Unemployment remains a critical issue impacting societies across the globe, and the Eurozone is no exception. High unemployment rates carry profound consequences, affecting not only those without jobs but also those employed, governments, and even central banks. For individuals experiencing unemployment, the repercussions can be devastating, leading to long-term income losses and personal hardship. For those who are employed, high unemployment can breed job insecurity and erode social cohesion. Governments grapple with strained public finances and diminished electoral prospects, while central banks face pressure to act, especially as unemployment significantly influences inflation dynamics. Even in scenarios where price stability is not immediately threatened, elevated unemployment and social unrest can push central banks to intervene.
1. Understanding the Drivers of Euro Area Unemployment
The central question for policymakers is the extent to which unemployment can be sustainably reduced. This hinges on whether the primary drivers are cyclical, reflecting temporary economic downturns, or structural, indicating deeper, systemic issues within the economy. Within the Eurozone, a monetary union comprising 18 diverse countries in 2014, this question becomes particularly complex. However, an overview of the European Central Bank’s (ECB) assessment of the situation provides valuable insights.
Figure 1: Change in the unemployment rate since 2008 – the euro area and the US
The Protracted Recession in the Euro Area
A key observation is that the Eurozone experienced a substantial and prolonged negative shock to its Gross Domestic Product (GDP), which had severe repercussions for employment. Figure 1 illustrates the unemployment trends in the Eurozone and the United States since 2008. While the US witnessed a sharp but relatively short-lived surge in unemployment following the Great Recession, the Eurozone endured two distinct periods of rising unemployment, coinciding with two successive recessions.
From early 2008 to early 2011, the unemployment trajectory in both regions appeared similar. Both the US and the Eurozone saw rapid increases in unemployment rates, followed by a plateau and a gradual decline. This parallel trend reflects shared origins of the economic shock: the synchronization of the financial cycle across developed economies, the contraction in global trade after the Lehman Brothers collapse, and significant corrections in asset prices, particularly in housing markets.
However, from 2011 onwards, the economic paths of the US and the Eurozone diverged. In the US, unemployment continued its downward trend at a steady pace.footnote{It is important to acknowledge that the difference in unemployment trends also reflects variations in labor market participation rates. In the US, a declining participation rate contributed to the fall in unemployment between 2010 and 2012. Conversely, a rising participation rate in the Eurozone partially explains the increase in unemployment. Had participation rates remained constant since 2007 in both regions, the US unemployment rate in 2012 would have been higher than that of the Eurozone. For detailed information, refer to Box 7 in the ECB Monthly Bulletin, August 2013.} Conversely, the Eurozone experienced a second wave of unemployment increases, peaking in April 2013. This divergence stemmed from a second shock specific to the Eurozone: the sovereign debt crisis. This crisis triggered a six-quarter recession within the Eurozone economy. Unlike the post-Lehman shock, which impacted all Eurozone economies, the job losses during this second phase were largely concentrated in countries heavily affected by government bond market instability (Figure 2).
Figure 2: Relationship between financial stress and unemployment
The sovereign debt crisis impacted the Eurozone through various channels, significantly disrupting macroeconomic stabilization tools.
On the fiscal front, public services like administration, education, and healthcare had initially provided a buffer, contributing positively to employment in most countries during the initial phase of the crisis. However, the second phase saw fiscal policy constrained by concerns over debt sustainability and the absence of a unified fiscal backstop, particularly amid discussions of sovereign debt restructuring. The necessary fiscal consolidation was accelerated to restore investor confidence, creating a fiscal drag and a contraction in public sector employment, further compounding job losses in other sectors.
Sovereign pressures also fragmented the uniform transmission of monetary policy across the Eurozone. Despite historically low policy interest rates, borrowing costs actually increased in stressed countries during this period. This effectively tightened both monetary and fiscal policies simultaneously. Consequently, a key focus of monetary policy during this time, and continuing into 2014, was to repair the impaired monetary transmission mechanism. Establishing a direct causal link between these impairments and unemployment is complex. However, ECB staff estimates of the “credit gap” in stressed countries – the difference between actual and normal credit volumes absent crisis effects – suggest that constrained credit supply significantly hindered economic activity.footnote{The “credit gap” is calculated as the difference between the actual credit to non-financial corporations and a counterfactual path simulated using a multi-country Bayesian Vector Autoregression (BVAR) model. The counterfactual path represents the credit stock consistent with pre-crisis business cycle patterns, assuming no financial friction in 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.}
Cyclical vs. Structural Unemployment Factors
Cyclical factors undoubtedly played a significant role in the surge in unemployment in the Eurozone leading up to 2014. The weak economic conditions across the region suggest that these cyclical forces remained influential. Recent GDP data confirmed a persistently weak recovery, with subdued wage growth even in economically stable countries, indicating sluggish demand. This environment likely fostered uncertainty about the strength of the recovery, dampening business investment and slowing down the pace of rehiring.
However, there were also indications that structural factors contributed significantly to unemployment, particularly in certain Eurozone nations.
For instance, the Eurozone Beveridge curve, which illustrates the relationship between unemployment and job vacancies (a proxy for labor demand), suggested the emergence of a structural mismatch in Eurozone labor markets (Figure 3). During the initial crisis phase, a sharp decline in labor demand led to a substantial increase in unemployment, reflected as a movement down along the Beveridge curve. However, the second recessionary period resulted in a further rise in unemployment, even as aggregate vacancy rates showed signs of improvement. This suggests a more permanent outward shift of the Beveridge curve, indicating structural changes in the labor market.
Figure 3: Evolution of the euro area Beveridge curve over the crisis
Part of this Beveridge curve shift can be attributed to the sheer scale of job losses in specific sectors, particularly the construction sector in some countries. This massive job destruction led to reduced job-finding rates, longer unemployment durations, and a higher proportion of long-term unemployment. The significant downsizing of the previously inflated construction sector (Figure 4) is consistent with experiences in the US, where such sectoral shifts tend to reduce labor market matching efficiency.footnote{US industry-level studies indicate that the decline in matching efficiency is largely driven by low job openings and hires per vacancy in the construction sector. See 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.} By the end of 2013, long-term unemployed individuals (those unemployed for a year or more) constituted over 6% of the total Eurozone labor force, more than double the pre-crisis level.
Figure 4: Evolution of euro area employment by sector and educational level
Another significant factor appeared to be the limited redeployment opportunities for displaced low-skilled workers. This was evidenced by a growing disparity between the skills possessed by the labor force and the skills demanded by employers. Analysis of skill mismatch trendsfootnote{Based on skill mismatch indices calculated as the difference between skill demand (proxied by educational attainment of employed individuals) and skill supply (proxied by educational attainment of the labor force or unemployed individuals). See (forthcoming) ECB Occasional Paper entitled “Comparisons and contrasts of the impact of the crisis on euro area labour markets’’.} indicated a notable increase in mismatch at regional, national, and Eurozone levels (Figure 5). As Figure 4 illustrates, job losses in the Eurozone were heavily concentrated among low-skilled workers.
Figure 5: Skill mismatch indices for the euro area
Overall, estimations from international organizations like the European Commission, OECD, and IMF suggested that the crisis contributed to an increase in structural unemployment across the Eurozone, rising from an average of 8.8% in 2008 to 10.3% by 2013 across these institutions.footnote{In calculating structural unemployment, the European Commission estimates the Non-Accelerating Wage Rate of Unemployment (NAWRU). The OECD estimates the NAIRU using a filter technique to separate unemployment rate movements into structural and cyclical components based on a Phillips-curve relationship. IMF estimates lack a publicly defined methodology, relying on internal judgments.}
Nuancing the Eurozone Unemployment Picture
Despite the clear evidence of rising structural unemployment, two important caveats are necessary.
Firstly, estimates of structural unemployment are inherently uncertain, particularly in real-time. Research from the European Commission suggests that NAWRU estimates in the prevailing economic climate likely overestimate the extent of unemployment attributable to structural factors, especially in countries most severely impacted by the crisis.footnote{European Commission, “Labour Market Developments in Europe 2013”, European Economy 6/2013.}
Secondly, aggregate data masks significant heterogeneity across the Eurozone. The overall Eurozone unemployment rate of 11.5% in 2014 was a weighted average of rates ranging from nearly 5% in Germany to 25% in Spain. Structural developments also varied considerably. For example, Beveridge curve analysis at the country level revealed a pronounced inward shift in Germany, while France, Italy, and especially Spain experienced outward shifts.
This heterogeneity reflects differences in initial conditions, such as varying sectoral compositions of employment (particularly the share of construction jobs) and historically persistent unemployment rate disparities among Eurozone countries.footnote{In the short pre-crisis period (1995-2007), average unemployment rates were around 9% in France and Italy but exceeded 14% in Spain. Germany’s 9% unemployment rate was the result of a prior increase following reunification.} However, it also reflects the interplay between labor market institutions and the impact of economic shocks on employment.footnote{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.} Economies that weathered the crisis with better employment outcomes tended to have more flexible labor markets capable of adapting to changing economic conditions.
Germany, for example, witnessed an inward shift of its Beveridge curve, a trend that began in the mid-2000s following the Hartz labor market reforms. Germany’s relatively strong employment performance was also linked to the availability of instruments allowing firms to reduce employee working hours at reasonable costs – focusing on the intensive margin. These instruments included reduced overtime, greater working time flexibility at the firm level, and widespread use of short-time work schemes.footnote{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.}
Even among countries severely impacted by the sovereign debt crisis, the influence of labor market institutions on employment outcomes was evident. Ireland and Spain, for instance, both experienced substantial job losses in the construction sector post-Lehman shock. However, their experiences diverged significantly 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 approximately 0.5 percentage points in Ireland, compared to over 2.5 percentage points in Spain.footnote{Average of European Commission, OECD and IMF estimates.}
This contrasting performance can be partly attributed to differences in net migration. However, it also reflects the fact that Ireland entered the crisis with a relatively flexible labor market and implemented further labor market 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.
Prior to these reforms, Spanish firms’ capacity to adjust to the new economic reality was hampered by sectoral and regional collective bargaining agreements and wage indexation. Survey data indicated that wage indexation was prevalent in Spain, covering around 70% of firms.footnote{European Central Bank (2010), Wage Dynamics in Europe: Final Report of the Wage Dynamics Network (WDN), European Central Bank.} 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 during the same period, as shown in Figure 6. In contrast, Ireland saw downward wage adjustments beginning 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 (wage reductions), the Spanish labor market adjusted primarily through quantity mechanisms (job losses). Due to the high degree of labor market duality in Spain, the burden of adjustment disproportionately fell on less protected workers, particularly those on temporary contracts. Temporary contracts were widespread in Spain before the crisis, accounting for roughly one-third of all employment contracts.footnote{See OECD Employment Outlook (2012), “How Does Spain Compare?”.}
In Spain, as in other stressed countries, structural reforms have since addressed some of these labor market rigidities, yielding positive effects. The OECD, for example, estimates that the 2012 labor market reform in Spain improved transitions from unemployment to employment across all unemployment durations.footnote{OECD, “The 2012 Labour Market Reform in Spain: a Preliminary Assessment”, December 2013.}
Figure 6: Unemployment and nominal compensation developments in Ireland and Spain
In summary, unemployment in the Eurozone in 2014 was characterized by complex interactions. Differentiated demand shocks across countries interacted with varying initial conditions and national labor market institutions in diverse ways. These interactions evolved as new reforms were implemented. Therefore, estimations of cyclical and structural unemployment components must be approached cautiously. However, the heterogeneity in labor market institutions clearly posed a source of fragility for the monetary union.
2. Policy Responses to High Unemployment
Considering the multifaceted nature of Eurozone unemployment in 2014, policymakers faced the challenge of formulating effective responses. A balanced approach, encompassing both aggregate demand policies and national structural policies, was deemed necessary.
Demand-side policies were justified not only by the significant cyclical component of unemployment but also by the prevailing economic uncertainty. In uncertain times, the risk of “doing too little” – allowing cyclical unemployment to become entrenched as structural unemployment – outweighed the risk of “doing too much” – triggering excessive wage and price pressures.
However, aggregate demand policies alone were insufficient without parallel supply-side reforms. Like other advanced economies, the Eurozone operated within conditions shaped by the previous financial cycle: low inflation, low interest rates, and significant debt overhang in both private and public sectors. The zero lower bound on interest rates raised the risk of monetary policy losing effectiveness in stimulating aggregate demand. Debt overhang also constrained fiscal policy space.
In this context, boosting potential growth and government revenue became crucial to regain policy maneuverability and enhance the effectiveness of both monetary and fiscal tools across the economic cycle. Reducing structural unemployment and increasing labor participation were key elements in achieving this. This was particularly relevant for the Eurozone, as high unemployment in certain countries could lead to increased loan losses, weaker banks, and a more fragmented monetary policy transmission mechanism.
Stimulating Aggregate Demand
Monetary policy had a central role to play in boosting aggregate demand. In 2014, this meant maintaining an accommodative monetary policy stance for an extended period. The ECB’s package of measures announced in June 2014 aimed to provide the necessary demand stimulus, and the ECB remained prepared to further adjust its policy stance as needed.
Exchange rate movements were already observed to support both aggregate demand and inflation, driven by the diverging expected policy paths in the US and the Eurozone (Figure 7). The ECB launched its first Targeted Long-Term Refinancing Operation (TLTRO) in September 2014, which garnered significant interest from banks. Preparations for outright purchases in asset-backed security (ABS) markets were also progressing rapidly, expected to further ease credit conditions and diversify liquidity-generating channels.
Figure 7: Expected real interest rate path in the euro area and the US
Inflation in the Eurozone had been on a downward trajectory from around 2.5% in the summer of 2012 to 0.4% recently. Several factors contributed to this decline, including falling food and energy prices, exchange rate appreciation post-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 posed a risk to price stability. Financial markets in August 2014 indicated a significant decline in inflation expectations across all horizons. The 5-year/5-year inflation swap rate, a key metric for medium-term inflation, declined by 15 basis points to just below 2%. Shorter and medium-term inflation expectations saw even more significant revisions. Real interest rates at shorter and medium-term horizons increased, while long-term nominal rates declined both in the Eurozone and globally. The ECB Governing Council acknowledged these developments and was prepared to utilize all available instruments within its mandate to ensure price stability over the medium term.
Regarding fiscal policy, since 2010, the Eurozone had experienced less available and effective fiscal policy compared to other major advanced economies. This was not solely due to higher initial debt ratios, as aggregate public debt in the Eurozone was comparable to the US or Japan. A key difference was that central banks in the US and Japan acted as backstops for government funding, preventing the loss of confidence that constrained many Eurozone governments’ market access and allowing for more backloaded fiscal consolidation.
Therefore, a greater role for fiscal policy alongside monetary policy would be beneficial for the overall policy stance. While acknowledging the Eurozone’s high levels of government expenditure and taxation relative to GDP and the constraints of the Stability and Growth Pact fiscal rules, there was scope for improvement.
Firstly, existing flexibility within the Stability and Growth Pact rules could be utilized to better address the weak recovery and accommodate the costs of necessary structural reforms.
Secondly, fiscal policies could be made more growth-friendly through adjustments in composition. For instance, budget-neutral tax burden reductions were possible.footnote{The 2014 European Semester recommendations for the Eurozone explicitly called on the Eurogroup to explore ways to reduce the high tax wedge on labor.} Lowering taxes in areas with higher short-term fiscal multipliers and reducing unproductive expenditures with lower multipliers could have positive short-term effects. Research suggested potential positive second-round effects on business confidence and private investment in the short term.footnote{Alesina, Alberto, Carlo Favero and Francesco Giavazzi (2014), “The output effect of fiscal consolidation plans”, mimeo, May 2014.}
Thirdly, a discussion on the overall fiscal stance of the Eurozone was warranted. Unlike other major economies with single national budgets, the Eurozone’s fiscal stance was an aggregation of eighteen national budgets and the EU budget. Enhanced coordination among national fiscal stances could lead to a more growth-supportive overall fiscal policy for the Eurozone.
Fourthly, complementary action at the EU level was necessary to ensure both an appropriate aggregate fiscal position and a substantial public investment program, consistent with proposals from the incoming European Commission President.footnote{The incoming European Commission President, Jean-Claude Juncker, proposed a €300 billion public-private investment program to incentivize private investment in the EU economy.}
Implementing Structural Reforms
While demand-side policies were crucial, they could not substitute for necessary structural reforms in the Eurozone. Structural unemployment was already high before the crisis (around 9%), and some research suggested it had been persistently high since the 1970s.footnote{Blanchard, Olivier, (2006), “European unemployment”, Economic Policy, pp. 5-59.} Given the interactions between cyclical and structural factors, delaying national structural reforms was no longer an option.
This reform agenda encompassed labor markets, product markets, and improvements to the business environment. Within labor markets, two cross-cutting themes were priorities.
Firstly, policies facilitating rapid worker redeployment to new job opportunities were essential to reduce unemployment duration. These policies included enabling firm-level agreements to better reflect local labor market conditions and productivity, allowing for greater wage differentiation across workers and sectors, reducing employment adjustment rigidities and labor market dualities, and product market reforms to accelerate resource and employment reallocation to more productive sectors.
Secondly, enhancing workforce skill intensity was critical. The disproportionate impact of the crisis on low-skilled workers highlighted the need for re-skilling initiatives. The long-term consequences of high youth unemployment further reinforced this conclusion. Youth unemployment (ages 15-24) increased from an already high level of around 15% in 2007 to 24% in 2013, likely causing significant “scarring” due to lost on-the-job training opportunities.
Skill enhancement was also crucial for potential growth. While increasing labor participation was important, demographic trends suggested a diminishing contribution to future potential growth. Lifting trend growth would increasingly rely on labor productivity improvements. Therefore, prioritizing employment in high-value-added, high-productivity sectors, which depended on skills, was essential.
In the global economy, the Eurozone could not solely compete on costs with emerging economies due to its social model. Its competitive advantage needed 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 pushing more workers out of the ‘competitiveness zone’ and into unemployability.
Skill enhancement primarily involved education. Significant improvements were still possible, as the proportion of the working-age population with upper secondary or tertiary education in the Eurozone ranged from over 90% in some countries to around 40% in others. Active labor market policies, such as lifelong learning and addressing labor market dualities, also played important roles. Reducing labor market duality, for instance, would decrease inefficient worker turnover and incentivize both employers and employees to invest in job-specific skills development.
3. Conclusion
In conclusion, unemployment in the Eurozone in 2014 was a complex issue, but the path to a solution was conceptually straightforward. A coherent strategy to reduce unemployment required a combination of demand and supply-side policies at both the Eurozone and national levels. This strategy’s success depended on its holistic and integrated nature.
Without stronger aggregate demand, the risk of higher structural unemployment increased, and structural reforms implemented by governments might struggle to achieve meaningful progress. Conversely, without decisive structural reforms, aggregate demand measures would quickly lose momentum and become less effective. The path to higher employment in the Eurozone, therefore, required a policy mix combining monetary, fiscal, and structural measures at both the union and national levels. This approach would enable each member state to achieve sustainably high employment levels.
The stakes for the monetary union were substantial. While regional unemployment disparities within countries are common, the Eurozone, lacking formal political union and permanent risk-sharing mechanisms like fiscal transfers,footnote{Cross-country transfers within the Eurozone exist through EU cohesion policy, but these funds are intended to be temporary, supporting the “catching-up” process in lower-income countries.} faced unique challenges. Cross-country migration flows were relatively limited and unlikely to become a primary driver of labor market adjustment after major shocks.footnote{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.}
Therefore, the long-term cohesion of the Eurozone depended on each member country achieving sustainably high employment levels. Given the significant risks to the union’s cohesion if this goal was not met, all member countries had a vested interest in pursuing this objective.
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This text has been updated to reflect new comments on inflation made during delivery.
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