Which countries were European Union members as of 2003?

1
Which countries were European Union members as of
2003?

• France
• Belgium
• Netherlands
• Luxembourg
• Italy
• Spain
• Portugal
• Greece
• United Kingdom
• Ireland

• Denmark
• Sweden
• Norway
• Finland
• Germany
• Switzerland
• Austria
• Cyprus
• Turkey

2
Which countries became EU members in 2004?

• Turkey
• Cyprus
• Malta
• Hungary
• Poland
• Czech Republic
• Slovakia
• Romania

• Latvia
• Estonia
• Lithuania
• Bulgaria
• Slovenia

3
Forms of Economic Integration

• free trade area - free movement of goods and
  services between member countries
• Example NAFTA
• customs union free trade area common external
  trade barriers
• Example Mercosur (Brazil, Argentina, Paraguay,
  Uruguay)
• common market customs union free movement of
  labor and capital
• Example European Union after Single Market
  Program
• economic union common market common currency
  ( common monetary policy and coordinated
  fiscal policies)
• Example European Union after Maastricht Treaty

4
Forms of Economic Integration

• free trade area - free movement of goods and
  services between member countries
• Example NAFTA
• customs union free trade area common external
  trade barriers
• Example Mercosur (Brazil, Argentina, Paraguay,
  Uruguay)
• common market customs union free movement of
  labor and capital
• Example European Union after Single Market
  Program
• economic union common market common currency
  ( common monetary policy and coordinated
  fiscal policies)
• Example European Union after Maastricht Treaty

5
Chronology of European Integration

• 2 problems after WWII
• Economic reconstruction
• History of German-French hostility
• Technical cooperation European Coal Steel
  Community (1951)
• Free trade area Treaties of Rome (1957)
• Customs Union (1967)

6
Legacy of segmented markets (pre-Single Market
Program)

• Markets segmented by protection - technical,
  physical and fiscal barriers - leading to
• Pattern of national champions
• Lack of economies of scale (high unit costs)
• Overcapacity, overstaffing
• Low incentive to innovate, invest
• Unresponsive to customers market changes
• Not globally competitive, so seek protection
• A vicious cycle...
• that can be broken by
• the dynamic benefits of economic integration

7
Common market the Single Market Program

• Eurosclerosis of early 1980s
• Lack of global competitiveness
• Lack of progress towards higher level of
  integration
• Euro-standards mentality
• 1987 Single European Act
• Mutual recognition
• 1992 target date
• Philosophy dynamic benefits
• Economies of scale
• More competition?cut costs, innovate,
• respond to market

Result increased global competitiveness
8
Broadening of membership

• Original Six France, Germany, Italy, Belgium,
  Netherlands, Luxembourg
• 1973 - U.K., Ireland, Denmark
• 1981 - Greece
• 1986 - Spain, Portugal
• 1995 - Austria, Sweden, Finland
• 2004 10 new members from Eastern Europe and the
  Mediterranean

Note geographic alternation between richer
(northern) and poorer (southern, eastern)
countries
9
Rationale for a single currency in Europe

• Logical extension of the 1992 Single Market
  Program
• Exchange rate fluctuations as barriers to a
  single market
• Growing percentages of intra-Community trade
• Further increase global competitiveness by
  reducing costs faced by European firms

10
Background post-WWII European exchange rate
arrangements

• Bretton Woods gold-dollar fixed exchange rate
  system
• Werner Report (1970)
• Breakdown of Bretton Woods System
• Snake (1974)
• snake in the tunnel
• snake in the lake

11
EMS - European Monetary System (1979)

• Fixed exchange rate system
• Components of EMS
• European Currency Unit (ECU)
• Exchange Rate Mechanism (ERM)
• Intervention funds
• EMS track record
• Realignments (devaluations and revaluations)
• Macroeconomic convergence

12
Rationale for a single currency (contd)

• Apparent success of EMS stable exchange rates,
  converging economic performance
• Fixed exchange rates w/o capital controls are
  vulnerable to speculation
• Public enthusiasm for Single Market
• Politics - bind unified Germany to western Europe

13
Maastricht plan for EMU (Economic and Monetary
Union)

• 1991 Maastricht Treaty criteria
• Government deficit ??3 of GDP
• Government debt ??60 of GDP
• Inflation ??3 per year
• Convergence of long term interest rates
• Everyone in ERM, no realignments for 2 years
• Original timetable for single currency
• All countries meeting the criteria join in 1997
• All other countries join in 1999

14
Exchange rate crises

• September, 1992 crisis
• Precipitating factors French referendum on
  Maastricht, high German interest rates
• Outcome UK, Italy left ERM
• July-August, 1993 crisis
• Precipitating factors European recession, high
  German interest rates
• Outcome bands of fluctuation widened from
  ?2.25 to ?15
• Lesson EMS vulnerable w/o capital controls

15
Revised timetable for EMU

• 1992, 1993 currency crises pushed back timetable
• 1998 conference to determine which countries
  qualified, set conversion rates
• Creation of European Central Bank (ECB)
• Choice of head of ECB Wim Duisenberg
• France preferred Jean-Claude Trichet
• January 1, 1999 - start of EMU C
• Exchange rates with euro irrevocably fixed
• Euro is introduced and co-exists with legacy
  currencies
• Jan. 1, 2002 - euro notes and coins circulate
• Early 2002 - national currencies disappear

16
Euro-zone whos in, whos out

• Countries that are in
• Austria
• Belgium
• Finland
• France
• Germany
• Greece
• Ireland
• Italy
• Luxembourg
• Netherlands
• Portugal
• Spain

• Countries that are out
• Denmark
• Sweden
• U.K.

Rejected euro in 2000 referendum polls show
support but no new referendum yet
Referendum in September 2003 Nos won
Joined 1/1/01
5 tests show UK not ready future referendum in
doubt
17
Technically, the launch of the euro was a great
success

• European Central Bank
• Contracts
• Stock and bond markets
• Public acceptance

18
But the euro lost a lot of value in the first 2 ½
years
19
Explanations for the euros fall

• Rates of return in US vs. euro-zone
• Interest rates
• Stock markets
• Rates of economic growth and productivity
• Central bank credibility

20
Then the euro reversed direction
Sep 2004
21
Explanations for the rise in the euro

• Rates of return in US vs. euro-zone
• Interest rates
• Stock markets
• Rates of economic growth and productivity
• Central bank credibility

22
Source Datastream
23
Monetary policy Euro-zone and US compared

• Who makes monetary policy decisions?
• How are these decisions communicated?
• What is the central banks mandate?
• How are monetary and fiscal policy coordinated?

24
ECBs policy challenges

• Balancing European and national economic needs
• Divergent economic performance
• Have seen higher inflation in peripheral
  countries like Ireland and Spain since euro
  launch
• Growth has been slow in core countries like
  Germany
• Critics over-emphasis on fighting inflation
  neglects economic growth effects of monetary
  policy
• Consensus decision-making
• Critics decisions are made too slowly
• ECB we dont fine-tune as much as US we realize
  policy takes a long time to have an effect

25
ECBs policy challenges (2)

• Communicating monetary policy getting the
  code right
• Credibility
• Consistency
• Transparency
• Critics too secretive, should publish minutes
• ECB we do not want policy to be interpreted as
  politically motivated

26
ECBs policy challenges (3)

• ECB Succession Jean-Claude Trichet took over
  November 1, 2003
• Cleared in Credit Lyonnais scandal
• Will Trichet make a difference?
• Trichet a more forceful personality
• May be better communicator
• Duisenberg too blunt, Trichet chooses his
  words more carefully
• Analysts disagree about whether Trichet will
  alter strategy of 2 inflation target
• He was tough on inflation at Banque de France
• Well-connected with central bankers who believe
  best practice is to support economic growth
  fight inflation

27
Fiscal policy in the euro-zone

• Fiscal policy governed by Stability Pact
• Fiscal policy coordination necessary in order to
  have a single monetary policy
• Pact budget deficits cannot exceed 3 of GDP
• Punishment for violations public reprimand,
  fines (of up to 0.5 of GDP)
• Exceptions in cases of recession
• Germany was biggest supporter of pact

28
Stability Pact in practice

• Expected that smaller, weak currency countries
  would have most trouble with the stability pact
• But its France and Germany whose budget deficits
  have been too big the last few years
• France has resisted deficit reduction, citing
  slow growth
• Undermines credibility of Stability Pact
• Looks like big countries are treated differently
• When Portugal breached limit in 2001, it was
  forced to reduce its deficit

29
Stability Pact in practice (2)

• European Commission and ECB urged Stability Pact
  compliance for France Germany
• Nov 2003 finance ministers agreed France
  Germany could cut less than Commission wanted
• Gave France, Germany until 2005 to meet 3 limit
• Effectively suspended Stability Pact
• Ministers were split Spain, Austria, Finland,
  Netherlands opposed agreement

30
Stability Pact in practice (3)

• Commission challenged ministers agreement in
  court
• In July 2004 European Court of Justice ruled
• Council of Ministers may not suspend the Pact
• However, Council may reject Commissions
  recommendations and interpret the Pact its own
  way
• 6 countries likely to go over deficit limit in
  2004
• Germany says its likely to breach limit in 2005,
  too (4th consecutive year)
• Looks like Pact will be revised Commission has
  proposed some ideas (see below)

31
Revising the Stability Pact

• General principle
• Cannot reduce fiscal policy to a single variable
  (budget deficit) and a single number (3)
• Ideas proposed by Commission in Sept. 2004
• Relate rules to business cycle can run bigger
  deficits in recession but must run surpluses
  during expansion
• Look at medium/long term debt sustainability
• Relate to economic growth, future pension
  liabilities, etc.
• Rely more on consultation, peer pressure than
  rules
• Differences of opinion
• Germany opposes weakening pact, sees fiscal
  prudence as necessary to avoid inflation
• ECB opposes changing pact