EUROPEANECONOMIC & MONETARY UNION

Abdul Basit Adeel

Contenets

• Introduction

• What is Economic and Monetary Union?

• Stages of Economic Integration

• Historical development (1969-1991) + (1991-2015)

• Economic & Political perspectives about EMU

• Criticism of Economic and Monetary Union

• Conclusion

Introduction

• EMU has been an integral part of European integration since 1970s

• Euro introduced on 1 January 2002

• Accepted by all member states

• Expect: Denmark, Sweden, UK

Economic Unions Before EU

• Roman Empire

• Latin Monetary Union (1865 – 1927)

• Scandinavian Krona Union (1872

• EMU is different because these earlier unions only harmonized coinage and did

not introduce a single monetary policy or a central bank.

Economic & Monetary Union

• EMU refers to the union of participating countries, which have agreed to:

• a single monetary policy which influences money supply and credit conditions

• a single monetary authority – European Central Bank which sets interest rates

• a single currency - Euro

• coordinated macroeconomic policies

Economic & Monetary Union

• EMU could have been introduced without having a single currency

• Two alternatives

• By keeping national currencies and fixing exchange rates

• By introducing a common currency in parallel to the existing national currencies

• Single currency reduces costs and shows full commitment to EMU

Coordination of Economic Policies

• Specific rules on public debts and budgetary deficits:

• Budget deficits must not exceed a reference value – 3% of GDP

• Government debts must not exceed a reference value – 60% of GDP

• Countries are not allowed to print money to finance their debts and deficits

• ‘No bail out’ clause put to reduce likelihood of ECB for bailing out a country

Debate between Monetarists and Economists

• In 1960s-70s, policy makers were not sure about how to create the EMU

• Monetarists – Belgium, Luxembourg, and France:

• Fixing the exchange rate will start necessary cooperation in the economic policies

• Economists – West Germany and the Netherlands:

• Economic policies needed to be coordinated before fixing exchange rates or

introducing a single currency.

Stages of Economic Integration

• Though to be consecutive/following each other but not anymore

• Free Trade Area (FTA) in which participating members remove barriers to trade amongst

themselves, but maintain the right to levy tariffs on third countries

• Customs Union in which a common external tariff s on goods and services from third countries,

in addition to the free trade among members

• A common market — 1985 =single market — in which free movement of goods, services,

labor, and capital among the participating states, and common rules, tariffs, and so on with

third countries.

Stages of Economic Integration

• Economic union has a common/single market with high degree of coordination in the

economic policy and market regulation, as well as monetary policies and income

redistribution policies.

• Monetary union contains a common/single market, but also further integration in the

area of currency cooperation. It also requires integration of budgetary and monetary

policies.

• An economic and monetary union (EMU) combines the features of the economic

union and the monetary union. This combination is what European leaders had in mind.

Further Stages of Economic Integration

• A full economic union (FEU) implies the complete unification of the economies of

the participating member states and common policies for most economic matters.

• A full political union (FPU) is the term used when, in addition to the FEU, political

governance and policy-making have moved to the supranational level.

• Positive integration refers to rules, norms, and policies. Negative integration is

taking away obstacles, and eliminating rules and procedures that are an obstruction

to integration

Review

Historical Development (1961-1991) – Initialization

• Process started in 1969 at Hague Summit

• Group of experts headed by Pierre Werner proposed 1970s Werner Plan

• 3 stages to reach EMU by 1980

• Recommended setting up 2 supranational bodies:

o Community System for the Central Banks to pursue monetary policies

o Centre of Decision for Economic Policy to coordinate macroeconomic policies (including some

tax policies)

Historical Development (1961-1991) – Halt

• The process slowed down in 1970s due to:

• Differences among states about how to reach EMU

• Changes in global economic and monetary system namely fall of Bretton Woods

System

• European states set up exchange rate mechanism (ERM), the so-called ‘snake’

• Not all members participated + included some non-EEC members

Historical Development (1961-1991) – Relaunch

• In 1979, the European Monetary System (EMS) was set up, in which all

European Community (EC) member states were to participate.

• Not all were immediately part of its most important feature, the ERM—a system

of fixed, but adjustable, exchange rates.

• UK currency was part of the European currency unit (ecu)

• Italy participated in the ERM from the outset, but was initially given more leeway

Historical Development (1961-1991) – Relaunch

• Rule: most currencies could not fluctuate more than ± 2.25 % from an agreed parity

• Those who needed more leeway (for example, Italy) was set at ± 6 % from the parity

• If a currency threatened to move outside the agreed band, central banks would intervene by

buying or selling currencies in order to keep the currency from leaving the band

• If an imbalance were persistent, EC Monetary Committee (MC) – renamed in 1999 as

Economic and Financial Committee, an informal advisory body created by the Treaty of

Rome to discuss monetary policy and exchange rate matters, would decide the adjustments

Historical Development (1961-1991) – Development

• Until 1992, became symbol of success in European Integration

• Deutschmark became anchor currency and other states started following policies of Deutsche Bank

• The 1986 Single European Act (SEA) facilitated the completion of the single market and EMU

• Delors Report (April 1989) proposed a road to EMU in three stages. It contained:

• Creation of a European System of Central Banks (ESCB)

• Same objectives of Werner’s Plan but idea of supranational economic institutions were sidelined

Historical Development (1961-1991) – Development

Historical Development (1961-1991) – Development

• 1st stage of EMU (the liberalization of capital markets ) started on 1 July 1990

• Intergovernmental conference (IGC) held negotiations on the point that countries

would have to meet certain criteria, dubbed ‘ convergence criteria ’, in order to be

allowed to join EMU.

Historical Development (1961-1991) – Criteria

• Participating countries should not have excessive budgetary deficits or public debts

• The national central bank needed to be made politically independent

• Authorities must not print money to reduce public debts and budgetary deficits

• There were ‘escape clauses’ built into the wording of the Maastricht Treaty

• Debt criteria could be soften for some countries, such as Belgium and Italy, not able to

meet the reference value in less than a decade. However, Budgetary criteria had to be

met

Review: Historical Development (1961-1991)

From Treaty to Reality (1992-2002) – Challenges

• Referendums: success in France but failure in Denmark

• ERM II was set up to replace ERM. It maintained the ± 15 per cent bands

• The accession treaty allowed new members to join EMU but:

• They had to wait at least two years and fulfill the convergence criteria

• Some concessions were provided

• Total members of Eurozone are 19

From Treaty to Reality (1992-2002) – SGP

• Stability and Growth Pact (SGP) is a deterrent and a set of rules designed to

ensure that countries in the EU pursue sound public finances and coordinate their

fiscal policies.

• Member states that violate the rules to keep their public debt and budgetary deficit low

can be penalized, and may have to pay a fine

• SGP involves:

• A preventive arm multilateral budgetary surveillance

• A corrective arm or a deficit limit, the excessive deficit procedure (EDP)

Historical Development (1961-1991) – Crisis

• In 2002, France, Germany, and Portugal were given an ‘early warning’ that they

were in breach of the SGP.

• Portugal made the necessary corrections but France and Germany failed to do so.

• Both were closer to the financial sanctions set out in the SGP but such proposal was defeated.

• SGP was interrupted for the cases of France and Germany.

• Other member states, notably Austria, Finland, the Netherlands, and Spain, were outraged at the situation.

• France and Germany had been exempted from the process because they were large.

• ECJ declared this move to be illegal.

Historical Development (1961-1991) – Aftermath

• In 2005, the SGP was revised so as to include more flexibility over the circumstances

• States may temporarily run deficits in excess of the 3 % reference value

• The preventive arm of the SGP was strengthened:

• By giving attention to the fiscal sustainability when setting budgetary objectives

• By basing the medium-term budgetary objective on its debt ratio and potential growth

• The Commission is to give them ‘policy advice’ if this consolidation of states’ public finances when in favorable economic conditions, fails

• The SGP’s corrective arm was also adjusted:

• allowing more room for economic judgements and leaving open the possibility that the one-year deadline for the correction of an excessive deficit could be increased to two years.

Explaining EMU – Economic Perspective

• Two different schools

1. State should create EMU only if they constitute a so-called ‘optimum currency area’ (OCA)

• When are sufficiently integrated economically and have mechanisms in place to overcome an economic downturn to maximize economic efficiency of the region

• Central bank credibility becomes important. Central banks can be effective only if financial markets have confidence in their policies.

• Maastricht regime ensured full central bank independence and gave the ECB a clear single mandate to maintain price stability.

Explaining EMU – Political Perspective

• Two schools considered for the sake of simplicity

1.Neo-functionalists: EMU as the result of spillover and incremental policy-making.

• The success of the exchange rate mechanism (ERM) and the completion of the single market necessitated further collaboration in the area of monetary integration.

• Supranational actors were instrumental in creating EMU/

• Commission President, various EC committees, such as the Monetary Committee significant

2.Intergovernmentalists: EMU can be understood by examining the interests and bargaining behavior of the largest member states.

• By examining the interests of the largest member states, one is able to see why EMU happened.

Explaining EMU – Criticism by states outside Eurozone

• People unconvinced of the need of creating a single currency

• Economic and Social prosperity of Sweden and Denmark

• Skepticism of UK

• Change in perception after 2008 financial crisis

• Euro remained rather stable compared to non-Euro countries

• Denmark now more interested in joining Euro

• Political pressure against joining Euro in Poland, Czech Republic

Explaining EMU – Criticism of Institutional Design

• EMU has poor institutional design

• Problem of legitimacy and accountability due to extreme independence of ECB

• No one can instruct ECB as it is independent as a result of related treaty

• To change its mandate a new treaty is needed which is a difficult task

• There are few checks and balances on the ECB’s policies

• There is no equivalent supranational policies, heteronomy of ECB

o French proposal of gouvernement économique

Explaining EMU – Financial and Sovereign Debt crisis

• Sovereign Debt: inability of a country to pay its public debt, usually due to critical high debt levels and suffers from (perceived) low economic growth

• Member state spent more than they taxed, leaving them with high deficits and public debt

• Creation of new institutions like European Financial Stability Facility (EFSF)

• Changes to rules of the Stability and Growth Pact

• The so-called ‘six pack’ (five regulations and one directive )

• The role of the debt is now taken to be as important as the deficit.

• A qualified majority vote (QMV) to stop the sanctions (before used to impose sanctions).

• European Commission has a supervisory role in guiding member states through the fiscal year and ensuring sound policies

CONCLUSION

EMU is a lengthy and gradual development. It is

not only about economic and monetary system but

also has a political dimension.

Q: What will be the future?