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Labour Market Slack in the UK

Given the recent unexpectedly rapid fall in the unemployment rate, the extent of labour market slack in the UK economy is an important issue for policymakers, particularly the Bank of England’s Monetary Policy Committee (MPC). However, in our view, the MPC is arbitrarily reducing its estimate of the impact of two important components of labour market slack, risking damaging mistakes in the formulation of monetary policy. The first is long-term unemployment and the second is underemployment. In each case the MPC has explained these adjustments in a box in its May 2014 Inflation Report called ‘Assessing the degree of spare capacity’. The purpose of this article is to explain why we think the MPC’s approach is incorrect.