-Analysis-

PARIS — It's a new puzzle for central bankers in developed countries. Improvements in economic activity and the subsequent drop in unemployment levels over the past two years haven't translated into higher wages, and inflation has thus been almost non-existent.

For those versed in economics, everything is happening as if the Phillips curve no longer existed. This longstanding model is based on the assumption of an inverse relationship between the inflation and unemployment rates: When unemployment is high inflation won't rise because there's no upward pressure on wages. On the contrary, in a full-employment situation, prices are expected to rise quickly. Nothing, in theory, could be more logical.

But this dynamic is no longer registering in developed countries. The three major economies with unemployment rates between 4% and 5.5% — the U.S., Britain and Germany — are experiencing no, or very little, rise in inflation. The Phillips curve, which was in vogue in the 1960s, lost its luster in the following decade as unemployment rates and prices grew together. It returned to favor in the 1990s and 2000s with the independence of central banks and the monetary policy focus on inflation. But 10 years after the financial crisis, this inverse correlation between unemployment and prices seems no longer valid. James Bullard, head of the Federal Reserve Bank of St. Louis, put it dryly: "Low unemployment readings do not appear to be an indicator of substantially higher inflation to come."

The Eurozone has 7 million people involuntarily working part-time.

What, then, is the explanation? For Benoît Coeuré, a member of the Executive Board of the European Central Bank (ECB), reasons are linked to the fact that, in the Eurozone, the proportion of the working population of full-time workers with permanent contracts has declined from 72% in 2004 to 66% in 2016. "Of the net employment created since the crisis, around one-third has been for workers on temporary contracts, and around a quarter part-time," Coeuré said in a speech in May.

The Eurozone now has 7 million people involuntarily working part-time, about 1 million more compared to the pre-crisis economy. "While the main objective for workers in permanent work is typically higher wages, those in temporary or part-time positions may pursue objectives other than wage increases, such as full-time employment or an increase in hours worked," Coeuré added. "Or if they do seek higher wages, they may be less likely to benefit from union representation and thus have less bargaining power."

The mechanism is well-known across the Atlantic, so much so that it recently led Larry Summers, former U.S. Treasury Secretary, to launch a plea in favor of reinforcing trade unions' powers.

There are, nonetheless, other reasons for the absence of inflation. There's globalization, which creates a worldwide competition among workers. The automation of certain tasks thanks to technological advances also plays a part. But the point raised by the ECB executive leads to the following question: What do unemployment figures mean nowadays on a macroeconomic level? The answer, in 21st-century capitalism and given the disruption on the jobs market, is: not much. Though still necessary, unemployment levels no longer appear sufficient to assess the true health of the labor market. "The unemployment rate is based on a rather narrow definition of labor underutilization," ECB economists wrote in a recent study.

Don't blame the measurement.

It's not about blaming the measurement but rather trying to improve it, or to add another one. This is the goal behind attempts to evaluate "labor underutilization" or "labor market slack," by adding to the number of unemployed those who are employed part-time but want to work more hours, and those who are without a job but aren't actively looking for work. These two categories — which are not officially counted as unemployed — each represent 3.5% of the Eurozone's active population. As a result, labor market slack would affect some 18% of the active population.

Miraculously, when the ECB tries to forecast inflation by using this labor market slack rate instead of the unemployment rate, it works: The Phillips curve, thus, becomes valid again.