The European Monetary Union (the eurozone )

1. The European Monetary Union(the eurozone) www.theglobaleconomy.com

2. About the slides The presentation is part of an open source project with free resources on the global economy. For more information visit: www.theglobaleconomy.com Please modify and use the slides as you see fit. They can be used along with the complete guide to the eurozone available here: Practical guide: PDF and interactive version www.theglobaleconomy.com

3. Contents • Basic facts about the EMU … slides 3-7 • The dollar-euro exchange rate … 8 • Indicators of the member countries … 9 • The economic benefits of the EMU … 10-11 • The economic costs of the EMU … 12-14 • When does a monetary union work well … 15-18 • Should Europe have a monetary union … 19-20 • The current crisis … 21-26 • Integration road map … 27 • Further exploration … 28 www.theglobaleconomy.com

4. What is the EMU • The European Monetary Union (the eurozone) is a group of 17 countries that use the same currency called the euro. • They have the same central bank that conducts monetary policy. It manages the interest rates and the rate of inflation for the entire union. www.theglobaleconomy.com

5. The 17 eurozone members on a map(Kosovo and Montenegro, in light blue, use the euro but are not EMU members) www.theglobaleconomy.com

6. Quick facts about the eurozone • Headquarters of the European Central Bank: Frankfurt, Germany • The President of the European Central Bank: Mario Draghi • Members of the eurozone: 17 • Members of the EU that are not in the eurozone: 10 • Introduction of the euro: 1999as “virtual currency”; 2001 physical implementation • Population of the eurozone in 2011: 334million • Gross Domestic Product in 2011: 13.1 trillion dollars • Unemployment rate in 2010: 10.0percent • GDP per capita in 2011: 39,267dollars • Public debt in 2009: 64.7percent of GDP www.theglobaleconomy.com

7. What the euro currency looks like www.theglobaleconomy.com

8. How big is the eurozone economy? The GDP of the eurozone was about 12 trillion dollars in 2010, compared to 16 trillion dollars for the entire European Union and 14 trillion dollars for the U.S. www.theglobaleconomy.com

9. The euro-dollar exchange rate The euro has appreciated against the dollar since 2001; that trend was somewhat reversed during the financial crisis. Euro per one U.S. dollar www.theglobaleconomy.com

10. Economic indicators of the member countries Click on the link below to see the following indicators for the 17 member countries, the U.S., the EU, the EMU, and world averages. - GDP - GDP per capita - population - unemployment rate and - government debt Economic indicators www.theglobaleconomy.com

11. The economic benefits of the EMU Having the same money eliminates currency conversion costs and currency risks. As a results, international trade and investment increase. Exports as percent of GDP www.theglobaleconomy.com

12. Economic benefits continued… As monetary policy is handled at a central level, some countries with traditionally high inflation rates now enjoy lower inflation. The inflation rate in Greece www.theglobaleconomy.com

13. Economic costs of the EMU With the same currency and common monetary policy, the interest rates on deposits and credits become similar. Interest rates on bank credit in Italy and the Netherlands www.theglobaleconomy.com

14. Having similar interest rates could be a problem Rapidly growing countries need higher interest rates and countries that grow slowly need low interest rates. Notice how different the economic growth rates across the eurozone are . GDP growth rates www.theglobaleconomy.com

15. The one-size-fit-all policy On the chart it is clear that Germany and Spain have been affected differently by the crisis. Should the European Central Bank base its policy on what is happening in Spain or in Germany? It cannot appease both. Unemployment rate www.theglobaleconomy.com

16. A one-size-fit-all policy does not fit anyone • How can the union function then? - Labor mobility between the countries. - Wages are flexible - Fiscal union • We look at each separately www.theglobaleconomy.com

17. Labor mobility (example) • Spaniards move to Germany. • The unemployment rate in Spain declines and it may increase somewhat in Germany. • The unemployment rates in the two countries become similar. • The one-size-fit-all policy is then not a problem. www.theglobaleconomy.com

18. Wage flexibility (example) • Wages in Spain drastically decline. • Then, Spanish goods and services become more competitive and Spanish exports to Germany and other countries increase. • That leads to lower unemployment in Spain. www.theglobaleconomy.com

19. Fiscal union (example) • German taxpayers make payments to unemployed people in Spain. • That gives a boost to the Spanish economy while the extra tax burden slows down the German economy. • The economic conditions in Spain and Germany become similar and the one-size-fit-all policy is not a problem. www.theglobaleconomy.com

20. Do these conditions hold in Europe? • Generally no. • There is limited labor mobility because of language and cultural barriers. • Wages are not very flexible because of long-term contracts and collective bargaining. • The member countries have decided not to coordinate tax collections and expenditures. www.theglobaleconomy.com

21. Why was the EMU formed then? • A political decision. • The euro is supposed to foster further economic, political and fiscal integration. • Over time, that integration could create the conditions necessary for a monetary union. www.theglobaleconomy.com

22. The current crisis Imagine the following scenario: • One of the member countries of the EMU cannot pay its international debts. • The banks that lent money to that countrytake losses. • Other governments are pressured to spend money to support the banks. • These other governments also go into fiscal trouble and may stop paying their international debt. • And so on, more and more governments and banks become insolvent and the EMU economy collapses. www.theglobaleconomy.com

23. Maastricht treaty To avoid that scenario, the EMU member states have to comply with the fiscal requirements set out in the Maastricht treaty: • Budget deficits no greater than 3 percent of GDP • Government debt no greater than 60 percent of GDP www.theglobaleconomy.com

24. Too much government debt in Greece Greece had high debt (much higher than the Maastricht treaty requirement) even before its entry into the eurozone. During the crisis its debt increased even more and could not be paid. Government debt as percent of GDP www.theglobaleconomy.com

25. Too much bank credit in Spain Spain had low public debt but its banks gave too many credits too fast. The credits were backed by property. When real estate prices fell, banks were in trouble. Bank credit to the private sector as percent of GDP www.theglobaleconomy.com

26. Lack of competitiveness The two countries also lack international competitiveness, evident in the large trade deficits. They would have devalued their currencies to gain competitiveness. Being in the eurozone, however, that option is not available. Trade balance as percent of GDP www.theglobaleconomy.com

27. Other problem countries Explore the economic indicators of the other problem counties in the eurozone: • Italy • Ireland • Portugal You can also use this tool to compare them to other countries: • Compare countries www.theglobaleconomy.com

28. Integration or collapse • To survive, the eurozone countries have to take further integration steps in terms of fiscal, economic, and political union. • Indeed, they are trying to do that. Here is the new proposed road map (June 2012): Integration road map www.theglobaleconomy.com

29. Further exploration Answer the following questions, based on the practical guide, individual research, and data from www.thegobaleconomy.com: • Why does the UK stay out of the eurozone? • Will the business cycles (the economic ups and downs) of the EMU countries become more similar over time? • Should all East Europeans countries join the eurozone? www.theglobaleconomy.com