The European Union and the single currency in the global economy

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The European Union and the single currency in the
global economy

• 2 from the euro to the sovereign debt crisis.

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Euro timetable

• 11/09/2001, attack on the Twin Towers
  reverberates on the world economy.
• In 2002 national currencies are replaced by the
  Euro. The switch was a complex and difficult
  operation and was handled with a degree of
  success.
• In 2003 Duisenburg is replaced as President of
  the ECB by the Frenchman Jean Claude Trichet.
• Summer 2007 first signs of the global financial
  crisis.

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The ECB and the governance of the Euro.

• Maastricht Treaty negotiations. Two different
  views the full independence of the Central Bank
  according to the German model, or a closer
  dependence from the political authority according
  to the French model. The first view prevails.
• Two ruling bodies of the ECB the Governing
  Council and the Executive Board. The Governing
  Council is composed of Governors of all the
  national central Banks. The Executive Board has
  six members, elected by the European Council. The
  President has a casting vote.

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Powers of the ECB

• The ECB sets it own inflation target, its main
  mandate being the achievement of price stability.
  
• Monetary policy is designed to be independent
  from political pressures. The ECB President and
  Executive Board are appointed for eight years.
• National central banks remain in charge of
  banking supervision.
• On matters relating to the exchange rate of the
  Euro with other currencies, decision rests with
  the Eurogroup and the ECB carries it out.
• Market interventions by the ECB are carried out
  through national central banks.
• The ECB has no direct power over fiscal policies
  of the member states, It can, however, issue
  recommendations. National governments are barred
  from intervening on matters of monetary policy.
• The Treaty forbids monetary financing of public
  expenditure (art 101)

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The Eurogroup.

• The Eurogroup is composed of the finance and
  economics ministers of the countries that have
  adopted the Euro. Currently they are sixteen.
  The President of the ECB takes part in its
  meetings, which are scheduled once a month.
• The Eurogroup
• A) monitors fiscal policy in the member states.
• B) is in charge of setting the Euros exchange
  rate policy (the Euro runs a flexible exchange
  rate)
• C) rules on admitting other countries in the
  Euro.
• The European Parliament conducts a yearly review
  on the policy of the ECB and the Eurogroup

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The ECB and its monetary policy.

• The ECBs stated objective is the achievement of
  an inflationary target of below 2 over the
  medium period (12 to 18)
• The ECB has only one objective price stability.
• The Fed on the other hand has the objective both
  of price stability and of GDP growth. The ECB
  does not have the political mandate to pursue
  objectives outside monetary policy. It is a
  federal body but with a limited mandate.

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The Euro in the world economy

• One of the key issues has been the Euro-dollar
  exchange rate. It was first set at 1,19 dollars
  for a euro.
• It first fell dramatically (1999-2002) due to the
  strength of the US economy in the late 1990s and
  the scarce credibility of the Euro in its initial
  stage. This weakness brought with it as a
  consequence higher Euro interest rates.
• After 2003 the Euro appreciated by about 90, to
  achieve 1,60 to the dollar. This was due to the
  growing balance of payments deficits in the US
  which triggered the dollar rate decline. The Euro
  also appreciated against all other currencies by
  about 40

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The Euro and the world economy

• Globalization accelerates, both financially and
  technologically.
• 2001-2007 Emerging economies accelerate in
  Asia, but also in Latin America, in some part of
  Africa and in Eastern Europe. Rates of growth go
  up sharply. Strong growth in world trade.
• Raw material prices shoot up.
• Savings from fast growing emerging nations are
  channeled to finance the growing debt of the US
  and other developed economies. Low rates of
  interest world-wide fuel short term capital
  movements and highly leveraged financial
  activities.

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The world economy before the crisis.

• 1999-2008 average rates of growth remain
  relatively high.
• Eurozone 2,1 (against 1.9 nel 1993-8)
• World 4 (against 3 in 1993-8)
• USA 2,6 (against 3).

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Provisional balance sheet of the Euro

• The BCE succeeds in enforcing a degree of
  anti-inflationary discipline. The inflation rate
  remains low. Nominal interest rates in the
  period 2000-2007 are on average below 5.
• The Euro has a positive impact on intra-EU trade
  and FDI.
• International Status. The Euro becomes the second
  international reserve currency.

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The discipline of belonging to the Euro

• Members of the Eurogroup have renounced a
  national monetary policy. They can not change
  their interest rates, nor obviously can they
  devalue or revalue their currencies.
• Costs need to be kept in line with productivity.
  If costs raise above productivity they are not
  justified and carry the consequence of a general
  loss of competitiveness in the natinal economy.
  A key indicator of competitiveness is the labour
  cost per unit of output
• A loss of competitiveness means relative falls in
  exports and increases in imports. This leads to a
  need for adjustment, which can only be carried
  out in real terms and not in nominal terms. Real
  term adjustment implies bringing costs in line
  with competitors, pushing down inflation, and
  restructuring of the economy.

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Euro countries performance

• The three main Eurogroup countries, Germany,
  France and Italy scored a weak economic
  performance. Germany, however, accelerated after
  2005.
• Peripheral countries, such as Ireland, Finland,
  Spain and Greece, grew more rapidly, exploiting
  relatively low interest rates. Their growth
  however was tied to a high national debt (both
  state and privately owned). This made them
  vulnerable to the financial crisis of 2008 and
  its aftershocks.

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Italy and the Euro

• Italy benefited from low interest rates inside
  the Eurozone. This factor alone accounted for a
  fall of 4,5 in its annual deficit between 1997
  and 2006. Public expenditure however was not
  kept in check and in fact continued to move
  upwards, making it necessary to keep taxes high.
• Italy Labor Costs have increased 20 above
  Germanys. This points to a competitive gap
  which will threatens Italys economic prospects.

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Labour costs per unit of ouput.
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Stability pact

• The first Growth and Stability Pact among EU
  members was signed in December 1996, under German
  insistence.
• Member states committed themselves to
• Balancing their budgets after joining the Euro
• Being fined if they overshot the 3 ceiling set
  at Maastricht.

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The new Stability Pact of 2004

• In 2002-3 Italy, France, Germany and other
  countries showed budget deficits of over 3 of
  GDP. Attempts to fine France and Germany, the
  main offenders, were voted down by the Eurogroup,
  against the opinion of the European Commission
  Ireland and Portugal, however, for the same
  reason had been fined one year earlier. This
  brought into evidence a disparity between the big
  and the small members of the Eurogroup, which was
  divisive and contributed to the negative
  responses of referenda in France and the Low
  Countries on the new Constitutional Treaty,
  preventing its passage into law (a new revised
  and scaled down treaty has come into force in
  2009).
• In 2004 the Stability Pact was reformed, making
  it more flexible in times of economic recession,
  and more stringent during favorable economic
  conditions, during which countries are supposed
  to achieve a yearly improvement of 0,5 in the
  budget deficit.

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Performance in 2006-2007

• Fairly good overall growth rates in 2006 and
  2007.
• Germany was able to restore its public finances,
  by carrying out a considerable fiscal correction.
  Growth resumed from 2005. Domestic market reform
  (labour market and others) have improved
  efficiency. Exports rose rapidly. German export
  were able to capture an important share of the
  Chinese market. Germany was able to meet the
  world crisis in 2008 from a position of relative
  strength.
• France did not carry out all the needed
  corrections.

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Performance in 2006-2010

• Italy undertook a fiscal correction to its
  budgetary deficit in 2007. However it used up
  public revenue to boost domestic expenditure. It
  found itself exposed to the crisis, which it met
  with extreme budgetary prudence. Good performance
  of Italian exports between 2005 and 2007.
• In 2009-2010 conditions for a new fiscal crisis
  build up. All countries build up deficits to
  offset the effects of the 2008-9 crisis and are
  then forced to engage in a sharp tightening of
  fiscal policies. Under threat from international
  hot money flows is the very existence of the Euro.

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The Euro and the 2008 crisis.

• Banks in the UK and Switzerland are severely hit.
• In the Eurozone German banks such as Deutsche
  Bank and HypoReal Estate suffer most.
• Some banks belonging to Euro members are heavily
  exposed in Eastern European countries. In Italy
  this was the case with Unicredit, which had
  recently taken over the German HypoVereinsbank
  (HVB).
• Other banks in trouble are Dexia (French-Belgian)
  and Fortis (Belgian-Dutch).
• As a reaction to the crisis, the ECB lowered
  rates dramatically on October 2008.
• European governments recapitalized their banks.
• Temporary suspension of the Growth and Stability
  Pact leads to mounting deficits which impose a
  dramatic correction in the first few months of
  2010.

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The Euro and the sovereign debt crisis

• Greece joined the Euro in 2001. However in order
  to meet the criteria its national account
  statistics seem to have been forged. After a
  few years new calculations brought its budget
  deficit up from 3.4 to 13.6 of its GDP.
• As a result there was a dramatic rise of the
  spread of Greek bonds, with immediate effects on
  the weaker members of the Euros periphery, such
  as Portugal, Ireland and Spain, the so-called
  PIGS.
• May 2010. An agreement is reached on a EU aid
  package to Greece of 110 bn Euros in 3 years,
  with the IMF also playing a role.
• The financial turmoil spreads to Ireland the
  Irish government intervenes to rescue the
  Anglo-Irish Bank, the countrys main financial
  institution. The EU discusses a permanent rescue
  fund as well as new monitoring procedures to
  check member states accounts.

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Great Britain and the Euro

• At Maastricht Great Britain negotiated an opt-out
  clause.
• Joining the euro would require a referendum in
  the UK.
• Convergence with the Eurozone. There has always
  been imperfect convergence. The UK has enjoyed
  slightly higher average growth during 1999-2008,
  but also higher interest rates. Its budget
  deficit has been above 3 and it has run a
  balance of payments deficit. If the UK had joined
  the Euro it would have determined higher interest
  rates throughout the Eurozone, and this might
  have impacted on overall growth rates.
• The UK government has blamed the lack of
  convergence for its refusal to join the Euro, but
  there are also underlying political resistances
  in the UK body politics.

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Great Britain and the euro

• London has retained its status of main financial
  centre in Europe. In 2007, 67 of international
  bonds were issued in London, and nearly three
  quarters of euro-denominated offerings were also
  issued in London.
• The effects of the financial crisis. The UK
  economy and the Uk banking system was hit very
  severely by the crisis. Large scale government
  intervention means the UK has run a large
  deficit, which needs a dramatic correction.
• To regain competitiveness the UK economy will be
  able to use devaluation. In fact during 2007-8
  sterling has lost 16 of its value against the
  euro and more since then.

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New member countries and the euro.

• New member countries enjoyed higher growth rates
  than EU-15 members. Between 2004 and 2007 the
  Baltic states grew by between 8 and 10 a year,
  Poland and the Czech Republic by about 5, while
  the Eurozone only by 2. The crisis has meant a
  deep recession for new as well as old member
  countries.
• Joining the euro would have meant adopting the
  same monetary policy as the founding members of
  the Eurogroup. Between 2004 and 2008 the ECB has
  held short term interest rates at around 3,2
  and long term rates at 4. These rates would have
  been too low for countries growing as fast as the
  new member countries. Had they adopted them, they
  would have suffered inflation. In fact the Baltic
  states, having pegged they currencies to the
  euro, experience high rates of inflation...
• Joining the euro, would entail for these
  countries a strong deflationary policy effect,
  with drastic fiscal measures likely to endanger
  their growth prospects.

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The new members and the adoption of the Euro.

• One option would be to revalue their currencies
  before joining the Euro. This is what Slovakia
  did in 2009. However this is only a short term
  solution. Once inside the single currency they
  would have to adjust to a different set of
  variables.
• The seven EU member states that have not adopted
  the Euro are relatively small, economically.
  There total GDB is no more than 6 of the total
  EU GDP. They have an important stock of FDI from
  the rest of the EU. The crisis of 2008-9 has led
  to some repatriation of FDI. It may also lead to
  a closer convergence with the Eurozone, and
  encourage early entry in the Single currency. But
  there are many big ifs.

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Current issues in the Euro area

• Will the current fiscal correction and
  restructuring lead to a stronger, centralized
  Eurozone decision-making, expanding integration
  further from monetary to fiscal policies? A
  stronger Eurogroup co-ordination seems to be on
  the cards.
• Tackling the deficit. How will corrective
  measures impact on growth rates? Is it possible
  to sustain a fiscal correction when recovering
  after a severe recession, or will this impact on
  rates of growth?
• In the medium term, the key factor will be the
  ability of the Eurozone to meet the challenge of
  competition from emerging countries in the global
  economy.
• Is the enlargement of the euro area still on the
  cards? Or has the crisis postponed it,
  indefinitely?

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Europe in the global economy issues

• Can the Euro survive?
• Can the Euro replace the dollar? In 1999-2002 the
  dollar accounted for 67 of global reserves, the
  euro for 13.4 and yen and sterling respectively
  for 5 e 4. The current crisis has weakened
  both currencies, but the Dollar is still the main
  reserve currency and likely to remain so for some
  time.
• Fortress Europe or a liberal Europe?
• Can the EU adjust to the needs of the global
  economy?