Measuring labour market slack is essential for central banks: without full employment in the economy, inflation will not stay close to target. Given this critical relationship, we examine different ways to assess the amount of slack in the labour market.
COVID‑19 has emphasized how diverse and segmented the labour market is.1 Traditional measures may:
- mask the presence of slack from weakness in hard-hit groups
- miss weaknesses in job quality and opportunities for workers—signs of weak demand for labour
We propose a way to assess the health of the labour market more comprehensively than has been done before. By providing a clearer picture of key turning points in the economic recovery from the pandemic, this approach could help mitigate potential risks to inflation from extended low policy rates. This new, detailed approach allows us to identify important areas of weakness (or strength) in the labour market. This approach could also improve understanding of whether labour market weakness is driven by cyclical factors or by long-term structural trends like digitalization, although this is not an area of focus of this paper.
We tackle the need for a more comprehensive assessment in two ways.
First, we construct the expanded labour market indicator (ELMI). The ELMI is similar to the Bank of Canada’s labour market indicator (LMI), a summary measure of labour market conditions, but features some changes in methodology and an expanded scope of variables to capture additional areas of slack. We also apply it differently: instead of using it as a summary indicator, we examine the amount of disagreement between measures to more systematically track and quantify unevenness in the labour market.
Because the ELMI captures more aspects of the labour market than previous indicators, it gives us a more comprehensive assessment of areas of weakness. It reveals that many measures are sending very different signals about the health of the labour market. This elevated variation across data series implies that traditional measures such as the unemployment rate cannot fully account for the difference in labour market slack across various groups or for the quality of job gains.
Second, to address the drawbacks of traditional measures, we propose a framework for assessing the labour market recovery along three different dimensions:
- overall labour market conditions
- labour market inclusiveness
- job characteristics
We present and discuss key measures for each of these dimensions.
We also discuss how to benchmark the recovery using this framework. Determining the exact end point for the labour market recovery is challenging. This uncertainty is particularly high as the Canadian economy comes out of a large and uneven shock. We suggest using possible signposts instead of a fixed target to determine when the labour market has recovered. These signposts include:
- most measures across the three dimensions returning to at minimum pre-pandemic levels
- the level of unevenness or disagreement between most measures in the ELMI easing to pre-pandemic levels of around one standard deviation (a sign that the recovery is inclusive)
We apply this framework to identify areas of concern within the Canadian economy as it recovers from the pandemic:
- the prevalence of long-term unemployment
- the slower recovery in the unemployment rates of those aged 55 years and older
- declines in the participation rate of non-university-educated workers
In addition to the work presented here, further research on barriers faced by groups underrepresented in the Canadian labour force could help improve the assessment of the health of the labour market. Central banks cannot fix structural barriers to employment. But understanding these barriers can give central banks greater insight into the limits of monetary policy in boosting employment.