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Italy & Euro: Story of a won Race

Italy & Euro: Story of a won Race. What did Italy gain from joining the European Monetary Union Roberto Piazza. The Monetary Union Today. 1989: Delors Report, preparing the EMU. Stage One: Increased co-operation between central banks Stage Two: Establishment of the ESCB

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Italy & Euro: Story of a won Race

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  1. Italy & Euro: Story of a won Race What did Italy gain from joining the European Monetary Union Roberto Piazza

  2. The Monetary Union Today

  3. 1989: Delors Report, preparing the EMU • Stage One: Increased co-operation between central banks • Stage Two: Establishment of the ESCB • Stage Three: Fixed exchange rates between national currencies and their replacement by a single European currency.

  4. 1993: Maastricht Treaty, the Rules of the Game • Inflation must not exceed by more than 1.5% that of low inflation countries. • Deficit/GDP ratio lower than 3%. • Cumulative Public Debt/GDP ratio converging to 60%.

  5. 3 May 1998: The Day of The Exam Heads of State and Government decide which States fulfill convergence criteria and would take part in the euro from 1 January 1999.

  6. 1993: Italy at the Starting Line • Excess Inflation (limit 1.5%) 3,1% • Deficit/GDP (limit 3%) 9.5% • Debt/GDP (limit 60%) 120%

  7. 1993-1998 Studying Hard to Pass The Exam First Criterium: Convergence in Inflation

  8. Convergence in Inflation:DONE!

  9. Which are the effects of high Inflation? • Prices change a lot, choices become very uncertain. • Some goods become relatively more expensive than others, some people gain, some people loose: uncontrolled wealth redistribution. • Value of Money is lower, “currency is weaker”, goods becomes chepear to EXPORTS! Disadvantage Disadvantage Advantage

  10. What Italy lost because of reduced inflation

  11. 1993-1998 Studying Hard to Pass The Exam Second Criterium: Deficit/GDP Ratio • Deficit: For a given year, government spending in excess of taxes collected. • GDP: Income of a country for a given year.

  12. Convergence in Deficit/Gdp:DONE!

  13. How was deficit reduced? • Higher taxes • Lower Government Spending

  14. 1993-1998 Studying Hard to Pass The Exam Third Criterium: Debt/GDP Ratio • Public Debt : Accumulated Deficit, total money that Government owes to lenders

  15. Convergence Debt/Gdp? ALMOST!

  16. Italy wins the race: 1 January 1999 Birth of the €uro

  17. What did Italy gain from EURO? Huge reduction in Interest Rate! From 9% to 0.2%

  18. Why Iterest Rates Converged? • Interest Rates between Debt in Lira and in Mark related by iIt - iGer=%Change in Exchange RateLira/Mark (Example: if Lira Depreciates with respect to Mark, it’s less valuable to invest in Lira, so higher iIt needed) • With unique currency, EURO, Exchange Rate is Fixed iIt=iGer

  19. Why Interest Rate Reduction is Important? • Suppose you have $100 debt, and interest rate is 9% per year. After 10 years debt is 100*(1+9%)10=$ 236 • If the interest rate is 1%, after 10 years debt is 100*(1+1%)10=$ 110

  20. Why is Interest Rate Reduction Important? • Italy’s Public Debt is Huge 2 trillion dollars (110% GDP) • With interest rate of 1% instead of 9% Italian Government saves in 10 years 2*(1+9%)10- 2*(1+1%)10= 1 trillion dollars

  21. Conclusion: Overall a Success • Italy Succeded in meeting Maastricht criteria. • Adjustment was painfull: Increased Taxes, Public Budget Cuts. • Italian Macroeconomic Variables (Inflation, Interest Rate, Deficit/Gdp) have converged to those of strong European Economies.

  22. Conclusion: Overall a Success • Italy has lost competitivness in Exporting. • Italy has stabilized Public Finances through interest rate reduction.

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