ECB faces role of unemployment scapegoat

The European Central Bank and national governments appear set to remain at odds over unemployment. With 18 million unemployed across the EU, both sets of authorities agree that unemployment is the biggest challenge facing the EU. But views on how to remedy the situation differ greatly.

Politicians are coming under increasing pressure to "do something". Now that they are enjoying low inflation and interest rates, stable exchange rates and large balance of payments surpluses, it will be difficult for them to resist the calls for more to be done.

In broad terms governments - and particularly centre-left governments - would like to see rate cuts and more exchequer money thrown at the problem. In contrast, the ever-vigilant monetary authorities believe the only correct medicine is structural reform of the markets as well as limited tax and some spending changes. Monetary or interest rate policy does not have a role to play, they insist.

This is perhaps the biggest battle between the German government in Bonn and the ECB in Frankfurt and indeed Paris and other capitals as well. But it is the German government which has the biggest role to play. Not only is it the largest economy in the euro zone but it also has one of the biggest unemployment problems.

And rising unemployment is about the only problem which the Gerhard Schroder government in Germany is unable to deal with.

The four million jobless at the end of former chancellor Helmut Kohl's long reign were at the centre of the election campaign and undoubtedly the main reason for the Christain Democrats' defeat.

The new socialist and green administration knows that the one thing the electorate will not forgive in 2002, or whenever they next go to the polls, is any increase in unemployment or indeed probably anything other than a much-improved position.

Soon after the new government took power the finance minister, the now infamous Mr Oskar Lafontaine, spoke about a reduction to three million by the end of the term - that is 25 per cent.

That sort of objective is formidable by Irish standards where our small regional economy can expand rapidly but it would be an almost miraculous achievement in an economy such as Germany's with its many labour and market rigidities.

Of course, as Ms Alison Cottrell of Paine Webber points out, Mr Lafontaine soon realised this and began backtracking.

But that has not stopped the number being bandied about by a broad range of newspapers and other media in Germany. The numbers unemployed, however, have continued to increase over the first few months of the new administration.

The problem for Germany is that not only is it not booming but it may even be slowing down once again, without really having left the last recession behind. Business confidence is low and falling as revealed in the latest IFO indicator, while consumers are still refusing to spend and the global environment continues to deteriorate in parts.

This leaves little chance that the numbers in employment will pick up purely on the back of private job creation.

Of course, government schemes are still contributing jobs. Many of these are concentrated in eastern Germany to prop up failing industries. But they still offer some kind of a way out for the politicians. And it is almost certain that the administration will nearly always choose a rising deficit over rising unemployment - and with some justification.

That means it can continue spending large amounts of money in these areas. But the task is great given that it takes at least two new jobs in Germany to take one person off the live register.

The government has also already used that tried and trusted means of bringing down unemployment - changing statistics to its benefit. From April a fall in the numbers of jobless can be expected as new measures relating to the very low paid kick in.

In France, Prof Jean-Paul Fitoussi of the OFCE thinktank and the prime minister's economic analysis council, has been demanding a radical turn around in policy and a setting aside of the Stability and Growth Pact which governs the public finances of euro zone members.

According to Prof Fitoussi, European governments have generally preferred unemployment to rising deficits, at least under previous administrations.

He is certainly applying pressure for that to change.

This is not what the ECB wants to see. In its first monthly report earlier this week, it repeatedly stressed - some would say to the point of tedium - the need for structural reform to solve unemployment.

The ECB sees no need to reduce interest rates, although immobile rates combined with a strong euro may kill off for good whatever confidence remains in the German manufacturing sector.

The ECB is also at pains to point out that the underlying - or structural - deficit increased in 1998 and that this is at odds with the Stability and Growth Pact signed in Dublin.

Nevertheless, the most likely outcome is that the governments will allow the deficits to reach the 3 per cent limit imposed by the pact and then, if the ECB does not cut rates, blame the bankers in Frankfurt for stubborn unemployment.

But the ECB is sticking to its guns and its president, Mr Wim Duisenberg, insists that the governments must introduce legislative reform to solve the problem.

The final outcome is still far from clear. But the ECB will have a job on its hands not to become the scapegoat for unemployment blackspots across Europe. Such an eventuality could ultimately undermine the whole institution in the eyes of European voters.