EMU Klas Fregert Department of Economics Lund University

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EMUKlas FregertDepartment of EconomicsLund
University
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• Theme
• Accommodation of national interests in EU/EMU for
  the common good
• Contents
• What is EMU?
• Gains and losses
• Rules
• Past The road to EMU
• Present The first years
• Future Risk and reforms

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What is EMU?

• Common monetary policy governed by European
  Central Bank in Frankfurt (ECB) from 1 Jan. 1999
• Irrevocably fixed exchange rates between 11, now
  12, countries, The ins
• Common currency from 1 Jan 2002
• Common currency (notes and coins) and unit of
  account, the euro

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Three outs

• Exempted in Maastricht treaty
• Denmark, United Kingdom
• Not qualified
• Sweden (not in ERM) 56 No-vote in fall 2003
• (New members)

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Economic gain (long-run)

• Trade frictions Þ Trade Þ Increased
  specialization Þ higher productivity through
  comparative advantage and large scale production
  Þ GDP per capita Þ Welfare
• Large gain if
• Nation is trade dependent (small)
• EMU helps creating inner market

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Economic loss (short-run)

• No national monetary policy to counteract
  nation-specific (asymmetric) shock
• Small loss if
• 1) Small risk for asymmetric shock
• or 2) easy adjustment to asymmetric shock
• Flexible labor markets, or
• Large scope for international labor mobility, or
• Efficient fiscal policy

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Rules

• 1. Rules for ECB (Maastricht, 1991)
• EU-level monetary policy
• 2. Stability and growth pact, SGP, 1998
• National fiscal policy

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ECB goal

• Intermediate, legal goal Price stability,
  defined as
• Between 0 and 2 per cent inflation
• Wider goal of EMU increased welfare through 1)
  higher long-run growth (efficiency) and 2) more
  macroeconomic stability

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European System of Central Banks ESCB

• National central banks (NCB)
• European central bank (ECB)
• ESCB governed by
• The General Council of the ESCB
• The Governing Council of the ESCB
• The Executive Board of the ECB

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The General Council of the ESCB

• 15 national central bank governors in EU and
  chairman and vice chairman of ECB executive board
• Surveillance of the economy in non-EMU countries
• Prepares the introduction of the euro in the new
  countries

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The Governing Council of the ESCB

• National central bank governors in the 12 EMU
  countries and the members of the executive board
  (6) 18 members.
• Council meets every other week to decide monetary
  policy
• Must work for price stability in the whole euro
  area average inflation weighted by country size

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Voting at ECB Council

• 18 total votes
• Board 6 votes
• Board exclusive right to formulate propositions
  to vote on
• Board votes to stabilize EMU average.
• 63 wins EMU average outcome of voting
• (average wins over median vote)

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Independence of governing board

• Members
• Can not receive directives
• Directors have long (8 year) mandates
• Can not be reelected
• Motivation for independence
• Credibility of low inflation high since
  short-term motivation to increase inflation to
  achieve a) lower unemployment or b) reduce value
  of government debt is minimized
• ECB modeled after Bundesbank

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Control of ECB

• Reports to European Parliament
• Press conferences
• No minutes published

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The stability and growth pact

• Budget deficit lt 3 of GDP
• Government debt lt 60 of GDP
• Exceptions
• budget deficit gt 3 , if serious downturn (real
  GDP growth lt 0,75 )
• Government debt gt 60 , if debt is decreasing.

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Purpose of Stability and growth pact (SGP)

• Avoid spill-over effects
• Rising interest rates
• Risk of financial crisis
• Inflation through ECB buying government debt (
  printing press financing)
• The Bail-out problem The too large to fail
  syndrome

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Sanctions

• Interest-free deposit 0,2 of GDP 10 of the
  deficit that is over 3
• The deposit is transformed to a fine if the
  deficit still is above 3 after three years
• Commission issues recommendations and warnings
  acc. to Excessive Deficit Procedure (EDP)
• Council (ECOFIN) must decide on sanctions
• Commission sued the Council at the European Court
  of Justice for breach of SGP. Guilty verdict June
  2004, but with no repercussions.
• Sanctions effectivley scrapped through revisions
  March 2005. See Council regulation No 1056/2005
  (Orwellian Newspeak acc. to The Economist Mar
  23, 2005).

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The road to EMU

• Rome treaty 1957 The inner market
• 1971 the Werner plan
• 1979 EMS and Ecu
• 1985 Unity act, The inner market
• 1989 The Delors report
• 1991 The Maastricht treaty
• 1996 The stability and growth pact
• 1999 EMU, common monetary policy
• 2002 Euro as cash and unit of account

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Forces

• Interaction between political initiatives and
  legal procedure with binding agreements
• Focus on gains
• Focus on inner market
• EMU a political and economic project
• The German reunification 1989

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The first years

• Plus
• Stable euro
• Stable inflation
• Increased financial integration

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The first years cont.

• Minus
• Relatively large spread of business cycle
  positions and inflation across members
• Debate over ECB goals, procedures and
  accountability
• Breach of SGP
• Low growth
• Too restrictive monetary policy?
• Big external shocks
• Euro not large reserve currency

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The futureMonetary policy risks and reforms

• 1. Enlargement average EMU inflation target
  threatened by many small countries
• reform new voting procedure to lessen influence
  of small countries
• 2. Central lender of last resort national bank
  supervision Þ increased risk for system-wide
  financial crisis
• reform European-level bank supervision
• 3. Degree of short-run stabilization
• reform increased accountability for ECB

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Fiscal policy risks and reforms

• Counteracting asymmetric shocks reforms
• EU fiscal policy transfers
• Labor market reforms
• Increased labor mobility
• Change SGP
• Scrap deficit rule, only debt rule
• redefine deficit as structural (cyclically
  adjusted) deficit to avoid pro-cyclical policy
• spending limits and other national institutional
  safeguards

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Internet resources

• ECB www.ecb.int
• EU Commisssion europa.eu.int/euro/
• Corsetti Europage
• www.iue.it/RSCAS/Research/Eurohomepage/

References

• Paul De Grauwe Economics of Monetary Union.
  Oxford University Press, 2003
• EMU after 5 years. 2004. European Commission,
  Directorate-General for Economic and Financial
  affairs
• http//europa.eu.int/comm/economy_finance/publicat
  ions/european_economy/eespecialreport0401_en.htm
• The European Central bank History, Role and
  Functions, www.ecb.int