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European Economic and Monetary Union (EMU)
Mustafa ATA January, 2007
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Introduction
In economics, a monetary union is a
situation where several countries have agreed to
share a single currency among them. The European
Economic and Monetary Union (EMU) consists of
three stages coordinating economic policy and
culminating with the adoption of the euro, the
EU's single currency. All member states of the
European Union participate in the EMU. Thirteen
member states of the European Union have entered
the third stage and have adopted the euro as
their currency. The United Kingdom, Denmark and
Sweden have not accepted the third stage and the
three EU members still use their own currency
today. Under the Copenhagen criteria, it is
a condition of entry for states acceding to the
EU that they be able to fulfil the requirements
for monetary union within a given period of time.
The 10 new countries that acceded to the European
Union in 2004 all intend to join third stage of
the EMU in the next ten years, though the precise
timing depends on various economic factors.
Similarly, those countries who are currently
negotiating for entry will also take the euro as
their currency in the years following their
accession.
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History of the EMU
First ideas of an economic and monetary
union in Europe were raised well before
establishing the European Communities. For
example, already in the League of Nations, Gustav
Stresemannasked in 1929 for a European currency
against the background of an increased economic
division due to a number of new nation states in
Europe after WWI. A first attempt to create
an economic and monetary union between the
members of the European Communities goes back to
an initiative by the European Commission in 1969
On the basis of various previous
proposals, an expert group chaired by
Luxembourgs Prime Minister and Finance Minister,
Pierre Werner, presented in October 1970 the
first commonly agreed blueprint to create an
economic and monetary union in three stages (
Werner plan). The project experienced serious
setbacks from the crises arising from the
non-convertibility of the US dollar into gold in
August 1971 and from rising oil prices in 1972.
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The debate on EMU was fully re-launched at
the Hanover Summit in June 1988, when an ad hoc
committee of the central bank governors of the
twelve member states, chaired by the President of
the European Commission, Jacques Delors, was
asked to propose a new timetable with clear,
practical and realistic steps for creating an
economic and monetary union. The Delors
report of 1989 set out a plan to introduce the
EMU in three stages and it included the creation
of institutions like the European System of
Central Banks (ESCB), which would become
responsible for formulating and implementing
monetary policy. Stage One 1
July 1990 to 31 December 1993 Stage
Two 1 January 1994 to 31
December 1998 Stage Three 1 January 1999
and continuing
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Exchange Rate Mechanism
Prior to adopting the euro, a member state
has to have its currency in the European Exchange
Rate Mechanism for two years. Cyprus, Denmark,
Estonia, Latvia, Lithuania, Malta, and Slovakia
are the current participants in the exchange rate
mechanism. The European Exchange Rate
Mechanism, ERM, was a system introduced by the
European Community in March 1979, as part of the
European Monetary System (EMS), to reduce
exchange rate variability and achieve monetary
stability in Europe, in preparation for Economic
and Monetary Union and the introduction of a
single currency, the euro, which took place on 1
January 1999. In 1999, ERM II replaced the
original ERM. The Greek and Danish currencies
were part of the system, but as Greece joined the
euro in 2001, the Danish krone was left as the
only participant member. Currencies in ERM II are
allowed to float within a range of 15 with
respect to a central rate against the euro.
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Current status of the ERM II
The Estonian kroon, Lithuanian litas, and
Slovenian tolar were included in the ERM II on 28
June 2004 the Cypriot pound, the Latvian lats
and the Maltese lira on 2 May 2005 the Slovak
koruna on 28 November 2005. The currencies of the
three largest countries which joined the European
Union on 1 May 2004 (the Polish zloty, the Czech
koruna, and the Hungarian forint) are expected to
follow eventually. Plans for Bulgaria are
to apply for ERM II membership in the beginning
of 2007 and to commit to its rules regardless of
the European Commission decision, while Romania
plans to join ERM in 2010-2012. EU
countries that have not adopted the euro are
expected to participate for at least two years in
the ERM II before joining the Eurozone. As
Slovenia adopted the euro in 2007, the Slovenian
tolar was excluded from the ERM II.
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Convergence Criteria
Convergence criteria, also known as the
Maastricht criteria, are the criteria for
European Union member states to enter the third
stage of European Economic and Monetary Union
(EMU) and adopt the euro. The four main criteria
are based on Article 121(1) of the European
Community Treaty. Those member countries who are
to adopt the euro need to meet certain criteria
which include 1. Inflation rate No more
than 1.5 percentage points higher than the 3
best-performing member states of the EU (based on
inflation). 2. Government finance Annual
government deficit The ratio of the annual
government deficit to gross domestic product
(GDP) must not exceed 3 at the end of the
preceding fiscal year. If not, it is at least
required to reach a level close to 3. Only
exceptional and temporary excesses would be
granted for exceptional cases.
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Government debt The ratio of gross
government debt to GDP must not exceed 60 at the
end of the preceding fiscal year. Even if the
target cannot be achieved due to the specific
conditions, the ratio must have sufficiently
diminished and must be approaching the reference
value at a satisfactory pace. 3. Exchange
rate Applicant countries should have joined the
exchange-rate mechanism (ERM II) under the
European Monetary System (EMS) for 2 consecutive
years and should not have devaluated its currency
during the period. 4. Long-term interest
rates The nominal long-term interest rate must
not be more than 2 percentage points higher than
the 3 best-performing member states (based on
inflation). The purpose of setting the
criteria is to maintain the price stability
within the Eurozone even with the inclusion of
new member states.
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Criticism
There have been debates as to whether the
Euro-zone countries constitute an optimum
currency area. By contrast with other single
currency areas such as the United States, the
Euro-zone seems to be lacking the same degree of
homogenity with regard to a common language,
history or culture. Additionally, there is
a significant amount of economic diversity within
the economies of the Eurozone. As a result,
Euro-zone interest rates have to be set for both
low-growth and high-growth Euro members. To
enable true free movement of goods and free
movement of capital, significant harmonisation
and opening-up of economies would be necessary,
but these aims are proving difficult to implement
in the real world.