The European Central Bank (ECB) has provided explanations for why wage growth may continue to moderate even when unemployment remains at historically low levels. The analysis highlights that broader labour market dynamics, beyond unemployment alone, influence wage developments across the euro area.
In a blog post by Oscar Arce and David Sondermann, the authors note that unemployment in the euro area is close to record lows and is expected to decline further. However, wage growth is projected to moderate. “Paradoxical? Not if we look beyond unemployment,” the authors state, adding that migration, labour market participation, job switching and companies’ hiring intentions all form part of the broader picture.
Looking beyond the unemployment rate
The blog examines labour market mechanisms to explain the combination of low unemployment and a projected slowdown in wage growth. According to the authors, focusing solely on the unemployment rate can be insufficient and potentially misleading.
“At times, unemployment reflects the balance between labour supply and demand less accurately,” the analysis notes. Assessing slack in the labour market therefore requires a broader perspective that takes into account both supply and demand dynamics across the labour market.
Labour supply may change due to migration, participation rates, underemployment and working hours, while labour demand may weaken without necessarily leading to layoffs.
“The increasing importance of these broader adjustment channels explains why wage growth may continue to moderate even when unemployment remains at historically low levels,” the authors state, noting that the labour market is less tight than the unemployment rate alone might suggest.
Labour force expansion
Referring to the filling of six million jobs over the past three years, the authors note that the pool of unemployed people accounted for only around 500,000 of these positions.
More than three million additional jobs were filled by people who migrated to the euro area, while approximately 2.5 million jobs were taken by previously inactive nationals who had not been seeking employment. Of these 2.5 million individuals entering the labour market, around 60% were women.
Both rising female participation and net inward migration had previously supported employment growth, but their contribution in recent years has been significantly stronger than usual.
Foreign workers accounted for around 53% of job creation, compared with 29% between 2015 and 2019. Meanwhile, greater activation of domestic workers contributed about 43% of job creation, compared with 9% in the 2015–2019 period.
At the same time, participation among older workers has increased noticeably over time. As life expectancy rises, workers tend to retire later. Since the third quarter of 2022, the participation rate among people aged 55 to 74 has increased by nearly 1.7 percentage points.
Compared with previous generations, more than 1.5 million additional older workers have remained active in the labour force. However, this trend had already been visible before the pandemic, when participation among older age groups rose by 3.2 percentage points between 2016 and 2019.
Overall, the authors note that despite the relatively small role of changes in unemployment, companies’ labour demand was largely met over the past three years. The available labour supply was therefore larger than suggested by changes in the number of unemployed alone.
This has helped ease labour market tightness and wage pressures.
According to European Commission forecasts, these factors are expected to maintain a flexible labour supply in the coming years and help moderate labour market tightening. In the longer term, however, population ageing is expected to reduce the euro area labour force by around 11 million people by 2035, unless net migration and higher participation rates can be maintained.
Additional labour supply
The unemployment rate in the euro area is already low and could decline further. In several countries it has not yet reached its historical minimum, and previous structural reforms may have reduced structural unemployment.
Beyond the unemployed, nearly seven million people in the euro area are generally willing to work but are currently either unavailable or not actively seeking employment. These individuals, described as “marginally attached”, could include people temporarily caring for a family member.
In addition, around five million workers are underemployed and would prefer to work more hours than they currently do. Matching them to their desired hours would be equivalent to roughly two million additional workers.
Job mobility and wage dynamics
The number of employed workers changing jobs is also an important indicator of labour market slack and wage pressures.
When companies face difficulties hiring additional staff, they often attempt to attract workers by offering improved employment conditions, including higher pay. Job-to-job transitions typically fluctuate between four and seven million workers annually, or around 3% to 5% of the workforce.
Currently, however, fewer workers are changing jobs.
The ECB Consumer Expectations Survey provides quarterly data showing that job-to-job transitions have lost momentum in recent quarters. This likely reflects a reduced willingness among companies to offer better employment conditions and a greater preference among workers to remain in their current positions.
This development suggests a less tight labour market.
Structural trends also play a role. With Europe’s ageing population, the share of older workers increases each year, gradually reshaping labour markets. Social systems in Europe, characterised by strong employment protection and collective agreements, often provide greater protection to workers with longer tenure.
Average job tenure increases from around two years to roughly twenty years as workers age. Individuals with longer tenure face a lower risk of dismissal.
Over the past three years, the unemployment rate among older workers has stood at around 4.5%, significantly lower than among prime-age workers at 6% and young people at approximately 14.6%.
Older workers are also less likely to search for new employment. Annual job transitions range from roughly 6.5% among younger groups to around 2% among older workers.
As a result, older workers are less likely to renegotiate wages. Annual growth in hourly wages is also lowest among older age groups.
Overall, both cyclical and structural declines in job mobility suggest lower labour market tightness and reduced wage pressures as the workforce gradually ages.
The role of business demand for labour
The blog also notes that focusing exclusively on labour supply overlooks the demand for workers from businesses. Lower labour demand does not always manifest itself through layoffs and rising unemployment.
Companies may sometimes retain staff to manage temporary difficulties. In periods of severe economic downturn, firms tend to adjust staffing levels more dramatically, which is reflected in higher unemployment.
The COVID-19 pandemic provided a recent example of such adjustments.
However, during more moderate slowdowns, companies may simply reduce hiring or choose not to replace workers who retire, without dismissing existing employees. This has been observed since mid-2022.
Firms have posted fewer vacancies without laying off staff, preventing an increase in unemployment.
“As a result, there are now fewer vacancies per unemployed person,” the analysis notes. This lower demand for labour indicates reduced competition among firms for additional workers.
All else being equal, this should translate into lower wage pressures than might be suggested by the current historically low unemployment rate.
The reduction in labour demand is also reflected in lower average working hours. More than 80% of firms adjust to fluctuations in product demand by changing employees’ working hours.
During the pandemic, hours worked per employee fell significantly and remain below pre-pandemic levels, although they have increased again more recently.
Working hours therefore represent another margin through which companies can increase effective labour input without necessarily generating additional wage pressures.