How can technology lead to underemployment?


Hans-Jürgen Krupp
What can monetary policy do for employment?

1. Business cycle and employment

One of the most pressing tasks of economic policy is the fight against unemployment. This applies not only to Germany (West and East), but - with the exception of a few countries - also to the other countries of the European Monetary Union. In Germany, the number of registered unemployed is currently around 4 million. After all, the number of unemployed has been falling for some time.

In the meantime there should be broad agreement that there are no patent remedies for overcoming employment problems. Unemployment has strong structural components, which must be combated in the goods and labor markets, and a cyclical component that can be reduced within the framework of a macroeconomic stabilization policy, which also includes monetary policy. In Germany, monetary policy has also played an important role in the past. Last but not least, the appreciation of the D-Mark in 1995 contributed to a significant slowdown in growth and thus to an increase in unemployment. The European Monetary Union has greatly reduced the exchange rate dependency of German foreign trade and thus also the importance of currency policy for domestic economic stabilization. The focus of the following remarks is therefore the European stabilization policy.

Estimates of the structural share of unemployment come to different conclusions. According to estimates by the OECD, structural unemployment in Germany was 7.9% in 1998, and totaled 9.4%. After that, around 85% of unemployment was structural. For West Germany, the Ifo Institute calculated for 1997 that around two thirds of unemployment were structural in nature. One reason for the difference between the two estimates may be that the OECD figures include Eastern Germany with its high structural unemployment. Ultimately, however, the question of exactly how high the proportion of structural unemployment is is not so crucial. The fundamental statement of these studies is essential: Even based on the more cautious estimate of the OECD, around 15% of unemployment in Germany in 1998 was due to macroeconomic factors. The improvement that has now occurred can certainly be explained in particular by an improvement in the general economic framework.

When this contribution discusses the possibilities of contributing to solving the employment problems with means of stabilization policy, we are talking about the smaller part of unemployment. If one assumes the OECD figures, the unemployment rate would also with full utilization of the existing production capacities.

rates remain at around 8%. In a somewhat simplified way, it is often argued that the attempt to lower unemployment below this structurally determined level by means of stabilization policy can only be temporarily successful and would always be associated with an increase in the inflation rate. Last but not least, such a policy would not be compatible with the requirements of the European Central Bank, whose primary goal is price stability.

Indeed, there is much to suggest that the possible employment contribution of monetary policy is of this magnitude under these rather short-term perspectives - some excitement in the discussion of the employment effects triggered by interest rate policy measures by the ECB may therefore seem exaggerated. However, in view of the still difficult labor market situation, every contribution to reducing unemployment is something that is worth working for.

In addition, a different picture emerges if one expands the time horizon and looks at the longer-term development of unemployment over several business cycles. To come back first to the OECD study already cited: For 1990, it is estimated that the measured unemployment of 6.1% in Germany was solely due to structural reasons. With the rise in unemployment in Germany, structural unemployment has also risen. In the USA, the opposite development took place during this period (see diagram). At the same time, the base of structural unemployment there has sunk. Accordingly, the developments in structural and overall observed unemployment are related.

For Germany, this connection can be made even more precise. Since 1970, the rise to the high level of unemployment with which we are confronted today has not occurred in a steady process, but in spurts. The phases of sharply rising unemployment always fall into recession phases. The systematic increase is due to the fact that not all of the workers made redundant in a recession phase could be reintegrated into the production process in the subsequent phases of stronger growth. Over time, the developments in the structural and cyclical unemployment indicated by the trend seem to be connected. If macroeconomic growth slows down, then this initially leads to a decline in demand leading to a decline in employment. Newly emerging unemployment appears to be predominantly cyclical unemployment. The rise in the unemployment base after a recession depends crucially on the length of the recession. The comparatively long recessions in Germany have regularly led to an increase in the unemployment base. In contrast, the brief recessions in the USA, for example, have not led to this trend-like increase in unemployment.

Unemployment rates in the EMU area, in Germany and in the USA 1970-1999

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The main characteristic of the development of unemployment in Germany is that the rate at which unemployment arises in a recession is far higher than that at which it is reduced during the economic upswing. There are different explanations for this: It is possible that the economic downturn intensifies the structural change that is already taking place. The job losses in the economic downturn then affect other sectors than the additional demand for labor in the upswing. The new jobs or the qualification requirements will then probably differ considerably from the ones that have disappeared. However, this can also be the case within a production sector, because in the event of a decline in production, unprofitable production technologies are initially shut down and, when production capacities are subsequently expanded, they are simultaneously converted to more modern production processes.

In addition, it must be assumed that the uncertainty on the part of companies caused by strong fluctuations in sales contributes to the fact that an increase in production during an upswing only leads to an expansion of capacity, i.e. to an increase in the number of employees, with a considerable delay.

All of these arguments suggest that strong economic fluctuations will exacerbate the problems on the labor market, which are already associated with structural change. In the long term, pronounced economic fluctuations therefore contribute to an increase in the base of structural unemployment. This has important consequences for assessing the effectiveness of monetary policy measures: even if it is not possible in the short term to solve the employment problems in Germany and Europe with economic policy measures, everything indicates that in the long term the level of structural unemployment will also be increased by means of stabilization policy measures can be influenced. Then monetary policy can also help to keep fluctuations in capacity utilization, which always preceded serious declines in employment, to a minimum. In the longer term, it is therefore quite possible to use monetary policy to help secure jobs.

2. Mechanisms of action of monetary policy

But what is the scope of monetary policy and the specific possibilities of influencing employment with monetary policy means? The basic problem of a central bank is that it actually has only one instrument at its disposal today to pursue its goals, the short-term interest rate level on the money market. As part of its basic and main refinancing operations, the ECB can control the overnight rate on the money market relatively precisely. Apart from outliers on individual days, the overnight rate in the monetary union has now leveled out at around the current (March 2000) level of 3.5% set by the key ECB interest rate.

Incidentally, changes in short-term interest rates affect growth and prices in several ways at the same time. One speaks of the transmission channels of monetary policy. The best known is the traditional investment channel: You leave

Assumes that the long-term interest rate influences investments, as we know it from, for example, building a home. Low interest rates encourage investment. The long-term interest rate, in turn, is influenced by the short-term one. The so-called credit channel emphasizes that interest rate policy measures also lead directly to a shortage of the loans granted by the banks. When interest rates rise, the banks' risk position worsens, so that they reduce their credit supply. In open economies, the exchange rate channel is also important. He claims that a change in international interest rate differentials also affects exchange rates. A lower level of interest rates in Europe tends to make investments in the USA, for example, more attractive. The outflow of capital leads to a depreciation of the euro, which supports growth. A relatively higher level of interest rates favors an appreciation trend, which slows growth.

A current example of the influence that international interest rate differentials have on exchange rate developments and real developments is likely to be the relationship between the euro and the dollar. Long-term interest rates in the USA are still around one percentage point above the European level. In the short term it is even two percentage points. International investors take advantage of this interest rate advantage. The resulting depreciation of the euro against the dollar undoubtedly favored the onset of the upswing in the countries of the monetary union - of course, it is not unproblematic for the acceptance of the euro.

Even if there are many influences of monetary policy on employment, it must be clarified in principle to what extent an employment orientation of the central bank is compatible with its targets. In the US, this question is relatively easy to answer, where price stability and employment are equal goals of monetary policy. The situation in Europe is different. As was the case in Germany, the Maastricht Treaty gives the inflation target priority for the ECB's monetary policy. Monetary policy should only take employment effects into account to the extent that this is possible without impairing this goal.

Experience with the ECB in the first 15 months of its existence has shown that the ECB takes this obligation to take real developments into account when making its decisions. Immediately after assuming responsibility for monetary policy in the monetary union, in April of last year she took the high degree of price level stability in the monetary union and the worsening economic outlook at the time as an opportunity to cut interest rates significantly by half a percentage point. This decision was preceded by a coordinated interest rate cut by the national central banks in December 1998.

In Germany in particular, this decision has been heavily criticized - especially with the view of money supply growth familiar from the days of the Bundesbank. In this connection, the position has been taken by various quarters that ensuring the lowest possible inflation rate is the best contribution the central bank can make to safeguarding employment. This position is often supplemented by the claim that the ECB is pursuing a medium-term strategy, see above

that for this reason, too, consideration of the cyclical development or even of employment is forbidden.

There are several misunderstandings here. The relationship between inflation and employment is by no means as clear as it is claimed here. In the past, people believed the opposite was true. With a little inflation one could reduce some unemployment. However, this cannot be proven any more than the new thesis that less inflation leads to more employment.

The last of these assertions is more serious, however: the medium-term character of the ECB strategy relates to securing price level stability and the strategic element of medium-term money supply growth, which the ECB currently estimates at 4.5%. However, both are only indirectly related to the actual instrument of monetary policy, the short-term interest rate level. The inflation rate is believed to have a delay of about two years in response to monetary policy measures. The relationship to money supply growth was much closer, at least in time - one of the reasons why money supply targets have enjoyed great popularity for a long time.

3. Interest rate policy in the business cycle

Neither a stabilization of the monetary framework nor the inflation trend is synonymous with a stabilization of the interest rate trend in the sense that the interest rate should be kept constant for as long as possible. On the contrary: Without an active central bank policy that brings about variations in short-term interest rates, the demand for means of payment would be subject to strong fluctuations over the course of the business cycle: the extent to which production, price levels and thus the value of the goods sold in a period fluctuate in the business cycle change also the money needs of an economy. This development can only be perpetuated by varying the costs associated with granting loans and holding money accordingly: interest rates have to fall in an economic downturn and rise in an upswing. This is the only way to stabilize monetary expansion and guarantee long-term price stability. However, such a policy is neutral with regard to economic development. A monetary policy that stabilizes in the medium term also requires discretionary interest rate steps by the central bank, because the central bank interest rates do not fluctuate automatically. This requires active decisions by the central bank. A monetary policy that overlooks this and misunderstands stabilization as inaction in interest rate policy intensifies economic fluctuations: in a boom the interest rate level is too low and thus has an additional expansionary effect, in a recession it is too high and thus slows down stabilization.

The Bundesbank has taken this into account in its policy: Since the end of the Bretton Woods system, which marked the transition from a purely exchange rate-oriented to an independent monetary policy in Germany, there has been a clear fluctuation in short-term interest rates in the economic cycle - no one will blame the Bundesbank for this having pursued a monetary policy that was too employment-oriented.

Unfortunately, a comparison with the course of American monetary policy over the same period shows that the Bundesbank only performed the task of an interest rate policy appropriate to the economic cycle with some delay: the interest rate cuts only took place after the onset of an economic downturn and not, as in the case of the USA , Right at the beginning. It must now be assumed that a rate cut only has a delayed effect on economic and monetary development, so that a monetary policy auctioning off monetary development would have to aim to cause interest rates to advance ahead of the business cycle - otherwise it would intensify development at economic turning points. Nominal interest rates should start falling before the onset of an economic slowdown and should have bottomed out before growth bottomed out.

Measured against this standard, the Bundesbank often reacted too slowly with its policy, especially in the beginning recession. This delayed policy of the Bundesbank could be one of the reasons why the recessions in Germany usually lasted longer than in the USA. Monetary policy therefore only has a stabilizing effect on the economy if interest rates run ahead of economic developments and do not follow them. By way of example, this refutes the assertion that there are no macroeconomic disadvantages from neglecting the economic situation when making monetary policy decisions.

Timely action by the ECB is therefore all the more to be welcomed. And in the meantime it has also proven its determination to hike interest rates in the other direction.She used earlier signs of an economic upswing in November of last year to raise interest rates, which has since been followed by two more (March 2000). In doing so, it certainly also had to take into account that the euro exchange rate has an overall economic supportive effect.

Against this background, if one asks for an overall assessment of the previous monetary policy of the European Central Bank, it can only be positive. The two-pillar strategy, which uses the development of the money supply on the one hand and the inflation outlook on the other to assess the situation, has proven to be sensible. If the monetary development and the inflation perspective did not always give signals in the same direction, this is not a strategy flaw, but an indication that it makes sense to look at more than one indicator. Monetary aggregates are subject to disruptive influences in a variety of ways. Their measurement is also not easy, as the frequent revisions show. Even the Bundesbank had to repeatedly explain decisions that could not be justified by the development of the money supply with special developments. On the other hand, there are also many uncertainties in presenting the inflation outlook. A point forecast for the inflation rate in two years would also be scientifically questionable. The most differentiated indicators possible, including those from the various countries, should be used to analyze the risk of inflation.

The expectation that partly exists in the markets that a monetary policy decision can be derived almost automatically from the strategy has turned out to be inappropriate.

aptly proven. What was wrong at this point was not the behavior of the ECB, but the expectations of the markets.

Regarding individual decisions of the ECB, one may criticize in one place or another. Overall, however, the ECB is showing that it is prepared to let interest rates fluctuate with economic developments. The intention to run ahead of economic developments is also clear.

Exchange rate developments should also be taken into account when assessing the policy of the ECB. It is true that the monetary union has led to a decrease in foreign trade dependency. Without a doubt, however, the current euro exchange rate is tantamount to an expansionary impulse that promotes exports and curbs imports. This must be taken into account when calculating an appropriate interest rate. In addition, a widening of the interest rate differential to the USA could be connected with a further weakening of the exchange rate, which would affect the acceptance of the euro. In this respect, the exchange rate development for the ECB's monetary policy is definitely a double-edged matter.

A different interest rate policy would certainly be called for if the euro were to move upwards. In this case it would be the task of the European Central Bank's monetary policy to sound out which employment growth is possible without violating the goal of price stability.

4. The role of monetary policy in the European policy mix

In order for monetary policy to be based on the business cycle in this way, an essential prerequisite must be met. What has been said so far applies under the premise that the rate of inflation is subject to only slight fluctuations caused by the business cycle. In particular, this means that financial and wage policy must also take into account their effects on the inflation rate in their decisions. Excessive wage agreements run the risk of companies passing the associated additional costs on to prices. Monetary policy can only counteract this by increasing interest rates above the cyclically neutral level. This leads to a decline in overall economic demand, which limits the companies' scope for passing prices on. In this case, the rise in the inflation rate can only be prevented at the cost of dampening economic effects. The same applies, of course, to the inflationary effects of fiscal policy measures.

In a somewhat simplified way, one can say that monetary policy is in a position to correct all other influences on price developments in the long term - hence the primary orientation towards the inflation rate. However, impulses from financial and wage policy are transferred much more quickly to price developments and may therefore have to be corrected for the price-dampening effects on growth through monetary policy.

This interweaving of goals and instruments in the policy areas suggests that the role separation model of economic policy that has prevailed in Germany since the 1980s, in which financial policy is solely responsible for growth, wage policy for employment and monetary policy for price level stability, do not produce optimal results can.

Even at the national level, the opposition of monetary, financial and wage policy implicitly approved in this role separation model could do a lot of damage. Coordination in the common currency area is even more urgent: the economic ties between the participating countries are close. Economic policy impulses therefore do not stop at national borders. This automatically raises the question of a suitable policy mix and the role of monetary policy in the Europe of the monetary union.

Since monetary policy is ruled out as a national stabilization instrument in the monetary union, financial policy is gaining in importance for national economic policy. It can only fill this, however, if a sufficiently large "buffer" in the form of government borrowing is possible during periods of economic downturn to absorb cyclical shortfalls in income and additional expenditure in upswing phases - should be well below the reference value of 3% of gross domestic product.

The government deficit ratios in all countries are now below this reference value. Nevertheless, further consolidation efforts are necessary in almost all countries because the debt level in several countries is still above the 60% of GDP threshold. This also applies to the "big four" Germany, France, Italy and Spain. A medium- and long-term strategy of consolidation must regain the ability of the public sector to shape itself The real tasks: Fiscal policy can then neither make its contribution to stabilization nor contribute to growth through sufficiently high public investments.

The wage policy is dominated by the high unemployment in Europe. Against this background, moderate collective bargaining agreements are required that take into account the likely price development and productivity gains. In the situation of severe underemployment in Europe, the rate of productivity gains can only be the upper limit of wage growth. The statistically measured labor productivity - and only this is known in practice - also increases when some of the employees are made redundant due to excessive costs. With rationalization, below-average productive jobs are lost. As a result, the average labor productivity increases. If this kind of productivity increase were passed on to workers through wages, the pressure for rationalization and job cuts would continue.

The prospects for a restrained wage policy increase if fiscal policy eases taxes and duties and thus increases the available income.

men the employee supports. However, there are limits to the level of net relief due to the tight budget situation.

A correct starting point is therefore to relieve the work factor by shifting taxes and duties towards the environment and consumption. In this way, non-wage labor costs can be reduced without drastic reductions in the disposable income of employees or in social benefits. The cost containment gives companies an incentive to create new jobs.

There are also links between wage and monetary policy. A monetary policy that assumes that the parties to the collective bargaining will take no account of price developments looks different from a monetary policy that assumes that wage policy will take price developments into account. Conversely, signals for wage policy also emanate from monetary policy: a strategy primarily committed to the goal of price stability shows the parties to the collective bargaining agreement that they cannot expect negative employment effects of expansive wage agreements to be corrected by inflation.

In the Europe of the monetary union, it should also be noted that this would of course only be possible with a common European wage policy, which is highly improbable. Since the price level is determined at the European level, wages that are above productivity in individual countries do not lead to price increases, but only to cost increases, which only lead to a loss of competitiveness and thus to unemployment in the country concerned. On a smaller scale, we have suffered such a process in East Germany.

In this respect, the introduction of the common currency in Europe creates new employment risks, but only if the collective bargaining policy is wrong. This raises the question of the employment dimension of the monetary union. The monetary union sets completely new economic framework conditions. Last but not least, the question arises as to the direct effects of the common money on the national labor markets. However, they are difficult to estimate. In any case, the elimination of exchange rates within the EMU area removes a considerable potential for disruption, which used to be caused by currency turbulence and which has cost many jobs in the past. Much has been gained for the labor market by eliminating such unnecessary job losses. But one can also expect that the intensification of economic integration within Europe will open up potential for growth. After all, from now on the transaction costs associated with the circulation of several currencies are eliminated. However, this will only have positive effects on employment in the medium term.

This also applies to the influence of the expected intensification of competition. On the other hand, the exchange rate channel of monetary policy is becoming less important because the new currency area is less dependent on foreign trade. At the same time there is a bit of an increase in autonomy, especially in relation to the dollar. The course of the euro

to the dollar is less significant today than it used to be the rate of the DM to the dollar. Therefore, the excitement about the euro is not understandable.

5. Limits of monetary policy in Europe

To the extent that the economic positions of the participating states of the monetary union differ from one another, this naturally affects the possibilities of the common monetary policy to have a stabilizing effect on the economy. The European Central Bank's interest rate policy can only be based on the average economic development in the monetary union. In concrete terms, this means that, even in the ideal case, the interest rate level will be a little too high for countries with weak growth and too low for those with stronger growth rates. At the beginning of monetary union, the economic positions of Ireland, Spain and the Netherlands differed from those of the other countries. These countries are still in a strong upswing. In other countries, too, such as Germany and especially France, the trend is now clearly upwards. It is likely that the intensification of trade relations and the common currency will continue to help bring national business cycles closer together. This would increase the effectiveness of monetary policy in Europe and thus also the possibilities of using monetary policy means to help reduce unemployment in Europe in the long term.

© Friedrich Ebert Foundation | technical support | net edition fes-library | October 2002