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One of the most common criticisms of central banks is that they are not interested in the labor market. In Colombia, different sectors question The Bank of the Republic’s decisions take only inflation into account, not the impact on employment. Yet the study of labor market conditions is, by definition, always immersed in monetary policy analysis.
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In the long run, only with stable prices can the economy move towards full employment and sustainable growth. In other words: price stability is a means to achieve the main goal and foothold of monetary policy, that is, to push the economy towards the level of maximum capacity operation.
Let’s start by explaining how what happens in the labor market is related to price stability. First, the level of employment is related to households’ spending power and the demand for goods and services in the economy. Second, Workers’ wages are a cost that companies must bear and pass on to consumers in the final price.
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To illustrate this situation, we can think of what happens during an economic boom: as employment grows, household demand increases, while supply cannot adjust and increase in the short term, leading to a general rise in prices. In addition, faced with greater production needs, companies also increase their demand for workers, which is reflected in more job vacancies and a tightening of the labor market, which manifests itself in rising wages and leads to higher prices for consumers. In this context, Monetary policy aims to smooth out excess demand (and smooth employment dynamics), thereby stabilizing wages and prices.

Bibiana Taboada.
Initial observations of the interaction between the labor market and inflation revealed a dilemma between employment levels and price stability. This is what economists call the Phillips curve, often depicted as a negative relationship between inflation and unemployment (Phillips, 1958). The Phillips curve shows that lower employment levels can indeed be tolerated to achieve price stability: that is, higher unemployment can be tolerated to reduce inflation (and vice versa).However, it is important to remember that this relationship can only be maintained in the short term and its strength varies according to the characteristics of each economy. In the long run, the dilemma of monetary policy disappears, since the level of full employment corresponding to the economy’s potential production is possible precisely through price stability.
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A key indicator in this analysis is the non-accelerating inflation unemployment rate or NAIR. This is the unemployment rate that occurs when the labor market is in line with the economy’s potential without creating price pressures (Modigliani and Papademos, 1975).

Mauricio Villamiza Villegas.
The level of Nairul has more to do with structural factors in the labour market and economic fundamentals than with specific circumstances. Therefore, it is independent of monetary policy and cannot be altered by monetary policy. Another important tool for describing the labor market and its possible impact on prices is the Beveridge curve, which relates available job openings to the unemployment rate to show how tight or loose the labor market is (Beveridge, 1945).
When the labor market is tight, there are more job vacancies and the unemployment rate is lower; when the labor market is loose, there are fewer job vacancies and the unemployment rate is higher. Intuitively, the Beveridge curve helps understand how easy it is for employers to fill vacancies given that workers are available; or in other words, how easy it is for workers to find jobs (and higher wages) given that there are vacancies.
Colombia’s labor market constraints result in high rates of unemployment and job vacancies that are not easily filled despite job losses. These frictions have been studied in employment missions and academic research, some of which was conducted by World Bank researchers, to inform possible structural reforms of the labor market.
In line with the recommendations of the previous employment mission (Alvarado et al., 2021), first, it is important to increase the level of formalization of the labor market, both to increase productivity and to achieve greater social security coverage; second, it is necessary to change the incentives for formalization by adjusting financing mechanisms and access to social security benefits; third, we must rethink the role of the minimum wage, given its very high level relative to the total wage distribution; and fourth, it is necessary to ensure an effective training and labor mediation system that meets the needs of the production sector.
In this context, we can conclude that what happens in the labor market is indeed important for monetary policy decisions. The evolution of employment and price stability are two sides of the same coin: it is impossible to think about monetary policy without analyzing the state of the labor market. Now, if we want to see an improvement in the long-term level of the economy and the labor market, what we need is structural reforms, not monetary policy adjustments.
-Bibiana Taboada Arango
-Mauricio Villamizar Villegas
Joint Director, Republic Bank.
**The views expressed in this article do not necessarily reflect those of Republic Bank or its Board of Directors.
**A longer version of this article is available at: https://www.banrep.gov.co/es/publicaciones-investigaciones/presentaciones-discursos/mitos-importa-mercado-laboral-politica-monetaria
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