For over 20 years I have argued that Western Europe’s high unemployment rates are unsustainable. At the end of the 1970’s, monetarists bet that only a transitory and modest increase in unemployment could rein in the creeping – and trotting – inflation of the industrial west, and that in retrospect the cost of returning to effective price stability would be judged worthwhile. In Britain and the United States, this monetarist bet turned out well. In Western Europe, it did not.
Over the past 25 years in Europe, unemployment rose as monetary policy was tightened and interest rates were raised to fight inflation. But after inflation succumbed, unemployment did not fall – or not by much. If unemployment was not stuck quite at Great Depression levels, it remained high enough to make long-term joblessness or the fear of long-term joblessness a defining experience.
Societies in which the official unemployment rate stands at 10% or more for generations are societies in which government economic management has failed. So, for 20 years it has seemed to me that Western Europe’s underlying political equilibrium – corporatist bargaining and ample social insurance, on the one hand, and tight monetary policies, on the other – must crack.
Twin fears appear to be paralyzing European policymakers. Europe’s central bankers fear that their political masters will order them to loosen monetary policy, that the structural reforms needed to free up aggregate supply will not be forthcoming, and that the result will be a return to the inflation of the 1970’s. In short, they fear that all of the sacrifices made for price stability will have been in vain.