How persistent will the impact of Covid-19 on unemployment be?

The purpose of Bank Overground is to share our internal analysis. Each bite-sized post summarises a piece of analysis that supported a policy or operational decision.
Published on 05 October 2020
Unemployment is likely to rise over 2020. Unemployment has been slow to fall from peaks in the past. The sharp rebound in spending in some parts of the economy could mean unemployment will fall back from its peak more quickly this time. However uncertainty over Covid-19 and mismatch between jobs and job seekers may slow hiring.

Covid-19 has had a profound effect on the UK labour market. Many workers have been furloughed and numbers in employment started to fall in 2020 Q2. Unemployment is likely to rise materially over the second half of the year.

High unemployment tends to unwind slowly. The unemployment rate took seven years to return to pre-recession levels after the past two recessions (Chart A). Two key factors help explain this.

First, uncertainty about future demand can cause firms to delay hiring decisions. Fewer new businesses and less hiring by surviving businesses were important reasons why high unemployment persisted after the financial crisis.

Second, it may take longer to fill any job vacancies that are available. Matching job seekers to jobs is time-consuming and costly and once people have been unemployed for longer spells, the likelihood of finding a job falls.

The Covid-19 shock has been different in nature to past shocks. The spending fall has been very sharp and closely linked to social distancing measures. As a result, some types of spending have rebounded strongly already. Activity and employment have also been supported by policy measures.

This could mean unemployment will fall back from its peak more quickly than in the past. But Covid-19 has led to greater uncertainty about the economic outlook and the likelihood of finding a job.

Continued Covid-related uncertainty is also expected to weigh on labour demand, so hiring may recover relatively slowly.

Covid-19 has also affected some parts of the economy more than others. This is likely to create a mismatch between the sectors in which more workers are losing their jobs and the sectors in which businesses are hiring. This could make it harder for people to find jobs, slowing the decline in unemployment.

Chart A Unemployment has tended to remain elevated for a period following recessions(a)

The unemployment rate and the Monetary Policy Committee’s August Monetary Policy Report projection(b)(c)

Footnotes

Sources: ONS and Bank calculations.

(a) Recessions are defined as at least two consecutive quarters of negative GDP growth.
(b) Per cent of the 16+ economically active population.
(c) The fan depicts the probability of various outcomes for Labour Force Survey (LFS) unemployment, conditioned on the assumptions set out in the August 2020 Monetary Policy Report (MPR) and based on LFS data to May 2020. For further details, see footnotes to Charts 1.1 and 1.2 of the August 2020 MPR.

This post was prepared with the help of William Abel, Tomas Key and Catherine Shaw.

This analysis was presented to the Monetary Policy Committee as part of its August 2020 round.

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