Working Paper Series no. 819: Job Polarization and the Flattening of the Price Phillips Curve

In the European Monetary Union (EMU), the negative relationship between price inflation and unemployment –the price Phillips Curve (PC)– has recently weakened. At the same time, the share of routine employment has declined, giving rise to a phenomenon called job polarization. This paper combines these two apparently unrelated facts and shows that the change in the occupational composition of the labor market is an important driver of the flattening of the PC. In other words, the paper highlights the importance of labor market characteristics, and in particular the heterogeneity across occupations, for the structural relationship between prices and unemployment.

The contribution of the paper is both empirical and theoretical. In the empirical part, first it shows that countries abundant of routine jobs exhibit a steeper PC. Conversely, countries abundant of non-routine jobs exhibit a flatter PC. Then, it exploits the fact that recessions temporarily accelerate the long-run trend of polarization. By using the cross-country cyclical heterogeneity in routine job destruction, we prove that each time the employment composition of the labor market changes in favor of non-routine jobs, the slope of the PC flattens afterward. Hence, we are able to assess that the shift in the employment composition matured during the Great Recession and Sovereign Debt Crisis can explain 25% of the flattening of the PC in the EMU.

In the theoretical part of the paper, we investigate why employment relocation from routine to non-routine jobs has implication for the price PC. The answer lies in differences across occupations. On the one hand, the market of non-routine jobs is more fluid, i.e. it exhibits higher separation and hiring rates. Conversely, the market of routine job is less fluid, i.e. it exhibits lower separation and hiring rates. We use a standard New Keynesian model with search and matching frictions to analyse how this occupational heterogeneity is important for the slope of the New Keynesian Phillips Curve. In particular, we show that an overall higher labor market fluidity implies a flatter price PC. Therefore, employment relocation from less to more fluid jobs – from routine to non-routine occupations – weakens the relation between inflation and unemployment.

The empirical and theoretical analysis allows to conclude that the occupational composition of the labor market –and in particular the heterogeneity across jobs– matters for the slope of PC. Any change in the composition has direct implications for the relation between prices and unemployment. This is an important fact for for monetary policy, especially in light of recent macro-trends affecting the labor market such as job polarization.