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8/6/2019 7 EMU-Wang Ao

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ECONOMIC AND MONETARY

UNION

Wang Ao2011-05-03


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Contents

Concept of EMU

The Road to EMU

Costs and Benefits of EMU


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1. Concept of EMU

Achieved when:

A single market is completed: free movement of

capital and labour

Bilateral exchange rates are permanently fixed or

a common currency


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Ra tion al e for EMU

Advances European integration

economic integrationpolitical integration

Builds on EMS (Economic Monetary System)

Strengthens the position of EU in global

economy


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Eu ro a re a

T he euro area consists of 17 EU countries that have

adopted the euro.

To join the euro area, countries have to fulfill

the convergence criteria . T he criteria set out the

economic and legal preconditions for countries to

participate successfully in Economic and Monetary

Union.


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Convergence Criteri a

F iscal CriteriaNational budget deficit less than 3% GDPNational debt less than 60% of GDP or heading in

the right directionMonetary Criteria

Inflation no more than 1.5 percentage points abovethe average of the 3 countries with the lowest ratesLong term interest rates no more than 2 percentagepoints above the average of the 3 countries with thelowest ratesExchange rate within normal band of ERM forprevious 2 years


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Eu rope a n Centr al Ba nk

Primary objective is price stabilityResponsibility for monetary policy i.e.

interest and exchange rate policy.F iscal policy remains national but Growthand Stability Pact to stop member statesundermining ECB


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ES CB a nd Eu rosystem

European System of Central BanksT he ESCB comprises the ECB and the nationalcentral banks (NCBs) of all EU Member States(Article 107.1 of the Treaty) whether they haveadopted the euro or not..

EurosystemT he Eurosystem comprises the ECB and the

NCBs of those countries that have adopted theeuro. T he Eurosystem and the ESCB will co-existas long as there are EU Member States outsidethe euro area.


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2 . Th e Roa d to EMU

19791957 1992 20021970

P hase I P hase II P hase III P hase IV

Treaty o f RomeWerner Report

EMS

EMUeuro andeuro area

Treaty of Rome

Treaty of BrusselsSEA

MaastrichtTreaty

AmsterdamTreaty

1967 1987 1999


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P h a se 1: t h e Werner Report

Treaty of Rome: had little to say about money.Bretton Woods System : currency instability

threatened the stability of other currenciesand the common price system of the commonagricultural policyEMU: became a formal goal to propose

greater economic coordinationEurope s leaders set up a High Level Group andLuxembourg Prime Minister Pierre Werner reportedon how EMU could be achieved by 1980.


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P h a se 2 : E conomic Monet a ry S ystem

N arrowing of exchange-rate fluctuationsSnake in the tunnel

Interest remained strongT he European Monetary System was built on theconcept of stable but adjustable exchange ratesdefined in relation to the newly created EuropeanCurrency Unit (ECU) a currency basket based on aweighted average of EMS currencies. Within the EMS,currency fluctuations were controlled through theExchange Rate Mechanism (ERM) and kept within 2.25% of the central rates.


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P h a se 3: Th e De l ors Report

A decade of success: currency realignments inEMS, short-term volatility of exchange rates

between currencies was reduced.T

his successformed an encouraging backdrop to thediscussions on EMU.N eed to complete the single market:relatively high business costs created by theexistence of several currencies and unstableexchange rates


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P h a se 3: Th e De l ors Report

President of the Commission, Jacques Delors chaired the committeeStage 1 (1990-1994)

Complete the internal market and remove restrictions on furtherfinancial integration.

Stage 2 (1994-1999)Establish the European Monetary Institute to strengthen centralbank co-operation and prepare for the European System of CentralBanks (ESCB). Plan the transition to the euro. Define the futuregovernance of the euro area (the Stability and Growth Pact).Achieve economic convergence between Member States.

Stage 3 (1999 onwards)F ix final exchange rates and transition to the euro. Establish theECB and ESCB with independent monetary policy-making.Implement binding budgetary rules in Member States


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P h a se 4: Th ree S t a ges to EMU

Stage One: the completion of the singlemarket was a reality by 1 January 1994.

Stage Two: EMI was established in 1994, SGPaimed to ensure fiscal discipline under theEMU, ECB and ESCB were established in 1998.Stage Three : in 1999 the euro was introduced

and the Eurosystem took over responsibilityfor monetary policy in the new euro area. In2002 euro banknotes and coins wereintroduced.


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How EMU W orks

T hree main economic activities:Implementing an effective monetary policy for

the euro area with the objective of pricestabilityCoordinating economic policies in MemberStatesEnsuring the smooth operation of the singlemarket


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4. Costs a nd Benefits of EMU

O ptimum Currency Area( O CA) is a geographicalregion in which it would maximize economicefficiency to have the entire region share a single

currency. It describes the optimal characteristics forthe merger of currencies or the creation of a newcurrency. T he theory is used often to argue whetheror not a certain region is ready to become amonetary union, one of the final stages in economic

integration.

Key Question: is the EU an O CA?


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I s t h e EU a n OCA?T hree issues to be checked:

Likelihood of asymmetric shocks: EC-6 countries are lesslikely to suffer from asymmetric shocks than US regions,hence, national exchange rate is a less useful instrument of adjustment in the EU.

Market adjustment mechanism: labor mobility with EU isindeed low but it is scarcely a greater problem within EUcountries.T he EU is not a less suitable currency area because it doesnot have a centralized fiscal stabilization policy.

In conclusion, it would seem that such an EMU without muchredistribution and no stabilization at central level, is possible andmay well be stable.


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Kr u gma n GG-LL Mode l

Assumptions:T he larger the trade volume with O CA, themore benefits to be obtained.T he fixed exchange rate is imposed in the O CA.T he more closer market relations with O CA ininternational business, the more benefits to beobtained.


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GG a nd LL Cu rves

LLGG

Convergence of Economic Integration

Benefitsor lossof EntryCountry


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Economic Benefits of EMU

Removes exchange rate uncertainty on intra-EMU tradeSavings due to lower reservesAvoids competitive devaluationsEliminates transaction costsIncreases price transparency

Low and stable inflation and interest ratesPromotes international specialisation andimproves EU competitiveness


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Economic Risks of EMU

Short term deflationLoss of economic sovereigntyAsymmetric shocks? especially if EMU leadsto specialisation.Burden of adjustment on wages and prices -flexible enough?

Transfer cost


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T hanks for Your Attention!

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