Economists have long viewed monetary policy as influencing labour demand, with little effect on labour supply. This column discusses four studies that use different methods and data from the US, the UK, the euro area, and Australia, and independently find that monetary tightening induces households to adjust their labour supply. Adjustment margins include hours worked, labour market participation, job search, and household balance sheets. These findings illustrate that labour supply is a quantitatively meaningful channel of monetary transmission that has implications for the resilience of labour markets, the interaction of monetary and fiscal policy, and macroeconomic models of monetary transmission.
For decades, economists have viewed monetary policy as transmitting to the labour market through the demand for workers. In the standard framework (see, for example, Gertler and Gilchrist 1994, Christiano et al. 1996, Blanchard and Galà 2010), higher interest rates raise firms’ borrowing costs, depress demand, and reduce employment as firms cut back on investment and hiring. Labour supply, by contrast, is generally assumed to be unresponsive to monetary shocks, with employment fluctuations reflecting changes in firms’ demand for labour rather than households’ willingness to work.
This view is reflected not only in macroeconomic models but also in statements by central banks themselves. Speaking about the shortfall in labour supply during the recovery from the COVID-19 pandemic in 2022, then-Federal Reserve Chair Jerome Powell articulated the prevailing consensus: “Policies to support labor supply are not the domain of the Fed: our tools work principally on demand.”
Recently, four papers produced independently by researchers from academic institutions, the Federal Reserve, the Bank of England, the Reserve Bank of Australia, the European Commission, and the International Monetary Fund have challenged that consensus. Spanning different countries and time periods, and using different identification strategies, these studies nevertheless arrive at a shared conclusion: monetary policy also transmits to labour supply. What makes this body of work particularly compelling is that the papers emphasise different margins along which households adjust the supply of labour in response to monetary shocks.
How does labour supply respond to monetary policy?
One way households can adjust to monetary policy shocks is by changing how much they work in the job they already have. Using survey data of households in the US and UK, Cantore et al. (2023, 2026) show that although aggregate hours worked decline following a monetary tightening, the picture looks very different once the data are disaggregated: workers at the bottom of the income distribution increase their hours and exhibit stronger labour supply elasticities than other groups (Figure 1). In other words, even as the economy slows overall, some households respond to the income shock associated with monetary tightening by trying to work more hours.
Figure 1 Impulse responses of hours worked to a monetary policy tightening shock
Source: Cantore et al. (2023, 2026)
Notes: This figure depicts the impulse responses to a monetary policy tightening shock. The left panel reports the responses of hours worked for the first quintile of the earnings distribution, the central panel the aggregate measure of hours worked using CPS data, and the right panel the alternative aggregate measure excluding the first quintile. Dark (light) red areas denote 68% (90%) confidence intervals.
Using labour market flows in the US, Graves et al. (2023) show that contractionary monetary shocks lead the non-employed to search more actively, non-participants to be more likely to enter the labour force, and the employed to quit less often (Figure 2). They interpret these flows through an estimated heterogeneous-agent model of extensive-margin labour supply and find that the labour supply response substantially offsets the employment decline: absent it, the fall in employment would be roughly twice as large. Thus, while the US and UK survey data highlight adjustments along the intensive margin, the US flow evidence points to an important role for participation decisions and transitions across labour market states. Monetary policy therefore influences not only how much households work, but also their attachment to the labour market itself.
Figure 2 A monetary tightening raises labour supply: More job search and labour force entry, fewer quits to nonparticipation
Notes. Estimated impulse responses to a 25 basis point monetary policy tightening shock to the two-year Treasury yield. Panels show a rise in flows from nonparticipation to unemployment (reflecting greater search effort among the non-employed), a decline in quits from employment to nonemployment, and a rise in entry into the labour force. Solid black lines report impulse response functions for composition-adjusted flows, while dark and light shaded regions report bootstrapped 68% and 90% confidence intervals for composition-adjusted flows. For more detail, see discussion of Figures 2, 3, and 4 in Graves et al. (2023).
Source: Graves et al. (2023)
The same broad patterns appear outside the US. Analysing labour market transitions in the euro area, Bloise et al. (2025) find that tighter monetary policy strengthens worker attachment to the labour market – increasing transitions from inactivity into unemployment and reducing exits from unemployment into inactivity (Figure 3). Interestingly, the magnitude and distribution of these responses differ considerably across countries, with the aggregate pattern emerging clearly in some but concentrated among particular income groups in others. The evidence suggests that while the existence of a labour supply channel is remarkably robust, the mechanisms by which it operates could depend importantly on national labour market institutions and the distribution of income and wealth.
Figure 3 Monetary tightening strengthens worker attachment to the labour market
Notes: Transition probabilities from inactivity to unemployment (left) and unemployment to inactivity (right); evidence from the euro area
Source: Bloise et al. (2025).
Evidence from Australia adds another layer to this picture by highlighting the role of household balance sheets. Using administrative data on Australian taxpayers, Das et al. (2026) show that highly indebted households increased employment, earnings, and the number of jobs held during the 2022–23 tightening cycle (Figure 4). These responses were weaker among households with young children, whose caregiving responsibilities limited their capacity to work more. Following an expansion of childcare subsidies, however, these constraints eased and labour supply responses strengthened, illustrating how fiscal policy can amplify or dampen the labour supply channel of monetary transmission.
Figure 4 Households with greater mortgage debt were more likely to become employed and more likely to take on additional jobs following monetary tightening
Notes: Percent change in the probability of employment (left) and percent change in additional jobs (right), both relative to the lowest debt quintile.
Source: Das et al. (2026)
Implications
Monetary transmission
The existence of a labour supply channel has implications for how economists think about monetary transmission. First, it clarifies that higher policy rates do not simply transmit to the labour market through weaker labour demand. Households themselves react to the income losses associated with tighter financial conditions by working more, delaying labour force exits, and intensifying job search. As a result, labour market adjustment may occur through different margins than those emphasised in standard models.
Macro modelling
More broadly, these findings point to a macroeconomic modelling agenda in which labour supply is no longer treated as unresponsive to monetary shocks. Graves et al. (2023) and Cantore et al. (2026) take complementary steps in this direction, the former modelling extensive-margin responses — search, participation, and quits — and the latter intensive-margin responses within a two-agent New Keynesian (TANK) framework with heterogeneous households. In this sense, the recent empirical evidence is beginning to be matched by a new generation of models capable of capturing a richer view of monetary transmission.
Source : VOXeu
