Crucially, rising inactivity among the working age population represents an adverse supply shock, which adds to the difficult shorter-term trade-offs facing monetary policy. Looking back to a year or so ago, the MPC debated whether the prospective end of the furlough scheme introduced during the pandemic would release furloughed workers into the labour market and ease the tightness emerging in the labour market. This was a difficult judgment to make, given that the furlough scheme was without precedent. As it turned out, that easing did not materialise: through the middle of this year, the labour market has continued to tighten and has proved tighter than we had expected, largely owing to the adverse developments in participation that we did not fully foresee. Brexit may also have weighed on labour supply. While aggregate levels of immigration into the UK remain elevated, the loss of flexibility associated with the end to free movement of EU workers into the UK may have steepened the Phillips curve, as post-Brexit immigration has proved less effective in addressing labour market mismatches and more costly for employers. Page 7  Now that the economy has slowed (and probably entered recession), we are starting to see labour market indicators turn. Vacancies have stabilised and there are tentative signs they will fall from their historically high levels. Should economic slack emerge and unemployment rise as the latest MPC forecasts imply, that will weigh against domestic inflationary pressure and ease the threat of inflation persistence.
In the US, demand has played an important role: the US economy has more than recovered pre-pandemic levels of activity. So there are grounds for seeing US labour market tightness as a symptom of ‘overheating’ in the broader economy. This case is harder to make in the UK, where aggregate activity has still to regain pre-pandemic levels on the latest vintage of data. As a result, adverse supply effects seem to play a larger role in Britain. That said, vacancy rates have reached historical highs in the UK over the past year, perhaps redolent of strong demand for labour and echoing developments on this side of the Atlantic. But high vacancy rates have been associated with high hiring rates: the labour market has exhibited a high degree of ‘churn’, with many people moving jobs. In part, this may reflect a process through which workers are allocated to more productive activities, after the pandemic – and the UK’s furlough scheme introduced in response to it – had constrained their flexibility to move from one job to another. Behind labour market tightness in the UK lies a decline in participation rates among the working age population, particularly those in the 50-65 age group. The reasons behind this decline remain the subject of debate, but the impact of the pandemic on early retirement and long-term health, as well as underlying demographic developments, all seem to have played a role.