EMU Klas Fregert Department of Economics Lund University

1. EMUKlas FregertDepartment of EconomicsLund University

2. Theme: Accommodation of national interests in EU/EMU for the common good Contents: What is EMU? Gains and losses Rules Past: The road to EMU Present: The first years Future: Risk and reforms

3. What is EMU? Common monetary policy governed by European Central Bank in Frankfurt (ECB) from 1 Jan. 1999 Irrevocably fixed exchange rates between 11, now 12, countries, ”The ins” Common currency from 1 Jan 2002: Common currency (notes and coins) and unit of account, the euro

4. Three ”outs” Exempted in Maastricht treaty: Denmark, United Kingdom “Not qualified”: Sweden (not in ERM): 56 % No-vote in fall 2003 (New members)

5. Economic gain (long-run) Trade frictions ¯ Þ Trade ­Þ Increased specialization Þ higher productivity through comparative advantage and large scale production Þ GDP per capita ­ Þ Welfare ­ Large gain if: Nation is trade dependent (small) EMU helps creating inner market

6. Economic loss (short-run) No national monetary policy to counteract nation-specific (asymmetric) shock Small loss if: 1) Small risk for asymmetric shock or 2) easy adjustment to asymmetric shock: Flexible labor markets, or Large scope for international labor mobility, or Efficient fiscal policy

7. Rules 1. Rules for ECB (Maastricht, 1991) EU-level monetary policy 2. Stability and growth pact, SGP, 1998 National fiscal policy

8. ECB goal Intermediate, legal goal: Price stability, defined as: Between 0 and 2 per cent inflation Wider goal of EMU: increased welfare through 1) higher long-run growth (efficiency) and 2) more macroeconomic stability

9. European System of Central Banks – ESCB National central banks (NCB) European central bank (ECB) ESCB governed by: The General Council of the ESCB The Governing Council of the ESCB The Executive Board of the ECB

10. 15 national central bank governors in EU and chairman and vice chairman of ECB executive board Surveillance of the economy in non-EMU countries Prepares the introduction of the euro in the new countries The General Council of the ESCB

11. The Governing Council of the ESCB National central bank governors in the 12 EMU countries and the members of the executive board (6): 18 members. Council meets every other week to decide monetary policy Must work for price stability in the whole euro area: average inflation weighted by country size

12. Voting at ECB Council 18 total votes Board 6 votes Board exclusive right to formulate propositions to vote on Board votes to stabilize EMU average. 6+3 wins: EMU average outcome of voting (average wins over median vote)

13. Independence of governing board Members Can not receive directives Directors have long (8 year) mandates Can not be reelected Motivation for independence: Credibility of low inflation high since short-term motivation to increase inflation to achieve a) lower unemployment or b) reduce value of government debt is minimized ECB modeled after Bundesbank

14. Control of ECB Reports to European Parliament Press conferences No minutes published

15. The stability and growth pact Budget deficit < 3 % of GDP Government debt < 60 % of GDP Exceptions: budget deficit > 3 %, if serious downturn (real GDP growth < 0,75 %) Government debt > 60 %, if debt is decreasing.

16. Purpose of Stability and growth pact (SGP) Avoid spill-over effects: Rising interest rates Risk of financial crisis Inflation through ECB buying government debt (= printing press financing) The Bail-out problem: The ”too large to fail syndrome”

17. Sanctions Interest-free deposit =0,2% of GDP + 10% of the deficit that is over 3% The deposit is transformed to a fine if the deficit still is above 3% after three years Commission issues recommendations and warnings acc. to Excessive Deficit Procedure (EDP) Council (ECOFIN) must decide on sanctions Commission sued the Council at the European Court of Justice for breach of SGP. Guilty verdict June 2004, but with no repercussions. Sanctions effectivley scrapped through revisions March 2005. See Council regulation No 1056/2005 (”Orwellian Newspeak” acc. to The Economist Mar 23, 2005).

18. The road to EMU Rome treaty 1957: The inner market 1971: the Werner plan 1979: EMS and Ecu 1985: Unity act, The inner market 1989: The Delors report 1991: The Maastricht treaty 1996: The stability and growth pact 1999: EMU, common monetary policy 2002: Euro as cash and unit of account

19. Forces Interaction between political initiatives and legal procedure with binding agreements Focus on gains Focus on inner market EMU a political and economic project The German reunification 1989

20. The first years Plus: Stable euro Stable inflation Increased financial integration

21. The first years cont. Minus: Relatively large spread of business cycle positions and inflation across members Debate over ECB goals, procedures and accountability Breach of SGP Low growth: Too restrictive monetary policy? Big external shocks Euro not large reserve currency

22. The future:Monetary policy: risks and reforms 1. Enlargement: average EMU inflation target threatened by many small countries reform: new voting procedure to lessen influence of small countries 2. Central lender of last resort + national bank supervision Þ increased risk for system-wide financial crisis reform: European-level bank supervision 3. Degree of short-run stabilization reform: increased accountability for ECB

23. Fiscal policy: risks and reforms Counteracting asymmetric shocks: reforms EU fiscal policy transfers Labor market reforms Increased labor mobility Change SGP: Scrap deficit rule, only debt rule redefine deficit as structural (cyclically adjusted) deficit to avoid pro-cyclical policy spending limits and other national institutional safeguards

24. Internet resources ECB: www.ecb.int EU Commisssion: europa.eu.int/euro/ Corsetti Europage: www.iue.it/RSCAS/Research/Eurohomepage/