Source: ONS and author’s calculations

As labour shortages eased and quit rates declined in late 2022, this marked a reversal of the labour market movements that had emerged a year earlier. Declines in resignations meant that the Beveridge curve started to shift back towards its pre-pandemic position. What’s more, job creation fell in 2022 as interest rate hikes deterred hiring.

Figure 4 illustrates how the Beveridge curve and hiring activity have shifted between 2022 and 2024. These mechanisms explain why unemployment has remained relatively stable since 2022 despite falling vacancies. They have also been used to explain a stable rate of unemployment in the United States since the pandemic (Barlevy et al, 2024).

Figure 4: Job creation and the Beveridge curve since the great resignation

Source: ONS and author’s calculations

Over this same period, wage growth has been elevated. Average wage growth was 6.1% between December 2021 and September 2024. This is much higher than the average wage growth of 2.1% seen between September 2009 and February 2020.

Can recent wage growth be explained by low unemployment?

Since 2022, average year-on-year wage growth has been 6.2% – over double that observed between July 2017 and December 2019 (at 3%).

One might (rightly) suppose that wage growth is a good thing as workers should see their efforts rewarded. But from a policy-making perspective, it can be a source of inflation.

If wages rise without corresponding productivity gains, businesses may pass on higher labour costs to consumers through increased prices. Wage inflation is a key contributor to ‘domestic inflationary pressures’, which the Bank of England’s Monetary Policy Committee (MPC) has repeatedly cited as one of the reasons for its gradual approach to cutting interest rates.

One might expect the unemployment rate to be related to recent wage growth in the UK. Lower unemployment coinciding with higher wage growth and vice versa is the relationship described by the Phillips curve (Phillips, 1958).

The intuition typically attributed to this relationship is that falling unemployment implies that the supply of workers is decreasing. In turn, firms find it increasingly difficult to fill vacancies and therefore offer higher wages to attract scarce labour.

Yet the data suggest that low unemployment cannot explain recent wage growth. Immediately before the pandemic, in the period between July 2017 and December 2019, the UK also saw historically low unemployment, averaging 4.1%. This is broadly in line with the rate of unemployment since December 2021, which has averaged 4.0%.

Additionally, the MPC suggested that the ‘non-accelerating inflation rate of unemployment’ (NAIRU) has risen in recent years. A higher equilibrium unemployment rate indicates that the low unemployment rates observed after the pandemic are compatible with higher wage growth.

This aligns well with our analysis as an elevated NAIRU is consistent with an outward shift in the Beveridge curve (see Figure 2). But unlike the MPC, we argue that the NAIRU is likely to have been falling since 2023 (see Figure 4), indicating that the contribution of low unemployment to wage growth has been relatively small over the past year.

If unemployment cannot explain recent wage growth, what can?

Considerable weight has been placed on the role of labour market ‘tightness’ (the scarcity of jobs relative to unemployed workers) for wage growth (Bank of England, 2024). When the labour market is tight, there are many vacancies relative to unemployed workers and so firms struggle to fill positions. In turn, firms are willing to pay workers higher wages to attract their labour.

Tight labour markets therefore amplify the ability of workers to bargain for higher wages. The UK labour market has been tight by historical standards since the pandemic. Over this period, workers have been able to leverage their scarcity to secure higher wages.

High inflation has also contributed to recent wage growth. Inflation has been elevated since late 2021 owing to a combination of supply shortages following the pandemic, demand-boosting fiscal support in 2020/21 and, most notably, hikes in the price of energy due to the war in Ukraine.

Persistently high inflation led households and businesses to expect inflation to stay high. In turn, workers have pushed for higher wages to maintain their standards of living (Bank of England, 2024).

Further, there is a ‘catch-up’ effect at play, where workers may demand higher wages to compensate for previous losses in real wages due to inflation (Haskel, 2023). It is worth noting that increased bargaining power from tight labour markets may have facilitated the materialisation of these second-round effects into wage gains.

Importantly, the Beveridge curve analysis above suggests that labour market tightness has come from elevated demand for workers rather than changes in unemployment. The key role of labour demand in relation to wage growth is discussed in recent analysis by the National Institute of Economic and Social Research (NIESR), which finds that the unemployment-to-vacancy ratio has been a better predictor of wage growth than the unemployment rate since the pandemic (Jimenez-England, 2024).

How will the labour market interact with monetary policy going forward?

In its November 2024 meeting, the MPC recognised ‘significant’ uncertainty about the future impact of the labour market on inflation.

Recent data suggest that the Beveridge curve has returned approximately to its pre-pandemic position. Therefore, the maintenance of high interest rates to wait out persistent inflation may have an increasingly adverse effect on the rate of unemployment as job vacancies continue to fall. This may be welcome news for the MPC, which has judged that a period of labour market cooling could be necessary for wages and prices to normalise.

Policy-makers should keep in mind that there is a lag between the time that a policy is implemented and when its effects materialise. A more responsive transmission of falling vacancies to rising unemployment requires diligent foresight to avoid large upward pressure on the unemployment rate.

Elevated unemployment could be particularly problematic for the Bank of England’s ability to pull off a ‘soft landing’ – returning inflation to target while avoiding a recession.

Of course, the path of inflation and growth is dependent on both monetary policy and fiscal (tax and spending) policy. Policies announced in the new government’s autumn budget have been forecast to front-load GDP growth in 2025 and 2026 (Office for Budgetary Responsibility, OBR, 2024). This may help to achieve a soft landing, provided that inflation expectations remain anchored.

Current data suggest that the Beveridge curve is likely to stabilise after shifting around in recent years. This means that the Bank of England’s cautious approach is likely to become a more potent drag on inflation and output in the near future, as a tighter relationship between job vacancies and unemployment re-emerges.

On the one hand, maintaining higher interest rates may prove particularly important given upside risks to inflation coming from additional government spending, hikes in employers’ national insurance contributions, the rising national living wage and global risks such as tariffs and geopolitical conflict.

On the other hand, as unemployment becomes more responsive to interest rates, we may see growing concern over labour market outcomes if interest rates are kept too high for too long.