Tight Job Markets under Higher Interest Rates After Pandemics: Why?

Recently after pandemics, many countries experiencing very high inflation have raised the interest rates. Typically, while curbing the inflation, a high interest rate has been supposed to dampen the economy, reducing the job creations. Surprisingly, however, the employment data did not show the typically expected outcome, but unexpected up in employment, meaning tight job markets. This experience raises a question about the relationship between interest rates and employment. Talking about the effect of interest rate on labor market, it would be fair to say that there has been an unexplained mismatching between the theory and the fact accepted widely by policy makers. It is firmly believed that a higher interest rate has a negative effect on job creation and employment, and a lower interest rate does a positive effect on them. But a labor market model of labor supply and labor demand never predicts that kind of deterministic relationship between interest rate and employment. It is simple to show that depending on the structure of labor supply and demand, the interest rate elasticity of employment may be negative or positive. It looks odd to see that mismatching between textbook theory and the fact accepted widely empirically is not given a serious attention. This paper’s modest goal is to say that the effect of interest rate policy on labor market needs to get one more attention and thorough evaluation, through which more appropriate policy could be implemented. For this purpose, a labor market model with job matching function is set, in which job seekers and vacancy postings are distinguished. This paper would be useful in understanding properly the employment effect of the interest rates raised in many OECD countries.