Euro – Benefits, Costs and Risks

1. Euro – Benefits, Costs and Risks Juraj Karpiš www.INESS.sk karpis@iness.sk

2. Topics • EU and Euro • Benefits as NBS sees them • Risks and costs as I see them • Is there an alternative?

3. I know that • Slovakia agreed before entering EU to adopt Euro in the future • We don’t have an official opt-out option as Denmark or UK have although there is a way: de facto opt – out (after NO in 2003 referendum) of Sweden • The majority of Slovaks support Euro • European Commission suggested in its latest report that we are ready = very probable that we adopt EUR in a month

4. Centralization There should follow deeper integration: one constitution, one currency, common foreign policy, common defense, harmonized taxes, central gvmnt. Goal: European Super-state Competition EU should only grant freedom of movement of : people goods services capital Goal: free trade and cooperation in Europe 50 years EU, two different views about future direction:

5. Benefits of Euro according to NBS Direct (immediate): • Abolishing exchange rate risks 0,02% GDP • Lower costs of capital • Lower transaction costs - 0,36% GDP • Transparency of prices Indirect (long-term) • Higher volume of international trade (allows deeper specialization) • Increased direct investments • Faster growth, higher living standards I would add: • PR for Slovakia – it’s a good sign that Slovakia is ABLE to adopt Euro • Hard limits for irresponsible politicians – “Maastricht leash”

6. Costs and risks according to NBS • One time expenses for currency change 0,3 to 0,8% GDP • Loss of some bank profits and temporary higher costs of banks • Loss of independent monetary policy as a tool for stabilizing economy • Probably slightly higher inflation rate NBS: Benefits are much higher than costs => Euro ASAP

7. Problems • Euro is a political construct, has not its own history and is not a choice of consumers • Currency change is a complicated process and its impossible to quantify its effect with precision • Factors that we can quantify (or we think that we can) are not automatically more important than factors thata we are not able to quantify • Costs and benefits can be reasonably used only when we talk about individuals not about nation. Costs and benefits are not evenly distributed. Some people will bear costs, other benefits.

8. Is Euro a Condition for Strong Economic Growth?Real Growth of GDP Euro Area Countries Noneuro Area Countries S-Sweden, UK – United Kingdom, D - Denmark F – France, G – Germany, I-Italy

9. Costs and Risks as I see them: Heavy wallets!

10. Costs and Risks as I see them: • Lack of real convergence – therefore inflationary pressures – depreciation of savings • Monetary policy not suited for Slovak Business Cycle • Centralization – all eggs in one ECB basket, less currency competition and flight opportunities • Arbitrariness in setting final exchange rate - impact on wealth of Slovak citizens • The biggest countries ignore Stability pact therefore we might in the future bear the risks of costly pension systems of the biggest euroarea countries (ITA, DE, FR)

11. Euro is in the long term inflationary • Hindering of currency competition which forced national central banks to behave responsibly or else flight to other currencies • Probable future pressure on expansive monetary policy to cover deficits of costly social systems of biggest euro areal countries • Euro makes fiscal free riding possible “ • Easier coordination in monetary expansion between world CBs

12. Entry – Strictly Political Decision • Maastricht Criteria and Stability Pact – designed by old member states for old member state • Introduced „to persuade German voter that the Italians will behave“ • They were not designed to measure if the entering country is ready : they measure nominal not real convergence • Real convergence issues are being downplayed and not discussed • Problematic criteria – exchange rate, inflation (reference countries in the case of Slovakia were Malta – EUR 2008, Denmark- no EUR, UK-no EUR)

13. Stability pact – does anyone care? • The biggest countries of euroarea ignore the Stability pact’s criteria • Greece entered the euro-area with the help of phony statistics

14. Problems Ahead Fiscal deficits as a % of GDP in the largest euro-countries

15. Where is the Real Convergence?Price level in Slovakia was only 58%of the EU average in 2006Price level and GDP per capita in Slovakia as % of EU averageGDP per capita Relative Price level

16. 25% in 4,5 Years CentralParity after entering ERM II 28.11.2005 38,455 New CP 19.3.2007 35,4424 They did it agian 29.5.2008 30,1260

17. Oil costs Slovaks today 25% less than it would, if we fixed SKK to EUR already in 2004.

18. Which means: Convergence of price levels only by the way of absolute price increases Higher inflation + Negative real interest rates = Devaluation of citizen’s SKK savings

20. Just a Dip? According to Convergence Report 2008 byEC Slovakia fulfills the criterion on price stability The question is FOR HOW LONG?

21. Example of Slovenia – Will We Follow?

22. What Can Slovak Government do About it? Only fiscal policy is left – decrease in public expenditures But how realistic is that expectation? The 13. pension for retirees is in making…..

23. Loss of control over monetary policy • Do they know (executive board ECB) what currency we need? • Control in the hands of people, on which Slovak won’t have any influence • No feedback – probability that you meet Mr. Trichet in the streets of your town is by magnitude lower than the probability that you meet Mr.Sramko • We will have to accept monetary policy of ECB which will be dictated by the needs of biggest countries – do we need lower interest rates when we grow double digit a year? (base rate 4.25% vs. 4,0%)

24. Is there an alternative? Let them compete ! Parallel circulation – legalize the use of other currencies in Slovakia as a legal tender (EUR, USD, SFR others) and let the people choose - exchange risk eliminated, lower transaction costs

25. Conclusion • Euro as a tool for further political integration, moves control far away from citizens – it is a way of centralization • Lack of real convergence – risk of higher inflation and saving devaluation • The biggest countries don’t fulfill the Maastricht criteria – inflationary risks in the future • Loss of control over monetary matters Therefore we should wait or not enter at all.

26. Thank You www.INESS.sk karpis@iness.sk