Labor Supply Effects of Monetary Policy

Macroeconomic models largely preclude a labor supply response to monetary policy shocks, and this view of monetary policy is reflected in explicit statements by major central banks. Our paper contributes to an emerging literature that challenges this view by providing evidence of a labor supply channel in monetary transmission. We study how Australian workers adjust labor supply in response to the Reserve Bank of Australia’s 2022–23 monetary policy tightening, exploiting administrative data covering the universe of employed workers. Because most Australian mortgages are floating-rate, higher policy rates quickly translate into higher mortgage repayments, allowing us to measure household exposure to the tightening using pre-tightening debt service ratios. We find that highly exposed individuals respond to higher interest payments by increasing labor supply, with sizable effects on employment probabilities, the number of jobs held, and labor earnings. The effects are strongest among those without children, consistent with childcare constraints limiting labor supply responses, but the discrepancy diminishes following a policy reform that increased the generosity of childcare subsidies, highlighting an interaction between fiscal policy and monetary transmission. Together, these findings provide causal evidence that liquidity pressures from higher mortgage repayments can transmit monetary policy to the labor market through house-hold labor supply decisions.