which countries were european union members as of 2003? france belgium netherlands luxembourg italy...
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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
Which countries became EU members in 2004?
• Turkey
• Cyprus
• Malta
• Hungary
• Poland
• Czech Republic
• Slovakia
• Romania
• Latvia
• Estonia
• Lithuania
• Bulgaria
• Slovenia
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
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
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)
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 bythe dynamic benefits of economic integration
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 competitioncut costs, innovate,
respond to market
Result: increased global competitiveness
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
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
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”
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
Rationale for a single currency (cont’d)
• 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
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
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
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
Euro-zone: who’s in, who’s out
Countries that are inAustriaBelgiumFinlandFranceGermanyGreeceIrelandItalyLuxembourgNetherlandsPortugalSpain
Countries that are out
Denmark
Sweden
U.K.Referendum in September 2003; No’s won
5 tests show UK not ready; future referendum in doubt
Rejected euro in 2000 referendum; polls show support but no new referendum yet
Joined 1/1/01
Technically, the launch of the euro was a great success
• European Central Bank
• Contracts
• Stock and bond markets
• Public acceptance
But the euro lost a lot of value in the first 2 ½ years:
Explanations for the euro’s fall
• Rates of return in US vs. euro-zone– Interest rates– Stock markets
• Rates of economic growth and productivity
• Central bank credibility
Then the euro reversed direction:
Sep 2004
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
US and Euro-zone 3-month interest rates (interbank)
0
1
2
3
4
5
6
7
8
07/24/1998 12/06/1999 04/19/2001 09/01/2002 01/14/2004 05/28/2005
pe
rce
nt
pe
r a
nn
um
Euro-zone interest rate US interest rate
Source: Datastream
Monetary policy – Euro-zone and US compared
• Who makes monetary policy decisions?
• How are these decisions communicated?
• What is the central bank’s mandate?
• How are monetary and fiscal policy coordinated?
ECB’s 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 don’t fine-tune as much as US; we realize
policy takes a long time to have an effect
ECB’s 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
ECB’s 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
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
Stability Pact in practice
• Expected that smaller, “weak currency” countries would have most trouble with the stability pact– But it’s 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
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
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 Commission’s recommendations
and interpret the Pact its own way
• 6 countries likely to go over deficit limit in 2004– Germany says it’s likely to breach limit in 2005, too (4th
consecutive year)
• Looks like Pact will be revised; Commission has proposed some ideas (see below)
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