Transcript Lecture Eight

ECONOMIC AND
MONETARY UNION (EMU)
Rationale for EMU
• Advances European integration
– Market integration – finishes the SEM?
– political integration - a key symbol of such
integration?
• Builds on EMS
• German unification - lessons
• Strengthens position of EU in global
economy
What is EMU?
• Achieved when:
– Bilateral exchange rates are permanently
fixed or a common currency (EU – the latter)
– Free movement of capital
EMU’s technocratic
requirements:
• Single Central Bank
• Common monetary policy – i.e. one
central rate and common exchange policy
• Some pooling of foreign reserves
• Common policies to remove obstacles to
factor mobility (i.e. to a single market)
• Some common ground - macroeconomics
Broader EMU requirements
• Possible interstate transfers to offset
negative aspects of EMU?
• Political and economic commitment
• Some limits to/pooling of sovereignty
• Domestic reform
Optimal currency areas
require:
1. An absence of asymmetric shocks
2. A high degree of labour mobility and
wage flexibility
3. Centralised fiscal policy to aid
redistribution
Key question: is the EU an OCA?
Road to EMU
• Not new – e.g. Rome, Napoleon, etc
I want the whole of Europe to have one
currency; it will make trading much easier
Napoleon in a letter to his brother, Louis, 1807
Emergence of modern
EMU
•
•
•
•
Werner Report – proposes EMU by 1980
1979 European Monetary System - ERM, ECU
1989 Delors Report – 3 stage approach to EMU
1993 Maastricht Treaty – EMU framework and
timetable
• 1992-3 ERM crises
• 1.1.99 - fixing of exchange rates
• 1.1.02 – notes and coins in circulation
Convergence criteria (EMU
entry requirements)
• Convergence criteria remain important
– Operation of EMU - Stability and Growth Pact
– For countries hoping to join EMU
• Fiscal criteria
– National budget deficit less than 3% GDP
– National debt less than 60% of GDP – or
heading in the right direction
Convergence criteria
• Monetary criteria
– Inflation no more than 1.5 percentage points
above the average of the 3 countries with the
lowest rates
– Long term interest rates no more than 2
percentage points above the average of the 3
countries with the lowest rates
– Exchange rate – within normal band of ERM
for previous 2 years
“Euroland” in 2006
• 12 member states form the Euro-zone – all
pre-2004 member states
• UK and Denmark ‘opt-out’
– Danish referendum: February 2000 – 53% against
– Sweden remains out: September 2003 ‘no’ vote
• May 2004 – enlargement
– All 2004 accession states new members
committed to membership – timing the issue
– First likely - 2007.
European Central Bank
• Independent and supranational
• Primary objective is price stability
• Responsibility for monetary policy – i.e.
interest and exchange rate policy.
• Fiscal policy – remains national – but
Growth and Stability Pact to stop member
states undermining ECB
Economic benefits of EMU
• Removes exchange rate uncertainty on intraEMU trade
• Avoids competitive devaluations
• Eliminates transaction costs
• Increases price transparency
• Low and stable inflation and interest rates
• Promotes international specialisation and
improves EU competitiveness
• Boosts the EU’s international economic profile
Economic risks of EMU
•
•
•
•
Short term deflation
Can ‘one monetary policy fit all’?
Loss of economic sovereignty?
Asymmetric shocks? – especially if
SEM and EMU lead to specialisation.
• Lack of real economic convergence
• Burden of adjustment on wages and
prices - flexible enough?
EMU and the Business Environment
• More predictable trade and investment
environment
• Initial transition costs
• Harder for SMEs to adjust?
• Intensified competition
– greater cost and price transparency
– some price convergence?
• Clusters
• Impact on external economic environment
EMU: The early years
€/S rate: Jan 1999 - July
2006
1.4
1.3
1.2
1.1
1
0.9
0.8
Source: European Central Bank
M
S
Ja
n06
M
S
Ja
n05
M
S
Ja
n04
M
S
Ja
n03
M
S
Ja
n02
M
S
Ja
n01
M
S
Ja
n00
M
Ja
n99
0.7
Stability and Growth Pact
• Fiscal convergence criteria continue after 1.1.02
• Why?
– Germany keen
– Avoid free riders
– Impact of budget indiscipline spreads in EMU →
higher interest rates all round
• Excessive deficit - Sanctions?
– 4 months to correct
– No correction - non-interest bearing deposit with
Commission up to 0.5% GDP becomes a fine after 2
years.
• But tight budget constraints unsustainable in
economic downturn?
→ Commission President Prodi describe SGP as
‘stupid’
• Portugal, France, Germany broke SGP rules
• By 2004, France and Germany on 3rd year
– November 2003 effective suspension of SGP with
agreement of members (except Sp, Nl, Aust and
Belgium)
– Commission takes Finance Ministers to European
Court of Justice and wins case in July 2004
• In reality, difficult to impose SGP if member
states do not agree to comply
Impact of SGP problems
• Large-small country divide
– Austria and Netherlands furious as they have
striven to comply
• Undermines credibility of system
• Implications for absorption of new
members
March 2005 – SGP
reforms
• 3% budget deficit/60% debt thresholds
remain
• ‘relevant factors’ to enable member states
to avoid ‘excessive deficit’ procedures
– e.g. economic cycle, structural reform,
research and development, public investment,
etc
• Countries have longer to correct
‘excessive deficit’ – 2 years. Can be
extended further.
SGP reform
• Has increased flexibility – has it gone too
far?
• Lack of clarity re ‘relevant factors’
• Weakens pact via exceptions
• Short term – reduces political rows but
how workable in long term?
Other problems for
eurozone
• Flexibility – member states need new
ways to adjust to economic imbalances especially labour markets
• Reform proving elusive in ‘Big 3’ – France,
Germany and Italy
• National economic reform essential for
long term health of Eurozone
EMU and EU non-members
1. The old ‘outsiders’
Support for the single currency, 1998-2004
%
80
70
60
50
40
30
20
10
0
Aut
98
Spr
99
Aut
99
Spr
00
Aut
00
Eurozone
Source: Eurobarometer
Spr
01
Aut
01
Denmark
Spr
02
Aut
02
Spr
03
Sweden
Aut
03
UK
Spr
04
Aut
04
€/£ rate: Jan 1999-July 2006
0.75
0.7
£
0.65
0.6
0.55
Source: European Central Bank
J
A
Jan-06
O
J
A
Jan-05
O
J
A
Jan-04
O
J
A
Jan-03
O
J
A
Jan-02
O
J
A
Jan-01
O
J
A
Jan-00
O
J
A
Jan-99
0.5
UK - not on the agenda in short
or medium term
• Political parties
– Labour in favour ‘in principle’ but some dissenters
– Conservatives – mostly Eurosceptic – some pro
– Liberal Democrats – the most ‘pro’
• Businesses – divided
– Foreign investors – more pro
– Big companies – more pro than anti
– Small companies – more anti than pro
• Public opinion
– Heavily anti – how deeply held?
Europhile and Eurosceptic views
• Pooling of sovereignty
– gains influence
• Left behind in EU
• Economic gains
• Commitment to
integration
• Loss of sovereignty
• Managing OK outside
• One policy fits all
flawed
• Misconceived and too
risky
• Identity concerns
Five economic tests
• UK government has own entry tests
– Sustainable convergence between UK & EU
– Enough flexibility to absorb economic change
– Effect on investment in UK
– Impact on financial services
– Impact on employment
• June 2003 – Chancellor Brown says
progress made – but only one test passed.
• Impact on City – no evidence that nonmembership causes problems
• FDI shift
– UK main destination for EU FDI inflows for
many years
– 2002: several EU countries attract more
inward FDI than UK. € effect?
– 2004: UK and Ireland recover – other
factors at play?
Inward FDI, US $ mn
140000
120000
100000
80000
60000
40000
20000
0
-20000
1992-7
(avge)
1998
1999
2000
2001
2002
2003
2004
-40000
-60000
UK
France
Germany
Source: World Investment Report, UNCTAD
Netherlands
Spain
Ireland
Sweden and Denmark
• Referenda defeat pushed membership
back
• Some more positive attitudes to
membership emerging but:
– Politicians wary of further defeats
– Difficult to justify given consistently better
performance of outsider economies in recent
years
Economic performance – inside and
outside the eurozone
GDP growth
GDP per head, 2005 (EU15 =100)
5
%
4
3
2
1
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Eurozone
UK
Sweden
Denmark
Finland
Portuga
Austria
Netherl
Italy
Ireland
France
Spain
Greece
Germ an
Belgium
Eurozon
Sw eden
Denm ar
UK
0
50
100
Inflation (% ) - annual average rate 2004/12
Unemployment (% )
3.5
3
2.5
2
1.5
1
0.5
0
15
10
5
0
1995
Denmark
Sweden
2000
UK
Eurozone
2005
Germany
France
Italy
e ny
k
e
n
in
ly
UK de mar zon
a
nc Ita pa
e
m Fra
o
S
n
r
r
w
e
S
De Eu
G
150
EMU and EU non-members
1. The new ‘outsiders’
The 2004 accession states
• Commitment to adopt euro – condition of EU
membership
• Many said as soon as possible
– 1st wave – smaller countries – 2007-09?
– 2nd wave – larger countries – 2010 plus?
• Have to comply with convergence criteria –
varies across countries
– 2004: Estonia, Lithuania, Slovenia → ERM 2
– 2005: Cyprus, Latvia, Malta, Slovakia → ERM 2
• 1.1.2007 – Slovenia to enter eurozone
(Lithuania turned back because of inflation)
• Membership – technical and political
• Convergence criteria – vary over time
– 2004 – inflation deterioration – temporary as
adjust indirect taxes on accession
• Clash between stability and growth
initiatives?
• Bigger countries – target entry dates
receding, especially Hungary
Convergence criteria - 2003
Inflation
(%)
Budget
Debt/GDP Interest
deficit/GDP
(%)
Cyprus
4.3
-5.2
60.3
4.6
Czech
0.0
-8.0
30.7
4.1
Estonia
1.6
0.0
5.4
6.4
Hungary
4.6
-5.4
57.9
6.5
Latvia
2.5
-2.7
16.7
5.1
Lithuania
-0.9
-2.6
23.3
5.1
Malta
1.3
-7.6
66.4
5.8
Poland
0.7
-4.3
45.1
5.9
Slovakia
8.5
-5.1
45.1
4.9
Slovenia
5.9
-2.2
27.4
5.5
Convergence criteria - 2004
Inflation
(%)
Budget
Debt/GDP Interest
deficit/GDP
(%)
Cyprus
2.4
-5.2
72.6
5.8
Czech
2.8
-4.8
37.8
5.0
Estonia
3.4
0.5
4.8
4.5
Hungary
6.9
-5.5
59.7
8.4
Latvia
6.8
-2.0
14.6
5.0
Lithuania
1.2
-2.6
21.1
4.6
Malta
3.7
-5.1
72.4
4.7
Poland
3.5
-5.6
47.7
7.2
Slovakia
7.7
-3.9
44.2
5.1
Slovenia
3.9
-2.3
30.9
4.8
Convergence criteria - 2005
Inflation
(%)
Budget
deficit/GDP
Debt/GDP
Interest (%)
Cyprus
2.0
-2.4
70.3 X
5.16
Czech
1.6
-2.6
30.5
3.51
Estonia
4.1x
1.6
4.8
3.98
Hungary
3.5X
-6.1 X
58.4
6.60X
Latvia
6.9X
0.2
11.9
3.88
Lithuania
2.7X
-0.5
18.7
3.70
Malta
2.5
-3.3
74.7X
4.56
Poland
2.2
-2.5
42.5
5.22
Slovakia
2.8X
-2.9
34.5
3.52
Slovenia
2.5
-1.8
29.1
3.18
Source: national governments and Eurostat:
X = above threshold value
Poland - example
• Legally compliant
• Technical issues:
– ERM II – Polish concerned about speculative
attacks/volatility of zloty
– Public expenditure – budget deficit in 2004
over 5.0% but technical adjustment in 2005
brought it within threshold
Public opinion in 2004 accession states
• Generally pro-EU (honeymoon period) but
declining
• Political elites in favour – little public
discussion of euro issue
• EU – more about jobs/ending poverty etc
Support for single currency - 2003.4
For
against
DK/NA
lk
S
lv
Tk
y
S
om
R
ol
P
M
al
C
C
20 -13
04
-1
0
B
ul
g
C
yp
C
z
E
st
H
un
g
La
t
Li
th
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
EU Priorities in new members and candidates
Institutional reform
Importance of EU
Euro
Illegal immigration
Closer to citizens
Successful
Guaranteeing rights
Consumer
Food quality
Environment
Organised crime
Peace and security
Terrorism
Fighting poverty
Unemployment
0
20
40
60
%
80
100
Final comments and questions
•
•
•
•
•
•
•
•
Strong commitment to EMU of its members
Economic benefits/costs - too early to assess.
Political motivation
Modification of Stability and Growth pact?
Expanding the remit of the ECB?
Does true EMU require fiscal federalism?
Need for increased labour market flexibility
Challenge of Enlargement