What does economic theory tell us about labour market tightness?

Labour market tightness is a phrase often used by commentators and policy-makers, but it is rarely defined. In this paper, the phrase labour market tightness is interpreted as describing the balance between the demand for, and the supply of, labour. A logical consequence of this approach is that tightness is not a helpful concept in those models of the labour market, such as the standard competitive and the basic matching model, where there are insufficient rigidities to create imbalances between labour demand and supply. It is proposed that changes in the labour share of income are a convenient yardstick for measuring changes in labour market tightness. In response to certain kinds of shock, changes in the labour share will give misleading signals, but this is likely to occur less frequently than with other oft-cited tightness indicators such as the unemployment rate or the employment rate. The paper concludes by considering the links between labour market tightness and inflation. A key lesson from this analysis is that any attempt to infer the relationships between labour market tightness, various market indicators of it, and inflation, requires both a clear definition of tightness and depends on the specific model of the labour market.