It is timely to draw attention to the unacceptable level of unemployment in the EU. There is a stark contrast between the US economy's ability to maintain unemployment below 5 per cent, without enkindling renewed inflation, and the double-digit unemployment rates now recorded in all the major continental European countries.
Predictably, the recent Luxembourg Summit was all about public sector initiatives and labour market measures. Possible links between the drive for a single currency and the rise in European unemployment were not discussed.
The official line remains that monetary union is good for the health of the European economies and offers the prospect of lower unemployment.
But why is unemployment so high in Europe today? Could there be any link between high unemployment and the push for a single European currency? For those with memories of recent economic history, some salutary lessons may be drawn from the role of monetary policy in the recent rise of European unemployment.
Europe has long suffered high unemployment compared to the US. The puzzle for economists is not that unemployment rose so sharply in Europe during recent recessions, but that it remained high in subsequent expansions. In the US, the unemployment rate falls fairly quickly back to pre-recession levels, but in Europe each recession sets a higher floor to the unemployment rate. Nonetheless, when the Maastricht criteria were adopted at the end of 1991, European unemployment was under 9 per cent and less than two percentage points above the US rate. The subsequent evolution of unemployment in the two regions deserves careful study by advocates of monetary union. American and European unemployment rates diverged after 1992, to the point where the latter is now almost two and a half times the former. The culprit for the contrast between the recent trends in European and US unemployment is the restrictive monetary policy pursued in Germany in the first half of the 1990s.
German monetary policy was transmitted to other European countries through the European Monetary System's exchange rate mechanism (ERM). Even after the virtual break-up of the ERM in August 1993, countries such as France, anxious to comply with the requirements for entry to EMU, maintained their currency closely linked to the deutschmark.
Germany's tight monetary policy was thus transmitted throughout the continent during one of the severest European recessions since the Second World War.
Enthusiasts for monetary union have all too readily forgotten how these events contributed to the high unemployment that Europe now suffers. The best indicator of the stance of monetary policy is the level of short-term real interest rates. German real interest rates rose to almost 6 per cent during the deep recession of 1992. In the US, on the other hand, where the Federal Reserve chairman Alan Greenspan conducted monetary policy with an admirable pragmatism, real interest rates were sharply reduced in 1992 and 1993 to avert a deepening of the recession.
The excess of German over US real interest rates helps account for the divergent trends in unemployment rates on the two continents after 1992.
The European authorities have been willing to tolerate this rise in unemployment in the name of price stability, which is seen as a prerequisite for the launch of a sound euro.
Europe had to live with the spread of historically high real interest rates from Germany as unemployment rose in 1992 and 1993. The ERM and the drive to meet the Maastricht criteria ensured this. The German authorities began to relax the stance of monetary policy after 1992, whereas the Fed tightened up after 1993, with the result that real interest rates crossed over in 1995.
The damage was, however, done. The evidence from previous recessions shows that increases in European unemployment are not easily reversed. The belated relaxation of monetary policy in Germany, was too little, too late for a Europe saddled with 12 per cent unemployment.
What is more disturbing is that, having seen unemployment rise throughout Europe in the manner just described, the German finance minister succeeded in having the Stability Pact added to the EMU repertoire at the Dublin Summit last December. This decrees that countries adopting the euro should aim to achieve a balanced budget over the business cycle. Deficits in excess of 3 per cent of GDP will attract large fines, unless excused by exceptional circumstances. Most countries in Europe - including Ireland - have tightened their fiscal policy to the point where, if interest payments on national debt are excluded, surpluses in excess of 2 or 3 per cent of GDP are now recorded. The Stability Pact commits them to run non-interest surpluses ad infinitum. Having contributed to high unemployment throughout Europe, through restrictive monetary policy in the first half of the 1990s, the German authorities have now imposed conditions for participation in EMU that will impose a deflationary bias on European fiscal policy for years to come.
Would things have been better if full-blown monetary union, instead of the ERM halfway house, had been in place earlier in the 1990s? It may be argued that a European Central Bank would have taken a broader view of monetary policy than the Bundesbank, but there is little support for this, either in the likely composition of the executive board of the ECB or in its absolute commitment to price stability.
In this regard the contrast with the Fed is notable. Not only does the Fed acknowledge the importance of maintaining a high level of employment but it is also more answerable to the American public than the ECB will be to the citizens of Europe.
Brendan Walsh is professor of eco- nomics at the Department of Econom- ics, University College, Dublin
