From Europe to the Euro

Plan of Attack

• John Stewart on the Euro launch

• Quiz – The Nuts of Bolts of the Euro

• National preferences and international institutions – negotiating the Maastricht Treaty and EMU

• Transitioning to the Euro

Nuts and Bolts of the EuroA quiz

1. What was the start date of Economic and Monetary Union?

a) Jan 1980 The first major monetary policy initiative (1970 Werner Plan) called for EMU by Jan 1980, but adverse economic conditions doomed the initiative.

b) Jan 1978The European Monetary System is launched consisting of an Exchange Rate Mechanism and the European Currency Unit (ECU) c) Jan 1999Correct. EMU officially started on Jan 1,1999. Conversion rates were irrevocablyfixed and legislation related to introduction of the euro came into force.

d) Jan 2002Circulation of euro banknotes began.

European Monetary System • Background:

– Collapse of Bretton Woods system (1971)– Europe agrees to follow the “snake” (1972)

• Bold diplomatic initiative by political leaders:– Architect: Joy Jenkins (Pres of the

Commission)– Schmidt & Giscard – Franco-German alliance• EMS adopted in 1979:

– Monetary stability in arena of fluctuating exchange rates

– Fight inflation and increase economic growth

– Importance: underpinned the single market program; laid foundations for EMU

Setting the stage for Maastricht….

Internal: – realization that single market can only be

fully achieved with European Monetary Union (EMU)….spillover???

External:– Fall of communism renews fear about

German hegemony; prefer a European Germany to a German Europe

– Kohl and Mitterand strike another Franco-German deal

2. How many countries are currently in the euro area?

a) 27 Number of current EU member states.

b) 11Number of countries that originally joined in 1999.

c) 17Correct. As of 2011, 17 EU member states are part of the euro area

1999 Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain

2001 Greece2007 Slovenia2008 Cyprus, Malta2009 Slovakia2011 Estonia

The “Outs”• Britain, Denmark, Sweden,

and most of Eastern Europe remain outside of euro

• To join would need popular support and low budget deficits

• Britain and Sweden unlikely to join unless economy tanks

• Eastern European countries perhaps more likely to join as they meet criteria

3. What were the set of rules set out for entry into the European Monetary Union?

a) Copenhagen Criteria The political, economic, and legislative requirementsthat countries must meet to join the EU.

b) Stability and Growth PactPact enacted in 1997 to ensure that fiscal disciplinewould be maintained and enforced in the EMU.

c) Convergence CriteriaCorrect. The 1992 Maastricht Treaty set out 5 criteria that countries needed to meet prior to joining the EMU.

The So-Called “Maastricht Criteria”Inflation rates: Must not be more than 1.5 percentage points

higher than the avg of the 3 lowest inflation MSs of the EU.

Long-term interest rates: Must not be more than 2 percentage points higher than the avg of the 3 lowest inflation MSs of the EU.

Exchange rate: Must have been a member of the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years without being forced to devalued its currency during the period.

Government finance:• Annual government deficit: Ratio of the annual

government deficit to GDP must not exceed 3% at the end of the preceding fiscal year.

• Government debt: Ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year.

4. Who sets interest rates in the EMU?a) The European CouncilDetermines membership in the eurozone.

b) Member States Manage national fiscal policies within EU limits. .c) The European Central BankCorrect. ECB controls interest rates for euro. Independent of political authorities; goal is low inflation.

d) The European ParliamentNot important here.

The European Central Bank

• Established under the Amsterdam Treaty (1998)

• Modeled after the German Bundesbank

• Headquartered in Frankfurt• Current president Jean-Claude Trichet• The primary objective of the ECB is to

maintain price stability within the Eurozone, or in other words to keep inflation low!!

5. What is the current dollar-euro exchange rate?

a) 86 centsJanuary 2002

b) $1.59 July 2008 .

c) $1.37Correct (November 11,

2011)

National preferences & international institutions

Negotiating the Maastricht Treaty

Why would governments agree to abandon their national currencies, and thus their ability to implement an autonomous monetary policy, in favor

of a single currency?

Answer: the benefits outweighed the costs

Benefits of Monetary Union• Promote trade and investment

• Eliminate competitive devaluations

• Tie Germany to west after unification

• Insulate EU from rest of world

• Lock in objectives of low inflation and smaller budget deficits

• Foster a European identity

Costs of Monetary Union

• Agree to share authority over interest rates, the single most important tool of economic policy

• Give up ability to devalue currency

• Agree to EU limits on overall fiscal policy stance (i.e. limit budget deficits)

A Single Currency - Competing Models

Technocratic• Priority of monetary

integration should be to maintain low inflation.

• Authority over monetary policy should be invested in a political independent central bank directed to keep inflation low.

• EU should have strict rules limiting size of budget deficits.

Politicized • Priority of monetary

integration should be to promote growth and employment.

• Governments need to coordinate all tools of economic policy – fiscal, monetary, exchange rate – to achieve these goals.

And the winner is….

Outcomes of negotiations favored the technocratic German view:– Politically independent ECB tasked with

keeping inflation low– Convergence criteria– Only Britain and Denmark allowed not to

participate (French victory)– Deadline for creation of single currency (small

victory for the French)Why did Maastricht So Closely

Match German Preferences?

Transition to Monetary Union

Rough Seas or Smooth Sailing?

Joining the Euro

• As late as 1995, only 3 countries had met the convergence criteria:

Ireland, Luxembourg, Finland

• In 1998 decided that all countries wanting to join passed muster…with the exception of Greece.

How did countries like Italy, Belgium, France, Germany meet the most important fiscal criteria?• Cheating• Large-scale privatization to increase

income• Italy introduced a “euro tax”• Fear of exclusion from euro to gain

domestic political support for cuts• Pro-European government in Italy with

supporters that wanted to reduce deficits• France ran a deficit of 3.07% of GDP and

dared anyone to keep them out!

Designing the Euro Sign

“Inspiration for the € symbol itself came from the Greek epsilon (Є)– a reference to the cradle of European civilization – and the first letter of the word Europe, crossed by two parallel lines to ‘certify’ the stability of the euro.”

– European Commission