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258 Unemployment and Monetary Policy in the European Union
through unemployment is successful in raising unemployment, but not very effective
in reducing inflation. Thus the traditionally accepted causation from low
unemployment to inflation through excess demand is replaced by a new one, from
inflation (possibly exogenous) to unemployment, through restrictive (and inefficient)
central bank policy.
By 1979–1980, the spiral is rekindled by the second oil crisis and inflation
returns to the peak level of 1975. But now a staunch non-accommodating policy
raises interest rates quickly back to 11 percent. By 1983 wage inflation was down
to 7 1 / 2 percent and price inflation to 8 1 / 2 percent, but unemployment had risen to
10 percent.
The analysis of the last two sections suggests that the high unemployment of
countries like Spain or Italy, or the world-wide unemployment during the oil crisis
could be readily understood in the light of a need, which had gradually emerged,
for a non-accommodating central bank policy in order to cut short an inflationary
spiral. However, it does not help to explain the high unemployment from 1983
to the end of the decade, which remains a puzzle.
4.5.3 The Puzzle of the 1980s
The puzzle arises from a set of seemingly inconsistent circumstances: i) during
this period, unemployment reached a very high postwar peak and remained close
to it until the very end of the decade; ii) the members of the EMS pursued very
tight monetary policies which were, presumably, largely responsible for the high
unemployment; iii) these policies were pursued despite the fact that inflation
declined steadily and became very moderate, at least by the middle of the decade.
These “facts” are illustrated in table 8.3 which shows for Germany, France and
the European Community the path of inflation (column (2)), and nominal and
“real” interest rates (column (3)) during the 1980s. At the top of each column,
we report for reference the mean value of the variables in the period 1961–1970.
The path of unemployment is given in table 8.2.1 for Germany, 8.2.2 for United
Kingdom and 8.2.3 for France.
For Germany, unemployment is very high in 1982 and 1983, but inflation is
also relatively high by German standards, and this could explain the very tight
policy in those years. That policy raises unemployment to a peak, but it also brings
inflation down in 1984 to a very modest 2 percent, a level that is pretty much
maintained until 1988; and yet the real rate remains quite high. 1 Over the five years
1984 to 1988, the nominal rate averaged 6.8 percent, or the same as in the 1960s.
But with inflation appreciably lower, the implied real rate was 4.6 percent instead
of 3 percent, which presumably kept unemployment at its high level.
This policy is hard to understand unless the Central Bank had become so
imbued with its role and responsibility as the guardian of price stability that it