Question

Currently the Eurozone countries differ quite significantly in terms of their unemployment rates (according to the most recent Eurostat data the highest unemployment rates in early 2017 were observed in Greece 23.5% and Spain 18.0%, while the lowest ones – in Malta – 4.1% and Germany - 3.9%). What are your suggestions for the Eurozone countries to address this situation from the macroeconomic policy perspective? What specific policies would you propose to use – fiscal, monetary, etc.?

Answer 1

Introduction

Eurozone countries have significanly been suffering a crisis in the employment numbers recently. The main contributing factor to this is that post recovery since the Great Recession has been far slower in the eurozone countries primarily due to the fact, that the ammount of debt that some countries have taken have been significantly very high. Notably Greece is one such country which has also seen the impact in the form of budget cuts.

Unemployment also more than often, hits the general working class with the quality of jobs that are available in the market space, and the revenue in terms of the salaries that are generated by the households also tends to decline at a rapid pace. This has further led to a vicious circle in which the demand, by house holds has declined as there spending capacity is significantly lower causing thus a direct implication on the supplies and producers profits getting marginalised.

The effects of unemployment cannot alone be solved by the markets, and therefore timely, govermnets across countries formulate strategies from time to time to allow countries to come out of the zone where unemployment causes a cycle and further recession takes place in an economy. This can widely be done by making and formulating fiscal and monetary polcies to adress the situtation. Also, there could be a wide variety of labor laws like the example of Germany which has tackled this problem with an explicit policy of pushing employers toward shortening work hours rather than laying-off workers.

Lets understand the meaning of fiscal and monetary policies before we decide which ones are appropriate to tackle the situation of unemployment.

1) Fiscal Policies to be followed:-

Fiscal policy is the use of government spending and tax policy to alter the economy. The best policy to be suggested for improving the unemployment rates would be that of Expansionary Monetary Policy.

Expansionary Monetary Policy:-

Expansionary Monetary policy, aims at solving the issue by increasing the supply of money available to sectors or the economy as a whole. This can be done by reducing the tax rates or/and increasing government spending in areas which need help. Further, payroll taxes can also be made less stricter to allow people with higher net salaries thereby, helping them with higher ammounts of money to buy things, and thereby generating demand. Also investments in this way get increased as the ammount of taxes after profit become lesser of a burdern for them.

Expanisionary policies have a direct impact on aggregate demand and supply and helps in increasing them thereby creating an environment wherein employment opportunites can further grow.

The figure bellow indicates shift in aggregate demand as a result of expansionary fiscal policy:-

Monetary Policies to be followed:-

Monetary policy is the process by which the monetary authority of a country, typically the central bank ( Federal Reserve System in USA) or currency board, controls the supply of money, by targetting the interest rates to ensure price stability and helps in tackling times of inflation/deflation in the economy.

The key monetary measures to be followed to allow unemployment to be reduced are as explained.:-

Quantitative Instruments of Monetary Policy:-

Quantitative instruments include two policy rates and two policy ratios besides the policy of open market operations. Details are as under:-

Bank rate and Repo rate:-

This is the rate at which banks can borrow money from the central bank of the country. In case of unemployment these rates can be decreased, this increases demand for credit from the commercial banks by the investors and the household. Further, leading to a rise in investment expenditure and consumption expenditiure implying a rise in aggregate demand. Accordingly, unemployment and deflation can be corrected by decreasing these rates.

Two Policy Ratios:-

A) Cash Reserve Ratio:-

This refers tho the propotion of total deposits of the commercial banks which they must keep as cash reserves with the Central Bank. We know, that Credit Multiplier = 1/Cash Reserve Ratio. To tackle the situation of low/unemployment it is recommended to reduce the Cash Reserve ratio this causes a multiple times increase in credit creation capacity of the commercial banks..

B) Statuary Liquidity Ratio:-

This refers to the liquid assets of the commercial banks which they must maintain ( on daily and/or quarterly basis) as a minimum percentage of the total deposits. These include but are not limited to 1) Cash 2) Gold and unecumbered approved securities. To enhance lending and thereby production and demand, it is recomended to reduce these rates to ensure higher lending capacity thus increasing lending capacity of the banks.

Qualitative Measures:-

Qualitative measures that the Federal Banks can follow include adjusting the margin requirements ie altering the ammount of colateral security that must be kept in banks by lenders. Rediucing this can also help in increasing the lending rates thereby reducing unemployment.

Some other tactics include rationing of credit to sectors that employ higher number of people and allowing them higher loans at lesser interest rates thereby helping generate employment.