How Rate Hikes Can Exacerbate Labor-Market Inequality

Overall, the researchers find, the shock led average unemployment (8.8 percent at the time of the tightening) to rise 1–2 percentage points. Three years after the rate hike, workers on average spent 3 percentage points less of the year employed. The level of labor-force participation fell by nearly 2 percentage points. Notably, Patterson says, job cuts weren’t concentrated in any one industry or in companies that are usually sensitive to rate changes—namely those that produce durable goods, are in greater debt, or are newer or smaller businesses. Those companies did see larger unemployment increases than less-rate-sensitive companies did, but the difference was smaller than expected.

Within a company, younger and less-educated workers were about 0.3 percentage points more likely than veteran workers to be unemployed. Similarly, lower-earning workers, compared with their higher-paid counterparts, were 0.5 percentage points more likely to be unemployed.

As for workers who had been with a company for fewer than six years, they were more than 1 percentage point more likely to be out of work than those who had at least 13 years tenure. Sweden follows a last-in, first-out rule, in which a company’s least-tenured workers must be laid off before similar, higher-tenure workers.

The study concludes that labor-market rigidities amplify the effects of monetary policy. Those rigidities include such policies as a minimum wage, unemployment insurance, and severance pay. In this case, sectors with more rigid union wage contracts had larger increases in unemployment, and individuals in these sectors were less likely to find new jobs and more likely than other workers to switch sectors. The rate hike had little impact on companies with less employee turnover, Patterson says, suggesting that the rise of gig workers or other broad-based changes in labor demand could also shape the effectiveness of future monetary policy.

After the shock, the Riksbank eventually reversed course and dropped the interest rate steadily over subsequent years. In response to the most recent bout of high inflation—numbers Sweden hasn’t seen since the 1990s—in April the Riksbank announced a rate increase from 0 to 0.25 percent.

As central banks around the world grapple with inflation and the potential for another recession, the study offers a window into what might happen when governments act while the economy is still recovering. The United States, for instance, could take heed, although its situation differs: US unemployment was 3.6 percent this April before the Federal Reserve hiked interest rates, inflation is above the Fed’s target (whereas it was below target in Sweden during the time period studied), and only about 10 percent of US workers belong to a union.

That said, “this type of interest rate ‘liftoff’ has become a key subject of study in the monetary policy literature as central banks around the world have experienced interest rates near or at a lower bound following recent recessions,” the researchers write. “Moreover, while the shock that we study is specific to Sweden, which is a small open economy reliant on exports, Sweden has a dynamic labor market with a large domestic manufacturing sector that makes many of the labor market insights relevant for other developed economies.”