Euro 2014: Understanding Unemployment Challenges in the Euro Area

Unemployment casts a long shadow across every facet of society. For individuals facing job loss, it’s a deeply personal crisis with enduring financial consequences. For those employed, it breeds insecurity and weakens the social fabric. Governments grapple with strained public finances and the threat to their political standing. Central banks are also keenly attuned to unemployment, recognizing its pivotal role in shaping inflation dynamics in both the short and medium term. Even when price stability isn’t immediately at risk, high unemployment and social unrest can intensify pressure on central banks to intervene.

1. Examining the Roots of Euro Area Unemployment in 2014

The crucial question for policymakers in 2014 was the extent to which unemployment could be sustainably reduced. This hinged on determining whether the primary drivers were cyclical, reflecting temporary economic fluctuations, or structural, embedded in the fundamental workings of the economy. In the diverse economic landscape of the 18-country Eurozone, this was a particularly complex issue. However, understanding the European Central Bank’s (ECB) assessment of the situation in 2014 provides valuable insights.

Figure 1: Divergence in Unemployment Trends: Euro Area vs. US Since 2008

Alternative text: Figure 1 displays a line graph comparing unemployment rate changes in the Euro Area and the United States from 2008, highlighting the Euro Area’s double-dip recession impact on joblessness.

The Protracted Recession in the Euro Area Economy

A key observation is that the Euro Area experienced a significant and prolonged contraction in GDP, which had severe repercussions for employment. Figure 1 illustrates the differing unemployment trajectories in the Euro Area and the United States since 2008. While the US saw a sharp, immediate spike in unemployment following the Great Recession, the Euro Area endured two distinct waves of unemployment, each linked to successive recessions.

From early 2008 to early 2011, the patterns in both regions were similar: unemployment rates surged, stabilized, and then began a gradual decline. This initial phase reflected shared global economic shocks: the synchronized financial cycle across developed economies, the sharp decline in global trade after the collapse of Lehman Brothers, and substantial corrections in asset prices, particularly in housing markets.

However, from 2011 onwards, the economic paths of the US and the Euro Area diverged. In the US, unemployment continued its downward trend. In contrast, the Euro Area witnessed a second surge in unemployment, peaking in April 2013. This divergence was attributed to a second shock specific to the Euro Area – the sovereign debt crisis. This crisis triggered a six-quarter recession across the Euro Area. Unlike the post-Lehman shock, which affected all Euro Area economies, the job losses during this second period were largely concentrated in countries most acutely impacted by government bond market instability (Figure 2).

Figure 2: Correlation Between Financial Stress and Unemployment Levels in Eurozone Nations

Alternative text: Figure 2 presents a scatter plot showing the relationship between financial stress, measured by bond spreads, and changes in unemployment rates across Euro Area countries, illustrating the impact of sovereign debt crisis.

The sovereign debt crisis impacted economies through multiple channels, notably by weakening macroeconomic stabilization tools.

On the fiscal front, public services like administration, education, and healthcare had initially provided some employment buffer in most countries during the first crisis phase. However, in the second phase, fiscal policy became constrained by concerns about debt sustainability and the absence of a unified fiscal safety net, especially as sovereign debt restructuring became a topic of discussion. The necessary fiscal consolidation was accelerated to restore investor confidence, leading to fiscal drag and public sector job cuts, further compounding job losses in other sectors.

Sovereign pressures also disrupted the uniform transmission of monetary policy across the Euro Area. Despite historically low policy interest rates, borrowing costs actually increased in stressed countries. This meant that monetary and fiscal policies were inadvertently tightening simultaneously. A key focus of monetary policy during this period, and continuing into 2014, was to repair this impaired monetary transmission mechanism. While directly linking these impairments to unemployment is complex, ECB analysis of the “credit gap” in stressed countries – the difference between actual and normal credit volumes – suggested that restricted credit supply was significantly hindering economic activity.

Cyclical vs. Structural Unemployment Factors in 2014

Cyclical factors undoubtedly contributed to rising unemployment in the Euro Area in 2014. The prevailing economic situation pointed to their continued influence. Recent GDP figures confirmed a persistently weak recovery across the Euro Area, with subdued wage growth even in economically stable countries, indicating weak overall demand. In this climate, uncertainty about the strength of the recovery likely dampened business investment and slowed down the pace of rehiring.

However, evidence also suggested that structural issues accounted for a substantial portion of unemployment in some Euro Area countries by 2014.

For example, the Euro Area Beveridge curve, which plots unemployment against job vacancies, indicated a growing structural mismatch in Euro Area labor markets (Figure 3). During the initial crisis phase, sharp declines in labor demand led to a steep rise in unemployment, represented by a movement along the Beveridge curve. The second recession, however, resulted in a further significant increase in unemployment, even as vacancy rates showed signs of improvement. This suggested a more permanent outward shift of the Beveridge curve, implying increased structural unemployment.

Figure 3: Euro Area Beveridge Curve Shift During Economic Crisis

Alternative text: Figure 3 illustrates the Beveridge Curve for the Euro Area, showing an outward shift during the crisis, indicating a rise in structural unemployment due to mismatches in labor supply and demand.

Part of this Beveridge curve shift appeared to be due to the sheer scale of job losses in certain sectors within some countries. This led to lower job-finding rates, longer unemployment durations, and a higher proportion of long-term unemployment. The significant contraction of the previously inflated construction sector (Figure 4) was a key factor, mirroring trends observed in the US where such sectoral shifts tend to reduce labor market efficiency. By the end of 2013, long-term unemployed individuals (unemployed for a year or more) represented over 6% of the total Euro Area workforce, more than double the pre-crisis level.

Figure 4: Sectoral Employment Shifts in the Euro Area Economy

Alternative text: Figure 4 shows a bar chart illustrating employment changes by sector and education level in the Euro Area, highlighting job losses concentrated in low-skilled sectors like construction during the crisis.

Another crucial factor was the limited opportunities for redeployment for displaced low-skilled workers. This was evidenced by a widening gap between the skills possessed by the workforce and the skills demanded by employers. Analysis of skill mismatch trends revealed a notable increase at regional, national, and Euro Area levels (Figure 5). As Figure 4 demonstrates, job losses in the Euro Area were heavily concentrated among low-skilled workers.

Figure 5: Skill Mismatch Trends Across the Euro Area Region

Alternative text: Figure 5 displays skill mismatch indices for the Euro Area, indicating a growing disparity between the skills of the labor force and the skills required by employers, contributing to structural unemployment.

Overall, assessments from international organizations like the European Commission, OECD, and IMF indicated that the crisis led to an increase in structural unemployment across the Euro Area. The average estimate across these institutions rose from 8.8% in 2008 to 10.3% by 2013.

Important Considerations for the Euro Area Unemployment Picture in 2014

It’s important to consider two key qualifications when interpreting these figures.

Firstly, estimates of structural unemployment are inherently uncertain, particularly in real-time. Research by the European Commission suggested that estimates of the Non-Accelerating Wage Rate of Unemployment (NAWRU) in the economic conditions of 2014 likely overestimated the extent of unemployment linked to structural factors, especially in the countries most severely affected by the crisis.

Secondly, aggregate data masked significant heterogeneity across the Euro Area. In 2014, the average Euro Area unemployment rate of 11.5% concealed a wide range, from around 5% in Germany to 25% in Spain. Structural developments also varied considerably. For example, country-level Beveridge curves revealed a pronounced inward shift in Germany, while in France, Italy, and especially Spain, the curves shifted outwards.

This heterogeneity reflected differing starting points, such as varied sectoral employment compositions (particularly the share in construction), and historically persistent differences in unemployment rates across Euro Area countries. But it also reflected how labor market institutions mediated the impact of economic shocks on employment. Economies that fared better in terms of employment during the crisis tended to have more flexible labor markets, allowing for quicker adjustments to changing economic conditions.

Germany, for instance, witnessed an inward shift in its Beveridge curve, a trend that began in the mid-2000s following the Hartz labor market reforms. Its relatively strong employment performance was also linked to the availability of instruments for German firms to reduce employee working hours at reasonable costs. These included reduced overtime, flexible working time arrangements, and widespread use of short-time work schemes.

Even among countries severely impacted by the sovereign debt crisis, the influence of labor market institutions on employment was evident. Ireland and Spain, both experiencing large-scale job losses in construction after the Lehman shock, had contrasting experiences during the sovereign debt crisis. Unemployment in Ireland stabilized and then declined, while in Spain, it continued to rise until January 2013 (Figure 6). From 2011 to 2013, structural unemployment was estimated to have increased by around 0.5 percentage points in Ireland, compared to over 2.5 percentage points in Spain.

This divergence was partly attributable to differences in net migration. However, it also reflected the fact that Ireland entered the crisis with a relatively flexible labor market and implemented further reforms under its EU-IMF program starting in November 2010. Spain, on the other hand, entered the crisis with significant labor market rigidities, and meaningful reforms only began in 2012.

Before these reforms, Spanish firms’ ability to adjust to the new economic realities was hampered by sectoral and regional collective bargaining agreements and wage indexation. Surveys indicated that wage indexation was more prevalent in Spain, covering approximately 70% of firms. As a result, nominal compensation per employee in Spain continued to rise until the third quarter of 2011, despite a more than 12 percentage point increase in unemployment (Figure 6). In contrast, Ireland saw downward wage adjustments starting as early as the fourth quarter of 2008, and these adjustments occurred more rapidly.

Consequently, while the Irish labor market facilitated adjustment through price mechanisms (wages), the Spanish labor market adjusted primarily through quantity mechanisms (employment). Due to the high degree of labor market duality in Spain, the burden of adjustment disproportionately fell on those with temporary contracts, who constituted around one-third of all employment contracts before the crisis.

Since then, Spain, like other stressed countries, has addressed some of these labor market rigidities through structural reforms with positive effects. The OECD, for example, estimated that the 2012 labor market reform in Spain improved transitions from unemployment to employment across all unemployment durations.

Figure 6: Contrasting Labor Market Adjustments: Unemployment and Wage Trends in Ireland and Spain

Alternative text: Figure 6 compares unemployment rates and nominal compensation per employee in Ireland and Spain, illustrating the contrasting labor market adjustments in response to the economic crisis.

In summary, unemployment in the Euro Area in 2014 was characterized by complex interactions. Differentiated demand shocks across countries interacted with pre-existing conditions and national labor market institutions in diverse ways. These interactions evolved as new reforms were implemented. Therefore, estimates of cyclical and structural unemployment must be approached with caution. However, the heterogeneity of labor market institutions was clearly a source of fragility for the monetary union.

2. Policy Responses to High Unemployment in the Euro Area in 2014

What policy conclusions can be drawn from this analysis? A balanced approach is necessary, requiring action on both the demand and supply sides of the economy. Aggregate demand policies must be combined with national structural policies.

Demand-side policies are not only justified by the significant cyclical component of unemployment in 2014. They are also crucial as they provide insurance against the risk of hysteresis effects – where prolonged economic weakness leads to cyclical unemployment becoming structural. In the uncertain economic climate of 2014, the risks of “doing too little” – allowing cyclical unemployment to become entrenched – outweighed the risks of “doing too much” – potentially generating excessive inflationary pressures.

However, aggregate demand policies alone are insufficient without parallel action on the supply side. Like other developed economies, the Euro Area in 2014 operated under conditions shaped by the previous financial cycle: low inflation, low interest rates, and significant debt overhang in both the private and public sectors. In such circumstances, the zero lower bound constraint on interest rates raised the risk of monetary policy losing some of its effectiveness in stimulating aggregate demand. The debt overhang also inherently limited fiscal space.

In this context, fostering higher potential growth – and thereby increasing government revenue – could help create policy space and allow both monetary and fiscal policies to regain traction over the economic cycle. Reducing structural unemployment and boosting labor participation are key components of this strategy. This is especially relevant for the Euro Area, as high unemployment in certain countries could lead to increased loan losses, weaker banks, and a more fragmented transmission of monetary policy.

Stimulating Aggregate Demand in the Euro Area

On the demand side, monetary policy had a central and crucial role to play in 2014. This required maintaining accommodative monetary policy for an extended period. The package of measures announced in June 2014 was intended to provide the necessary boost to demand, and the ECB stood ready to further adjust its policy stance if needed.

Exchange rate movements were already observed that should support both aggregate demand and inflation. These were expected to be sustained by the diverging expected policy paths in the US and the Euro Area (Figure 7). The first Targeted Long-Term Refinancing Operation (TLTRO) was scheduled to launch in September 2014, and had already garnered significant interest from banks. Preparations for outright purchases in asset-backed security (ABS) markets were also progressing rapidly, and these purchases were expected to contribute to further credit easing, diversifying the channels for liquidity provision.

Figure 7: Diverging Real Interest Rate Expectations: Euro Area vs. US

Alternative text: Figure 7 presents expected real interest rate paths for the Euro Area and the US, highlighting the diverging monetary policy stances and their potential impact on exchange rates and inflation.

Inflation in the Euro Area had declined from around 2.5% in the summer of 2012 to 0.4% recently. Several factors contributed to this downward trend: falling food and energy prices, exchange rate appreciation after mid-2012, geopolitical risks related to Russia-Ukraine, relative price adjustments in stressed countries, and high unemployment.

While many of these effects were expected to be temporary, a prolonged period of low inflation would increase risks to price stability. Financial markets in August 2014 indicated significant declines in inflation expectations across all horizons. The 5-year/5-year inflation swap rate, a key metric for medium-term inflation, had fallen to just below 2%. Shorter and medium-term inflation expectations had seen even more significant downward revisions. Real interest rates at the short and medium-term horizons had increased. The ECB Governing Council acknowledged these developments and was committed to using all available instruments within its mandate to ensure price stability over the medium term.

Turning to fiscal policy, the Euro Area since 2010 had experienced less available and effective fiscal policy compared to other major advanced economies. This was not primarily due to higher aggregate debt ratios compared to the US or Japan. Instead, it reflected the fact that central banks in those countries acted as a backstop for government funding, preventing the loss of market confidence that constrained many Euro Area governments’ market access. This allowed for more backloaded fiscal consolidation in the US and Japan.

Therefore, a greater role for fiscal policy alongside monetary policy would be beneficial for the overall policy stance in the Euro Area in 2014. There was scope for this, within existing constraints and legal frameworks. Euro Area government expenditure and taxation levels were already among the highest globally relative to GDP. The Stability and Growth Pact provided an anchor for confidence that should not be broken.

Within this context, four key elements were emphasized:

First, existing flexibility within the Stability and Growth Pact rules could be used to better address the weak recovery and accommodate the costs of necessary structural reforms.

Second, there was room to shift towards a more growth-friendly composition of fiscal policies. A starting point could be lowering the tax burden in a budget-neutral manner. This strategy could have positive short-term effects if taxes were reduced in areas with higher short-term fiscal multipliers, and unproductive expenditures with lower multipliers were cut. Research suggested potential positive second-round effects on business confidence and private investment in the short term.

Third, a discussion on the overall fiscal stance of the Euro Area was warranted. Unlike other major economies, the Euro Area’s fiscal stance was not based on a single budget, but on the aggregation of eighteen national budgets and the EU budget. Stronger coordination among national fiscal stances could lead to a more growth-friendly overall fiscal stance for the Euro Area.

Fourth, complementary action at the EU level, including a large public investment program, as proposed by the incoming President of the European Commission, was deemed necessary to ensure both an appropriate aggregate fiscal position and stimulate investment.

Implementing Structural Reforms for Long-Term Growth

However, no amount of fiscal or monetary accommodation could substitute for necessary structural reforms in the Euro Area. Structural unemployment was already high before the crisis, estimated at around 9%. Some research even suggested it had been persistently high since the 1970s. Given the complex interactions between demand and supply, national structural reforms to address this problem were urgently needed in 2014.

This reform agenda encompassed labor markets, product markets, and improvements to the business environment. In labor markets, two overarching themes were prioritized:

Firstly, policies to facilitate the rapid redeployment of workers to new job opportunities, reducing unemployment duration. These included enabling firm-level agreements to better align wages with local labor market conditions and productivity, allowing for greater wage differentiation, reducing employment adjustment rigidities and labor market dualities, and product market reforms to accelerate resource and employment reallocation to more productive sectors.

Secondly, enhancing the skill intensity of the workforce. The disproportionate impact of the crisis on low-skilled workers highlighted the need for reskilling initiatives to facilitate their return to work. The long-term consequences of high youth unemployment further reinforced this. The youth unemployment rate (15-24 years) had risen from an already high level of around 15% in 2007 to 24% in 2013, likely causing significant “scarring” as young people missed crucial on-the-job training opportunities.

Skill intensity was also crucial for potential growth. While increased labor participation was important, demographic trends suggested its contribution to future potential growth would diminish. Lifting trend growth would increasingly depend on raising labor productivity. Therefore, it was essential to concentrate employment in high-value-added, high-productivity sectors, which depended on skills.

In the global economy, the Euro Area could not solely compete on costs with emerging economies due to its social model. Its competitive advantage had to stem from combining cost competitiveness with specialization in high-value-added activities, a model successfully demonstrated by countries like Germany. Insufficient skill levels would effectively raise the non-accelerating inflation rate of unemployment (NAIRU) by causing more workers to become unemployable and fall outside the ‘competitiveness zone’.

Raising skills required significant improvements in education, with substantial scope for progress. The proportion of the working-age population with upper secondary or tertiary education varied widely across the Euro Area, from over 90% in some countries to around 40% in others. Active labor market policies, such as lifelong learning, and addressing distortions like labor market duality were also crucial. Reducing labor market duality, for example, could decrease inefficient worker turnover and incentivize both employers and employees to invest in developing job-specific skills.

3. Conclusion: A Coherent Strategy for Euro Area Employment in 2014

In conclusion, unemployment in the Euro Area in 2014 was a complex issue, but the path to a solution was conceptually clear. A coherent strategy to reduce unemployment required a combination of demand-side and supply-side policies, implemented at both the Euro Area and national levels. Only a truly coherent approach could be successful.

Without stronger aggregate demand, the risk of higher structural unemployment increased, and structural reforms might prove insufficient to generate employment growth. Conversely, without determined structural reforms, aggregate demand measures would quickly lose effectiveness and potentially become less impactful. The path back to higher employment in the Euro Area in 2014 required a policy mix combining monetary, fiscal, and structural measures at both the union and national levels. This would enable each member of the union to achieve a sustainably high level of employment.

The stakes for the monetary union were high. While regional unemployment disparities within countries are common, the Euro Area was not a formal political union and lacked permanent mechanisms for risk-sharing through fiscal transfers. Cross-country migration flows were relatively limited and unlikely to become a primary driver of labor market adjustment after major shocks.

Therefore, the long-term cohesion of the Euro Area depended on each country achieving sustainably high employment levels. Given the significant costs associated with threats to the union’s cohesion, all countries had a vested interest in achieving this goal.

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This text has been adapted and updated to focus on the economic context of 2014 based on the original article.

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References

1. [1]It is important to note, however, that the difference in euro area unemployment developments relative to the US also reflects very different developments in labour market participation. Over the period 2010-12, the decline in the participation rate contributed significantly to the fall in the unemployment rate in the US. At the same time, the rising participation rate in the euro area explains part of the rise in the unemployment rate. Assuming that, in both the US and the euro area, the labour force participation ratios had remained unchanged compared with 2007 and that the difference to the actual ratios had been fully reflected in the number of unemployed, the US unemployment rate in 2012 would have been higher than that of the euro area. For more information see Box 7 in the ECB Monthly Bulletin, August 2013.
2. [2]The “credit gap” is computed as the difference between the actual and the counterfactual path of the total credit to non-financial corporations simulated by using the multi-country BVAR of Altavilla et al. (2014). More precisely, the counterfactual path has been obtained by measuring the stock of loans consistent with pre-crisis past business cycle regularities in absence of financial friction for the banking system. For further details see Altavilla, Carlo, Domenico Giannone and Michele Lenza (2014). “The Financial and Macroeconomic Effects of the OMT Announcements,” ECB Working Paper No.1707.
3. [3]U.S. industry-level studies find that a large part of the decline in match efficiency is driven by the low level of job openings and hires per vacancy in the construction sector—see e.g. Barnichon, Regis, Michael W. L. Elsby, Bart Hobijn and Ayșegül Șahin (2012) “Which Industries are Shifting the Beveridge Curve?” Monthly Labor Review, June 2012, 25-37; Davis, Steven J., R. Jason Faberman, and John C. Haltiwanger (2012) “Recruiting Intensity during and after the Great Recession: National and Industry Evidence,” American Economic Review: Papers and Proceedings.
4. [4]Based on skill mismatch indexes computed as the difference between skill demand (proxied by educational attainments of the employed) and skill supply (proxied by the educational attainments of the labour force or unemployed, respectively). See (forthcoming) ECB Occasional Paper entitled “Comparisons and contrasts of the impact of the crisis on euro area labour markets’’.
5. [5]In terms of calculating structural unemployment, the European Commission estimates a NAWRU while OECD estimates the NAIRU using a filter technique that seeks to disentangle movements in the unemployment rates into a structural and a cyclical component, on the basis of a Phillips-curve relationship. The estimates by the IMF are not based on any “official” method – meaning that they do not publish a model or a given methodology, since their internal estimates are subject to judgement.
6. [6]European Commission, “Labour Market Developments in Europe 2013”, European Economy 6/2013.
7. [7]In the short pre-crisis period between 1995 and 2007, for which we have homogeneous euro area data, average unemployment rates were around 9% in France and Italy, but above 14% in Spain. In Germany, the unemployment rate was also 9%, but only as a result of a large, previous increase following reunification.
8. [8]Blanchard, Olivier, and Justin Wolfers (1999), “The Role of Shocks and Institutions in the Rise of European Unemployment: the Aggregate Evidence”, NBER Working Paper 7282.
9. [9]See Burda, Michael C., and Jennifer Hunt (2011), “What Explains the German Labour Market Miracle in the Great Recession”, NBER Working Paper No. 17187; and Brenke, Karl, Ulf Rinne and Klaus F. Zimmermann (2013), “Short-time work: The German answer to the Great Recession”, International Labour Review Vol. 152, Issue 2.
10. [10]Average of European Commission, OECD and IMF estimates.
11. [11]European Central Bank (2010), Wage Dynamics in Europe: Final Report of the Wage Dynamics Network (WDN), European Central Bank.
12. [12]See OECD Employment Outlook (2012), “How Does Spain Compare?”.
13. [13]OECD, “The 2012 Labour Market Reform in Spain: a Preliminary Assessment”, December 2013.
14. [14]The recommendations for the euro area adopted in the context of the 2014 European Semester explicitly call on the Eurogroup to explore ways to reduce the high tax wedge on labour.
15. [15]Alesina, Alberto, Carlo Favero and Francesco Giavazzi (2014), “The output effect of fiscal consolidation plans”, mimeo, May 2014.
16. [16]The incoming European Commission President, Jean-Claude Juncker, has proposed a €300 billion public-private investment programme to help incentivise private investment in the EU economy.
17. [17]Blanchard, Olivier, (2006), “European unemployment”, Economic Policy, pp. 5-59.
18. [18]Cross-country transfers between euro area countries exist as part of the EU cohesion policy. These funds are however in principle temporary, as they designed to support the “catching-up” process in lower income countries.
19. [19]Beyer, Robert C. M., and Frank Smets (2013), “Has mobility decreased? Reassessing regional labour market adjustments in Europe and the US”, mimeo, European Central Bank.