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EMU, the Euro, and theCurrent Economic Situation

in the Euro Area

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What are we going to cover?

The Euro: how did we get there?

What is EMU?

What are the costs and benefits of having a singlecurrency? Benefits of EU versus euro membership?

How is economic policymade in a monetary union? What is the current economic situationin the Euro

Area?

How should Europe deal with the current economic

and financial crisis? And what does the crisis meanfor EMU?

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A Brief History of European Economic Integration

The original goal behind the integration of Europe was to

prevent the devastating wars of the first half of thetwentieth century from ever happening again

Dresden, Germany, 1945.

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A Brief History of European Economic Integration

Political end by (mainly) economic

means European Coal and Steel Community 1951;

European Economic Community 1957 (Treaty ofRome)

Customs Union (1968): Free trade area +common external tariff

Single (or Internal) Market (launched 1986,completed in1992): breakdown of all tariff andnon-tariff barriers to trade and business

Single currency (approved1993 MaastrichtTreaty, euro launched 1999, notes and coins2002): eliminated exchange rate transactioncosts and risk

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A Brief History of European Economic Integration

The euro was already envisaged as a goal

back at the start of European integration in1950sIt was always seen as the next logical stepafter the single market The idea gained academic attention through

the work of economist like Robert Mundell(Optimal Currency Areas) Break-up of the gold standard in the 1970sled to creation of the forerunners of the euro,European Monetary System (EMS) and

Exchange Rate Mechanism (ERM) German reunification (1990) and currencycrisis of 1992 as catalysts for push toward theeuro leading to Maastricht Treaty in 1992/93?

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What is EMU?

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What does EMU stand for?

Does EMU stand for:

European Monetary Union?

Or:

Economic and Monetary Union?

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EMU vs. the euro area

EMU is a Treatyobjective shared by all27 EU Member States

The euro is a realityfor 16 Member States(the euro area)

What about the E inEMU?

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What are the three parts of EMU?

1) The euro countries give up their owncurrency when they join the euro area. TheECB sets interest rates for the euro area (16)

2) The single market all countriesparticipate in the single market, with freemovement of goods, services, capital andpeople (27)

3) Enhanced policy coordinationcountries retain sovereignty over othereconomic policies but commit to coordinatemore closely at the European level (27/16)

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Which countries are in the euro area?

Euro area: Austria, Belgium,Cyprus, Finland, France,Germany, Greece, Ireland,Italy, Luxembourg, Malta,Netherlands, Portugal,Slovakia, Slovenia, Spain.

EU Member States obligedto adopt the euroeventually: Bulgaria,Czech Republic, Estonia,Hungary, Latvia, Lithuania,Poland, Romania, Sweden.

EU Member States with anopt out from adopting theeuro: Denmark, UnitedKingdom.

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How does a country join the euro?

A Member State must fulfill the convergence

criteria laid down by the Maastricht Treaty:

Low inflation Low interest rates

Low government deficit

Low government debt Stable exchange rate (ERM II)

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What are the benefits of the euro? And the costs?

CITIZENS benefit from greater price

transparency, which should stimulatecompetitionand reduce pricesand from theelimination of currency exchange costs

For BUSINESSES it is easier to makeinvestment decisions (no exchange rate risk)

The ECONOMY benefits from price stability,and lack of exchange rate risk

Countries that adopt the euro can nolonger change their INTEREST RATEor their EXCHANGE RATE. In amonetary union, you cannot have anINDEPENDENT MONETARY POLICY.

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The benefits of EU membership the single market

Larger market morecompetition

More competition more choice, lower

prices for consumers

More competition promotes efficiency

Larger market firmscan exploit economiesof scale

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The single market economies of scale

Larger firms enjoy costadvantages over smaller firms(e.g. purchasing, marketing)

EUfirms can produce for a

market of 500m consumers

And pass on lower costs toconsumers

This should encourageeconomic efficiency andstimulate economic growth

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The euro and the single market

The euro eliminatescurrency transactions costs

Leads to greater pricetransparency price

convergence

Eliminates exchange rateuncertainty stimulates

investment

Euro leads to increasedtrade and investment flows

One market, one money

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Economic policy in EMU

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Economic policy making - the euro area and the US

Monetary policy

Federal Reserve Chairman

Ben S. Bernanke

ECB President

Jean-Claude Trichet

Fiscal policy

Treasury Secretary

Timothy Geithner

Eurogroup Finance Ministers

Economic policy co-ordination more difficult?

http://en.wikipedia.org/wiki/File:Timothy_F_Geithner.jpg/

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: Happy Birthday, euro!

The euro has helped to bringEuropeans together

It has fostered greater economicintegration (reinforcing the Single

Market) It has contributed to

macroeconomic stability (e.g.lower inflation)

But now the euro area is confrontedby a very dire economic situation

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The Euro Area Economic Situation: Not Good!

Real annual % change

unless otherwise stated2008 2009 2010

Real GDP growth 0.8 -4.0 -0.1

Inflation 3.3 0.4 1.2

Unemployment rate(percentage of labor force)

7.5 9.9 11.5

Source: European Commission Spring Forecast May 2009

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Why is the euro area so affected?

US and euro area economies are

closely connectedMany European banks bought

securities tied to US subprimeloans

German exports have fallen sharply

Spanish and Irish housing bubbleshave burst

Euro area economy is less flexible,has lower productivity growth

Exposure to Eastern Europe?

Toto, I dont think were in

Kansas anymore

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Europes response to the crisis

The ECB reduces interest rates tohistorically low levels (1.25%) and begun

quantitative easing

Dec 08: EU governments adoptEuropean Economic Recovery Plan - a

coordinated fiscal stimulus

Oct 08: euro area governments adoptconcerted action plan to support theirfinancial systems

Th fi i l i i

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The financial crisis:Other ways Europe should respond?

Speed up economic reforms(Lisbon Strategy)http://ec.europa.eu/growthandjobs/index_en.htm

Make the single market workbetter (especially for Services)

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EMU and the financial crisis

Crisis exposes persistent

divergences in the euro area

One size fits all monetarypolicy problematic?

Countries need to use fiscalstimulus, just as in US

But difficult to coordinate

fiscal response of 16 MemberStates

Break-up of EMU?

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Conclusions

The launch of the euro was a tremendousachievement for the EU

But EMU is still a work in progress (especiallyfor the E part)

The euro area is in its first recession; how willit cope?

Will the crisis lead to further divergence inEMU, or will it encourage countries to speed

up reforms? Can you have a monetary union without a

complete economic union? Political union?