Sebastian Dullien gives a novel explanation for unemployment and inflation in the Euro-Zone. He argues that unemployment stems from a lack of cooperation between unions and monetary authorities. In an economy with endogenous money and monopolistic competition in good markets, the standard economic textbooks' distribution of macroeconomic responsibilities are turned upside down - wage setters are now responsible for price stability, while the European Central Bank is responsible for level of output.
Only unions with a small and limited constituency can increase employment by simple wage restraint. However, this is shown to be a beggar-thy-neighbour policy, destroying employment elsewhere. On a European level, only when unions and the central bank cooperate can high employment and low inflation be achieved simultaneously. The institutional set-up with the 1999 Cologne process is found to be unable to assure such a cooperation.

Introduction: The Unsolved Unemployment-Inflation Puzzle
Development of Literature on Interaction of Monetary Policy and Wage Bargaining
European Empirics
Problem with Standard Approaches: Criticising the Real Balance Effect
Monetary Policy Transmission in a World of Endogenous Money
Output and Prices in a World Without the Real Balance Effect
The Central Bank: Restrictions in a World of Endogenous Money
Optimal Policy Mix and Logic of a Social Pact
Conclusion

SEBASTIAN DULLIEN is Economics Correspondent at the Financial Times Deutschland, the German language edition of the FT. Previously he worked as a short term expert for the Deutsches Institut für Wirtschaftsforschung. He also teaches at the Freie Universität in Berlin.