EU Days

1
EU Days

• The Single Currency

2
Joining the Euro

• Introducing the Euro
• Economic and monetary union (EMU) comprises
  various stages.
• The main objective of Stage One, which began in
  1990, was the complete liberalisation of capital
  movements under Article 56 of the EC Treaty.
•  
• In Stage Two, which began on 1 January 1994, the
  Member States implemented measures enabling them
  to achieve the convergence targets necessary in
  order to enter Stage Three of EMU and guaranteed
  the independence of their central banks. The
  process of coordinating economic policies and
  ensuring multilateral surveillance of progress
  with convergence began in the course of Stage
  Two. The Member States were called on to do all
  they could to avoid excessive public deficits.
•  

3
Joining the Euro

• In Stage Two the Member States had to take
  measures to free their central banks of political
  interference. Central banks are now responsible
  for monetary policy and, as such, determine
  interest rates in the euro zone. They were also
  prohibited from financing a budget deficit
  affecting the European institutions, the
  governments of the Member States or other
  authorities, be they regional or local, and from
  granting loans to state-owned companies.
•  
• Stage Three of EMU began on 1 January 1999 with
  the launch of the euro on financial markets.
  Under the accession treaty, the new Member States
  went straight into Stage Three of EMU on 1 May
  2004.

4
Joining the Euro

• What you must show before entering the Euro Zone
•  
• Price stability, measured according to the rate
  of inflation in the three best performing Member
  States
• Long-term interest rates close to the rates in
  the countries with the best inflation results
• An annual budget deficit which does not exceed 3
  of gross domestic product (GDP) and total
  government debt which does not exceed 60 of GDP
  or which is falling steadily towards that figure
  
• Stability in the exchange rate of the national
  currency on exchange markets The exchange-rate
  mechanism of the European Monetary System
  requires this stability to be demonstrated and
  sustained for two years.
•  

5
Why did the Euro appear?

• Needed to reduce uncertainty and volatility of
  currencies
• needed to bring national monetary and fiscal
  policies more together
• needed to reduce use of exchange rate as macro
  tool
• Needed to control money expansion within member
  states
• needed to control expansion on money stock v
  competitive de-valuations
• Started with ERM

6
Convergence Criteria

• amount of money owed by a government - known as
  the budget deficit, has to be below 3 of Gross
  Domestic Product (GDP) - the total output of the
  economy.
• The total amount of money owed by a government,
  known as the public debt, has to be less than 60
  of GDP. The public debt is the cumulative total
  of each year's budget deficit.
• Countries should have an inflation rate within
  1.5 of the three EU countries with the lowest
  rate. This was supposed to push down inflation
  rates and lead to more stable prices.
• Long-term interest rates must be within 2 of the
  three lowest interest rates in EU. 
• Exchange rates must be kept within "normal"
  fluctuation margins of Europe's exchange-rate
  mechanism.

7
UKs 5 tests

• The UK's five tests
• These are the five economic tests on UK entry to
  the euro as outlined by The Treasury in 1997.
•  
• Convergence
•  
• The Treasury sees the first test, the need for
  the UK economy to come together with the euro
  zone economy, as the "touchstone" towards a
  successful single currency.
•  
• And it says it must converge in a "sustainable
  and durable" way.
•  
• It says that to be passed, the UK economy must
•  
• have converged with Europe
• be shown to have converged
• show convergence capable of being sustained
• have sufficient flexibility to adapt to change
  and unexpected economic events
•  

8
5 Tests

• The UK's five tests
•  
• In the past, the UK's economic cycle has been
  both more volatile than others in the EU,
  reflecting different economic policies, oil price
  rises and German unification.
•  
• Are business cycles and economic structures
  compatible so that we and others could live
  comfortably with euro interest rates on a
  permanent basis?
• This also been affected by differences in the UK
  economy such as trade patterns, oil, company
  finance and the housing market
•  
• Setting out the five tests, the government said a
  period of stability - via low inflation and
  controls on spending - would be needed in order
  to promote sustainable and durable convergence
  with the rest of the European Union.
•  

9
5 tests

•  
• Flexibility
•  
• The Treasury says the success or otherwise of the
  euro depends on business and the workforce being
  flexible.
•  
• The economy, it says, must have "the ability to
  adjust to change".
•  
• If problems emerge is there sufficient
  flexibility to deal with them?
• It says this is because of the "inevitable loss
  of domestic control over monetary policy" and the
  risk of future economic turbulence.
•  
• Firms would need to be flexible in terms of
  pricing and margins, and in their business
  strategy.
•  
• Wage bargaining in the labour market must be
  "realistic and take account of developments in
  productivity".
•  
• Employees would need to increase their skills in
  order to adapt to change in the job market

10
5 tests

• Investment
•  
• The Treasury believes that a successful single
  currency would
•  
• Would joining EMU create better conditions for
  firms making long-term decisions to invest in
  Britain?
• create an attractive area - with low inflation
  and stability - for firms to invest
• be a complement to the Single Market, boosting
  competition and providing new opportunities for
  companies
•  
• The Treasury says the euro could, if successful,
  help to reduce the risk of poor investment
  performance by reducing instability.
•  
• Investment could be boosted by the reduction of
  transaction costs and exchange rate uncertainty,
  it says.
•  
• And more transparent pricing - with companies
  able to compare prices between countries much
  more easily - could also encourage investment.
•  
• But the Treasury says entering the single
  currency before the UK economy has sufficiently
  converged with the euro zone would discourage
  investment.

11
5 tests

• Financial services
•  
• The Treasury says joining the euro would affect
  the financial services industry "more profoundly
  and more immediately" than other sectors of the
  economy.
•  
• What impact would entry into EMU have on the
  competitive position of the UK's financial
  services industry?
• It says whether the UK joins the euro or not, the
  City of London's strengths "should help it to
  thrive".
•  
• The test centres on whether the introduction of
  the euro would be advantageous for the sector and
  whether the sector is fully prepared for the
  introduction of the single currency in the UK.

12
The Euro?

• Fixed exchange rates from 1999
• Started 2002
• Transaction costs
• reduce uncertainty
• transparency of prices
• encourage mergers
• BUT what of initial costs?
• Role of ECB
• loss of control of economic/political decisions
• problems with expansion

13
5 tests

• Employment and growth
•  
• This is the "fundamental" test, says the
  Treasury.
•  
• Will joining EMU promote higher growth,
  stability and a lasting increase in jobs?
• Joining the euro could "enhance both growth and
  employment prospects".
•  
• But without sufficient convergence and
  flexibility, "the resulting turbulence could
  considerably damage them".
•  
• The Treasury will have to decide as it assesses
  the tests the potential effect on jobs and growth
  from joining the euro. In 2003 Gordon Brown
  announced that the UK did NOT then meet the 5
  tests
•  

14
Gains and Losses

• Gains? one catalogue price, one bank account,
  less formalities, stability, enhanced competition
  as prices remain stable, integrated bond markets,
  stricter discipline in tax issues
• BUT Loss of economic sovereignty
• Asymmetric shocks
• Lack of convergence two speed Union? Different
  labour market regulations
• Different growth rates
• What if one country gets out of synch?
• What if monetary flexibility required?

15
Gains and Losses

• Structural differences between countries we
  export 52 to EU, Germany 56, France 63
• Different housing market mortgage debt in UK
  57 of GDP, 33 within rest of EU
• More vulnerability to oil price hikes?
• Can it be sustained as enlargement continues?
• Can Regional Policy cope
• Can the poorer nations be accommodated?

16
Will it survive?

• Will probably depend on?
• Competitiveness on economy (price/non-price),
  spare capacity, financial resources,
• Knowledge of market, distribution systems,
  strength/stability of Euro, affect of joining
  Euro on macroeconomic management, loss of
  sovereignty, implications for UK business, price
  at which we join (ERM memories).

17
Single Currency Quick Re-cap

• Fixed exchange rates from 1999
• Started 2002
• Transaction costs
• reduce uncertainty
• transparency of prices
• encourage mergers
• BUT what of initial costs?
• Role of ECB
• loss of control of economic/political decisions
• problems with expansion

18
Re-cap 2

• Trade diversion - switch purchases to high-cost
  supplier
• Will trade creation grow? replace high cost
  domestic production with imports from a more
  efficient EU partner?
• If economic welfare is to increase the EU needs
  to (a) be as efficient as outside producers (b)
  be aware of demand and supply curve inelasticity
  of the commodities affected by the CET

19
Re-cap 3

• Membership based on meeting convergence criteria
  and accepting political rules
• Price stability no more than 1.5 above average
  of three best performing members
• Interest Rates no more than 2 above average of
  the three member states with lowest inflation
  rates in previous year. Long term rates
  convergence.
• Gov deficit no more than 3 of GDP.
• Public Sector Debt Control must not exceed 60
  of GDP
• Independent Central Bank
• Euro a powerful currency, greater parity with ,
  integration of financial markets, greater market
  liquidity, sounder fiscal policy

20
Re-cap-continued

• Gains? one catalogue price, one bank account,
  less formalities, stability, enhanced competition
  as prices remain stable, integrated bond markets,
  stricter discipline in tax issues
• BUT Loss of economic sovereignty
• Asymmetric shocks
• Lack of convergence two speed Union? Different
  labour market regulations
• Different growth rates
• What if one country gets out of synch?
• What if monetary flexibility required?

21
Some other problems?

• Structural differences between countries we
  export 52 to EU, Germany 56, France 63
• Different housing market mortgage debt in UK
  57 of GDP, 33 within rest of EU
• More vulnerability to oil price hikes?
• Can it be sustained as enlargement continues?
• Can Regional Policy cope
• Can the poorer nations be accommodated?

22
Deciding factors?

• Will probably depend on?
• Competitiveness on economy (price/non-price),
  spare capacity, financial resources,
• Knowledge of market, distribution systems,
  strength/stability of Euro, affect of joining
  Euro on macroeconomic management, loss of
  sovereignty, implications for UK business, price
  at which we join (ERM memories).

23
Competitiveness