The Single European Currency
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
A2 Economics
The Single
European
Currency
Key Issues
• The essentials of Euro Area
membership
• Convergence criteria
• Optimal currency area theory
• Recent macro performance of
the Euro Area
• Single currency membership
and external shocks
• The crisis for some Euro Area
members
1
Basic history of the Euro Project
• 1991: Maastricht Treaty – pathway for Euro
• 1999: Euro starts life as a currencyy
• 1999-2001: Original members of system lock their
currencies for two years
• 2002: Notes and coins come into circulation
• 2007: Slovenia becomes first of the new member
states to enter the currency union
• 2008-09: Three new nations – Slovakia, Cyprus
and Malta – the Euro Area extends to 16 nations
• 2009-10: Major stresses in the Euro as a fiscal
crisis engulfs a number of member nations
The Euro Zone in 2006 – 12 Baffling Pigs
Belgium
Austria
France
Finland
Luxembourg
Italy
Netherlands
Germany
Portugal
Ireland
Greece
Spain
2
The Euro Zone in 2010 – 16 Members
Belgium
Austria Slovenia
France Slovakia
Finland Cyprus
Luxembourg Malta
Italy
Netherlands
Germany
Portugal
Ireland
Greece
Spain
UK, Denmark and Sweden
are all outside of the Euro
Euro Essentials
• Monetary union is a deepening of economic integration
between participating countries
• A single currency requires a common interest rate for
the Euro Zone – i.e. a common monetary policy
• Countries have locked their currencies together forever
and adopted one currency as a medium of exchange
• Euro as a currency floats against US dollar and sterling
e be nations
• Member at o s a
are
eaalso
so required
equ ed ((in p
principle)
c p e) to keep
eep
control of government borrowing i.e. They are not
allowed to run large budget deficits > 3% of their GDP
(in normal times)
3
Britain & the Euro – The Current Position
• Britain is outside of the Euro Zone
• It has
h an ‘opt
‘ t out’
t’ from
f the
th single
i l
currency
The European Central Bank (ECB)
• ECB sets policy interest
rates for the sixteen
participating nations
• ECB objective is price
stability – defined as
CPI inflation of 2% or
below
• Countries joining the
Euro must meet the
convergence criteria
4Convergence Criteria
• Inflation:
– Average inflation over previous year must not exceed
by more than1.5%
than1 5% that of the three lowest inflation
countries
• Government Finances
– Budget deficit must not exceed 3% of GDP
– Gross government debt must not exceed 60% of GDP
• Interest Rates:
A
– Average i ld on govtt b
yield d mustt nott exceed
bonds db
by more
than 2% bond yields of three lowest inflation countries
• Exchange Rate Stability:
– Currency must have adhered to fluctuation margins of
the ERM in two previous years without severe tension
Euro Area and UK Policy Interest Rates
Percent
5A2 Economics
Optimal Currency Areas (OCA)
Is the Euro Zone an
optimal currency area?
Is the Euro an Optimal Currency Zone?
• An optimal currency zone occurs when:
– (1) Countries have achieved real convergence
– (2) They respond in similar ways to external economic
shocks or policy changes
– (3) They have sufficient flexibility in both their product
markets and labour markets to deal with these shocks
• High geographical mobility of labour
• High
g occupational
p mobility
y of labour
• Wage and price flexibility in factor markets
– (4) Countries are prepared to use fiscal transfers to
even out some of the regional economic imbalances
within the European currency union
6Optimal Currency Zones (2)
• The Euro Zone is not an optimal currency zone!
– The core group of EU countries are broadly similar
(Germany + France + Netherlands)
– Peripheral countries have big structural differences e.g.
Ireland, Greece, Portugal and Spain
– Response to interest rate changes varies across
countries
– And there are barriers to the mobility of labour
– The Euro Area is a diverse group of countries and this
k a one-size-fits-all
makes i fit ll monetaryt li h
policy l diffi
hugely difficultlt
– Less of a problem during benign economic conditions of
the late 1990s and first half of the last decade
– But recent economic and financial turmoil has exposed
weaknesses in the currency union
Optimal Currency Zones
Highly Monetary Union
Flexible Works
Labour
Market
Flexibility
High risk
currency union
Inflexible
Divergent Real Economic Convergence Convergent
7A2 Economics
The Case for
Entry into the
Euro
Microeconomic Benefits of Entry
(1) Potential Gains for consumers
– Gains from price transparency
– Reduction in the transactions costs
of travelling within Europe (e.g. costs
of currency exchange)
– Cheaper mortgages if interest rates
are lower
8Microeconomic Benefits of UK Entry
(2) Possible gains for businesses
• Invoicing with just one currency
• Lower transactions costs when
trading
• Stable currency and low inflation
might allow businesses to fund
their capital investment at lower
real interest rates
A2 Economics
The Case for
Staying
y g Outside
9Microeconomic Disadvantages
(1) Changeover Costs from joining the Euro:
– Menu Costs (vending machines, catalogues,
f ki machines,
franking hi postage
t
– Customer confusion (imperfect information)
(2) Higher prices
– Potential loss of consumer welfare if suppliers
increase prices when converting from sterling to euro
((3)) Lost instruments of p
policy
y adjustment
j
– Problems of a one-size fits all policy rate
– Retaining the option of making an exchange rate
adjustment is useful
Recent performance of the Euro Area
10Comparing growth rates – UK & Euro Area
Percent
Germany - the largest country with the
Euro - a driver of policy decisions?
Percent
112000=100
Convergent Economic Cycles?
Low real interest rates stimulated an
unsustainable boom in some countries
12Ireland boomed but over-heated
A similar story in Spain – now
unemployment soars as recession bites
Percent
13One currency – but different inflation rates
1996=100
And diverging unit labour costs – which
affects competitiveness in Euro Area
Index
14Percent
UK and Euro Area Inflation Compared
What about unemployment rates?
Per cent of the labour force
15Percent
Unemployment in Spain and Ireland
Some EU states are not ready to join the
Euro – E.g. interest rates still Poles apart
Percent
16Some countries have pegged their
currency to the Euro
EUR/EEK
EUR/LVL
Fiscal Crisis: A Growing Debt Problem
PERCENT
17The Euro floats against the US Dollar
USD/EUR
And against UK sterling
EUR/GBP
18Challenges facing the Euro Zone
Stresses and challenges facing Euro Area
1. Little common fiscal policy
– Big differences in size of fiscal deficits and debt levels
– Fiscal stability pact has effectively collapsed
– Growing risk of one or more Euro Area countries
defaulting on some of their debts
– Will Euro Area nations bail out fellow members?
– Years of fiscal austerity for some nations will create
deep economic and social pressures
2. Doubts about the likely strength of recovery
– Unemployment high and rising
– Rising cost-push inflation could lead to higher interest
rates and choke off confidence as recovery starts
19Longer-term challenges
• Growth and employment creation in the Euro Area
has not been noticeably higher than in countries
o tside the ccurrency
outside rrenc union
nion
• 2008-10 crisis has highlighted the problems of
setting a common interest rate for 16 nations
• Larger economic imbalances within the 16 nation
currency union over wage levels, trade balances
and
a dpproductivity
oduc y will a
also
so need
eed to addressed
o be add essed if
the Euro Zone is to avoid future crises
• Several weaker countries have become
uncompetitive inside the Euro and this requires
painful corrective policies which will be unpopular
20You can also read
