Transcript FEATURES OF ECONOMIC UNION

FEATURES OF ECONOMIC UNION
• Single market for persons, goods, services and capital
• High level of co-ordination of economic policy
- esp. central control of fiscal policy
• Greater role for competition policies
• Structural Funds
- transfer of funds to weaker countries
FEATURES OF MONETARY UNION
• Total and irreversible convertibility of currencies
• Complete liberalisation of capital movements
• Full integration of banking and other financial markets
• Elimination of margins of fluctuation and irrevocable
locking of exchange rates (implying a single currency)
MAASTRICHT CRITERIA
• Level of inflation to be within 1.5% of 3 lowest member countries
• Level of long term interest rates to be within 2% of 3 lowest inflation
countries
• Budget deficit to be less than 3% of GDP
• National debt to be less than 60% of GDP
• Any country proposing to join to have been member of ERM for two
years prior to entry
ADVANTAGES OF EMU
•
Symbolic of overall union
•
Would reduce transaction costs for business
•
Would eliminate uncertainty due to exchange rate adjustments facilitating
trade
•
Individual countries do not have to hold reserves as all are pooled
•
Would encourage more co-ordination of economic policies
•
Beneficial effects on efficiency
•
Currency would become international reserve asset
•
Help to reduce interest rates
•
Help to reduce inflation
•
Could facilitate overall growth and employment in Community
POSSIBLE DISADVANTAGES
• Considerable loss in national sovereignty
• Effects might not be equally spread throughout
Community
• Possible difficulties in dealing with crisis situations
• No guarantees in relation to stability of currency in relation
to other world currencies
• Special problems for Ireland (in relation to UK and US
currencies)
PROGRESS TO EMU
Stage 1 (1990-1994)
• Completion of Internal Market
• Provision of structural funds
• Enforcement of Competition Policy
• Participation of all countries in ERM
• Stabilisation of exchange rate movements
Exchange Rate Crisis (1992-1993)
PROGRESS TO EMU (con)
Stage 2 (1994 - 1997)
• Continuation of market liberalisation
• New round of funding
• More economic convergence
• Starting procedures for new Central Bank
• Further narrowing of currency bands
PROGRESS TO EMU (con)
Stage 3
• Beginning Jan. 1999
• Introduction of Euro
• ESCB and ECB now in operation
• Monetary Committee to be dissolved
EMI
Interim arrangement (1994 – 1998) managed by council
consisting of a President and Governors of Central Banks
located in Frankfurt
Three Tasks
• To facilitate convergence by strengthening co-ordination of
monetary policies
• Responsible for overseeing operation of ERM: EMCF to
be dissolved
• Required to prepare all the procedures and methods of
control necessary when final stage was to arrive
ESCB
• Assigned the task of defining and implementing monetary
policy of community
• Foreign exchange reserves of member states to be
centralised with ESCB
• Collaborative structure of NCB's and ECB
• Subject to review by European Court of Justice
• ECB has exclusive right to issue notes, engage in open
market operations, impose minimum reserve requirements,
carry out foreign exchange operations etc.
• Primary objective is price stability
EUROPEAN CENTRAL BANK (ECB)
• Decision-making body of Euro-zone
• Design of ECB
• Maastricht Treaty and EMI (founded 1994)
• ECB (founded 1998)
• European System of Central Banks
• Executive Board and Governing Council of ECB
EUROPEAN CENTRAL BANK (Con)
• Responsibilities of ECB
• to maintain price stability
• to support "the general economic policies of the
Community"
• independent of national governments and Central Banks
• may not lend to any Community institution or government
• will be concerned with one overriding objective of price
stability
MONETARY POLICY IN EMU
• Control of inflation targeting
• Control of money supply
• Government Borrowing
- Central Bank
- Commercial Banks
- Abroad
- Non-bank public
FISCAL POLICY IN EMU
• Stability Pact
- governments not to incur deficit over 3% GDP
- over medium-term budgets to be close to
balanced or in surplus
- fines for deficits in excess of 3% but for
exceptional cases
• Could be major problems in the case of a sudden
shock such as a recession
MACROECONOMIC POLICY COORDINATION
• Since 1998 the ECB has managed to keep inflation to about 2% p.a.
- however actual inflation has varied considerably between member
states with inflation much higher in Ireland, Greece and the
Netherlands and lower in Germany
- variations in economic performance much greater with sharp
slowdown eveident in Germany, France and Italy and boom
conditions In Ireland, Greece and Spain
- fears that in future ECB policy could be geared more to the interest
of stronger economies such as Germany and France with inflation
more difficult to control
- fears that because fiscal policy can be be more effectively used in
a common monetary zone that it could thereby be used irresponsibly
by some governments
FISCAL POLICY AND CROWDING OUT EFFECTS
• One of the limitations on conventional fiscal policy is that attempts to
increase government spending in an attempt to stimulate economic
activity can lead to increase in interest rate(due to increased demand by
Government for money to fund expansion)
• The consequent rise in interest rate can then depress private sector
borrowing and spending
• Thus the crowding out effect is the reduction in private sector spending
that counterbalances increased government spending
• Crowding out (and crowding in) effects - when significant can
considerably reduce effectiveness of fiscal policy
• However in a common monetray zone because interest rate increases
are likely to be greatly restricted fiscal policy potentially can be much
more effective in each member country
GROWTH AND STABILITY PACT
• Set up in 1996 with a decision to
- limit budget deficits of Eurozone members to no more than 3% GDP
in a given year
- public debt/GDP ratio not to exceed 60%
- larger deficits temporarily allowed to combat severe recessions
- complicated system of penalties to be imposed on countries who
break terms of agreements
- problems in major economies of France and Germany - where recent
budget recent deficits exceeeded 3% led to temporary abandonment
of rules
EXCHANGE RATE POLICY IN EMU
• Euro and ECU
- responsibility for exchange rate policy
- provision for formal agreements linking Euro to other
currencies
In the final stage Monetary Committee to be dissolved and
replaced by an Economic and Financial Committee
• The Euro as a Global Currency
- importance for trade
- importance for reserves
EMU AND IRELAND
• Other Options
- setting an effective exchange rate target
- return to sterling link
- free floating
• Political Benefits to Ireland
- decision making
- economic support
EMU AND IRELAND (Con)
• Economic Benefits
- completing internal market
- price transparency
- reduced transactions costs
- reduction in exchange rate uncertainty
- scale economies
• Economic Costs
- transition costs
- difficulty in adjusting to shocks
- loss of fiscal autonomy
- loss of economic independence
- loss of unemployment/inflation trade-off