The Times is running briefings to coincide with Target Two Point Zero, the Bank of England contest for sixth-formers, which is run in conjunction with the newspaper. The competition challenges students to play the role of the Bank’s Monetary Policy Committee (MPC) and decide the best level for interest rates. This week: the role of labour markets.

Why is the jobs market important for the MPC?

Inflation is caused by money demand exceeding supply of services and goods. But external factors, such as a sharp rise in the price of oil, can also lead to sustained inflation by cost push unless the Bank curbs credit. The labour market is crucial in both. Supply shortages most often show up in tightness in the labour market. Employers bid up pay to recruit people with scarce skills. Wage bargaining can then transmit these rises across the workforce.

The MPC is also on guard to see whether higher energy and tax bills cause “second round” inflation by employees trying to recoup the costs in the pay negotiation round, which is concentrated in the year’s early months. The median settlement has recently risen from 3.0 per cent to 3.5 per cent.

Do wage bargainers believe that the MPC will meet its 2.0 per cent inflation target?

Not quite. The Bank’s latest survey found that people on average expect inflation to be 2.7 per cent. This shows some faith because the latest annual rise in the targeted consumer prices index was 3 per cent. A complication is that pay bargaining uses the retail prices index as its cost-of-living reference. Hence pay deals that offered rises in line with inflation in January 2007 will be 4.4 per cent.

Does the Bank worry if unemployment falls below a given level?

The concept that a pool of idle labour is needed to check inflation, the nonaccelerating inflation rate of unemployment (Nairu), is a less compelling guide to policy than 15 years ago. Nairu has fallen with inflation expectations. Migration and benefit changes also affect unemployment, so it is no longer clear what Nairu is. A recent rise in unemployment made some of the MPC feel that the economy had spare capacity, but numbers in jobs kept rising.

Has immigration from Eastern Europe reduced jobs’ role in monetary policy?

Over the past two or three years, half a million mainly skilled workers have come to Britain from new EU states, preventing shortages in key areas. Some economists say ability to recruit imported labour freely removes a constraint and lets the economy grow faster without inflation rising. This does not remove other constraints, such as low investment, and the UK cannot rely on a regular influx of artisans sufficient to alter market relationships.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive