FEATURES OF ECONOMIC UNION

1
FEATURES OF ECONOMIC UNION

• Single market for persons, goods, services and
  capital
• High level of co-ordination of economic policy
• - esp. central control of fiscal policy
• Greater role for competition policies
• Structural Funds
• - transfer of funds to weaker countries

2
FEATURES OF MONETARY UNION

• Total and irreversible convertibility of
  currencies
• Complete liberalisation of capital movements
• Full integration of banking and other financial
  markets
• Elimination of margins of fluctuation and
  irrevocable locking of exchange rates (implying a
  single currency)    

3
MAASTRICHT CRITERIA

• Level of inflation to be within 1.5 of 3 lowest
  member countries
• Level of long term interest rates to be within 2
  of 3 lowest inflation countries
• Budget deficit to be less than 3 of GDP
• National debt to be less than 60 of GDP
• Any country proposing to join to have been member
  of ERM for two years prior to entry
•  

4
ADVANTAGES OF EMU

• Symbolic of overall union
• Would reduce transaction costs for business
• Would eliminate uncertainty due to exchange rate
  adjustments facilitating trade
• Individual countries do not have to hold reserves
  as all are pooled
• Would encourage more co-ordination of economic
  policies
• Beneficial effects on efficiency
• Currency would become international reserve asset
  
• Help to reduce interest rates
• Help to reduce inflation
• Could facilitate overall growth and employment in
  Community    

5
POSSIBLE DISADVANTAGES

• Considerable loss in national sovereignty
• Effects might not be equally spread throughout
  Community
• Possible difficulties in dealing with crisis
  situations
• No guarantees in relation to stability of
  currency in relation to other world currencies
• Special problems for Ireland (in relation to UK
  and US currencies)
•  

6
PROGRESS TO EMU

• Stage 1 (1990-1994)    
• Completion of Internal Market
• Provision of structural funds
• Enforcement of Competition Policy
• Participation of all countries in ERM
• Stabilisation of exchange rate movements
• Exchange Rate Crisis (1992-1993)

7
PROGRESS TO EMU (con)

• Stage 2 (1994 - 1997)  
• Continuation of market liberalisation
• New round of funding
• More economic convergence
• Starting procedures for new Central Bank
• Further narrowing of currency bands

8
PROGRESS TO EMU (con)

• Stage 3
• Beginning Jan. 1999  
• Introduction of Euro
• ESCB and ECB now in operation
• Monetary Committee to be dissolved

9
EMI

• Interim arrangement (1994 1998) managed by
  council consisting of a President and Governors
  of Central Banks located in Frankfurt    
• Three Tasks
• To facilitate convergence by strengthening
  co-ordination of monetary policies
• Responsible for overseeing operation of ERM EMCF
  to be dissolved
• Required to prepare all the procedures and
  methods of control necessary when final stage was
  to arrive
•  

10
ESCB

• Assigned the task of defining and implementing
  monetary policy of community
• Foreign exchange reserves of member states to be
  centralised with ESCB
• Collaborative structure of NCB's and ECB
• Subject to review by European Court of Justice
• ECB has exclusive right to issue notes, engage in
  open market operations, impose minimum reserve
  requirements, carry out foreign exchange
  operations etc.
• Primary objective is price stability  

11
EUROPEAN CENTRAL BANK (ECB)

• Decision-making body of Euro-zone  
• Design of ECB  
• Maastricht Treaty and EMI (founded 1994)
• ECB (founded 1998)
• European System of Central Banks
• Executive Board and Governing Council of ECB  

12
EUROPEAN CENTRAL BANK (Con)

• Responsibilities of ECB  
• to maintain price stability
• to support "the general economic policies of the
  Community"
• independent of national governments and Central
  Banks
• may not lend to any Community institution or
  government
• will be concerned with one overriding objective
  of price stability  

13
MONETARY POLICY IN EMU

• Control of inflation targeting
• Control of money supply
• Government Borrowing
• - Central Bank
• - Commercial Banks
• - Abroad
• - Non-bank public
•  

14
FISCAL POLICY IN EMU

• Stability Pact
• - governments not to incur deficit over 3 GDP
• - over medium-term budgets to be close to
• balanced or in surplus
• - fines for deficits in excess of 3 but for
• exceptional cases  
• Could be major problems in the case of a sudden
  shock such as a recession  

15
MACROECONOMIC POLICY COORDINATION

• Since 1998 the ECB has managed to keep inflation
  to about 2 p.a.
• - however actual inflation has varied
  considerably between member
• states with inflation much higher in
  Ireland, Greece and the
• Netherlands and lower in Germany
• - variations in economic performance much
  greater with sharp
• slowdown eveident in Germany, France and
  Italy and boom
• conditions In Ireland, Greece and Spain
• - fears that in future ECB policy could be
  geared more to the interest
• of stronger economies such as Germany and
  France with inflation
• more difficult to control
• - fears that because fiscal policy can be be
  more effectively used in
• a common monetary zone that it could
  thereby be used irresponsibly
• by some governments

16
FISCAL POLICY AND CROWDING OUT EFFECTS

• One of the limitations on conventional fiscal
  policy is that attempts to increase government
  spending in an attempt to stimulate economic
  activity can lead to increase in interest
  rate(due to increased demand by Government for
  money to fund expansion)
• The consequent rise in interest rate can then
  depress private sector borrowing and spending
• Thus the crowding out effect is the reduction in
  private sector spending that counterbalances
  increased government spending
• Crowding out (and crowding in) effects - when
  significant can considerably reduce effectiveness
  of fiscal policy
• However in a common monetray zone because
  interest rate increases are likely to be greatly
  restricted fiscal policy potentially can be much
  more effective in each member country

17
GROWTH AND STABILITY PACT

• Set up in 1996 with a decision to
• - limit budget deficits of Eurozone members
  to no more than 3 GDP
• in a given year
• - public debt/GDP ratio not to exceed 60
• - larger deficits temporarily allowed to combat
  severe recessions
• - complicated system of penalties to be imposed
  on countries who
• break terms of agreements
• - problems in major economies of France and
  Germany - where recent
• budget recent deficits exceeeded 3 led to
  temporary abandonment
• of rules

18
EXCHANGE RATE POLICY IN EMU

• Euro and ECU
•     - responsibility for exchange rate policy
• - provision for formal agreements linking Euro
  to other currencies
•  
• In the final stage Monetary Committee to be
  dissolved and replaced by an Economic and
  Financial Committee  
• The Euro as a Global Currency  
• - importance for trade
• - importance for reserves

19
EMU AND IRELAND

• Other Options
• - setting an effective exchange rate target
• - return to sterling link
• - free floating
•  
• Political Benefits to Ireland  
• - decision making
• - economic support

20
EMU AND IRELAND (Con)

• Economic Benefits  
• - completing internal market
• - price transparency
• - reduced transactions costs
• - reduction in exchange rate uncertainty
• - scale economies  
• Economic Costs  
• - transition costs
• - difficulty in adjusting to shocks
• - loss of fiscal autonomy
• - loss of economic independence
• - loss of unemployment/inflation trade-off