Download Notes on the European Monetary Union Elements of the EMU: free

Notes on the European Monetary Union
Elements of the EMU:
 free movement of capital
 a single currency whose issue is authorised by the ECB.
 control of national deficits (Stability and Growth Pact, Fiscal Compact, 2 Packs, 6 Packs)
 Coordination and surveillance of national economic policy
 broad economic policy guidelines.
As follows:
Article 3(4) TEU
The Union shall establish an economic and monetary union whose currency is the euro.
Article 119 TFEU
1. For the purposes set out in Article 3 of the TEU, the activities of the Member States and the Union shall include, as
provided in the Treaties, the adoption of an economic policy which is based on the close coordination of Member
States’ economic policies, on the internal market and on the definition of common objectives, and conducted in
accordance with the principle of an open market economy with free competition.
2. Concurrently with the foregoing, and as provided in the Treaties and in accordance with the procedures set out
therein, these activities shall include a single currency, the euro, and the definition and conduct of a single monetary
policy and exchange-rate policy the primary objective of both of which shall be to maintain price stability and,
without prejudice to this objective, to support the general economic policies in the Union, in accordance with the
principle of an open market economy with free competition.
Free movement of capital
It has to be possible for people in one part of the Union to make investments and payments for assets in other
parts of the Union. National restrictions on payments and investments, which limit the movement of capital
from one part of the Union to another, in principle, therefore have to be abolished. Alongside this, if there is
not a single currency all currencies have to be fully convertible. That is to say there should be no limits on the
amount of one legal tender that can be exchanged into another EU legal tender. Otherwise, it would be
possible to limit the amount that could be invested in a state with another legal tender. To this end, Article 63
TFEU prohibits, subject to certain limited exceptions, restrictions on the free movement of capital and
payments. (Chalmers et al.)
Article 63 TFEU
1. Within the framework of the provisions set out in this Chapter, all restrictions on the movement of capital
between Member States and between Member States and third countries shall be prohibited.
2. Within the framework of the provisions set out in this Chapter, all restrictions on payments between Member
States and between Member States and third countries shall be prohibited
A single currency whose issue is authorised by the ECB.
The model of EMU adopted by the Union requires a single currency issued by a central bank, the European
Central Bank (ECB). Based in Frankfurt, this bank has a monopoly over the authorisation of the issue of the euro
and over the setting of short-term interest rates as these set the terms at which it will lend money to financial
institutions. (Chalmers et al.)
Article 128 TFEU
1. The European Central Bank shall have the exclusive right to authorise the issue of euro banknotes within the
Union. The European Central Bank and the national central banks may issue such notes. The banknotes issued by the
European Central Bank and the national central banks shall be the only such notes to have the status of legal tender
within the Union.
2. Member States may issue euro coins subject to approval by the European Central Bank of the volume of
the issue . . .
Control of national deficits:
The Delors Report talks of ‘binding rules governing the size and the financing of national budget deficits’
(paragraph 30). The philosophy behind this is that excessive borrowing (in other words the running of an
excessive deficit) by one government creates costs for other governments. To finance the deficit the borrowing
government will have to turn to the capital markets to borrow the money. These will insist on higher interest
rates for the currency both to offset the risk of the greater size of the debt and as a price for payment. This
penalises other states who now have to borrow on less favourable terms. This can in turn lead them to
pressurise the central bank to reduce short-term interest rates, which, as this affects the cost of borrowing for
investors, will in turn lower long-term interest rates. Alternatively, to counter inflationary pressures generated
by excessive borrowing, the central bank may increase short-term interest rates, thus penalising governments
who have not borrowed in this way. The TFEU therefore prohibits excessive government deficits. (Chalmers et
al.)
Article 126(1) TFEU
Member States shall avoid excessive government deficits.
The controls on national budgets and the coordination of economic policy are known as the Stability and Growth
Pact. It comprises the following instruments. Resolution of the European Council on the Stability and Growth Pact
[1997] OJ C236/1; Regulation 1466/97/EC on the strengthening of the surveillance of budgetary positions and the
surveillance and coordination of economic policies [1997] OJ L209/1; Regulation 1467/97/EC on speeding up and
clarifying the implementation of the excessive deficit procedure [1997] OJ L209/6; Regulation 1055/2005/EC
amending Regulation 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance
and coordination of economic policies [2005] OJ L174/1; and Regulation 1056/2005/ EC amending Regulation
1467/97/EC on speeding up and clarifying the implementation of the excessive deficit procedure [2005] OJ L174/5.
A simple injunction is not seen as sufficient. A procedure is put in place, therefore, the Excessive Deficit
Procedure, which places the determination of whether there is an excessive deficit in the hands of the
Commission and the Council. If they find an excessive deficit, recommendations will be made to the Member
State. It can then be warned and even strongly sanctioned if it does not reduce the deficit.
The Stability and Growth Pact therefore had a preventive and a corrective mechanism.
Coordination and surveillance of national economic policy
Other instruments, notably fiscal policy, can be as important as monetary policy in managing the economy.
Thus, if the European Union is experiencing strong growth this can be reduced by high interest rates, but this is
countered if Member States continue to engage in significant public spending. By contrast, if the Union is in
recession, it may no longer be possible to lower interest rates, in which case government spending becomes
important. Within a monetary union with a single interest rate, national policies have to be coordinated on this
if they are to support each other and not cancel each other out. In addition, some states (notably France)
argued for an EU dimension to fi scal policy by proposing European economic government in which fiscal policy
would be coordinated at EU level. There is therefore coordination of national economic policy within the
Council. (Chalmers et al.)
Article 120 TFEU
Member States shall conduct their economic policies with a view to contributing to the achievement of the
objectives of the Union, as defined in Article 3 TEU, and in the context of the broad guidelines referred to in Article
121(2). The Member States and the Union shall act in accordance with the principle of an open market economy with
free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in
Article 119.
Article 121(1) TFEU
Member States shall regard their economic policies as a matter of common concern and shall
coordinate them within the Council, in accordance with the provisions of Article 120.
This coordination is not just about aligning national economic policies. It is also about guiding them. A
commitment to coordination has been judged not to be sufficient. There must also be surveillance of whether
national policies are actually coordinated both with each other and with the policies of the ECB. This
coordination and surveillance is known by the institutional levers that guide it: the broad economic policy
guidelines. EMU therefore has four dimensions: free movement of capital, a single monetary policy, constraints
on excessive government deficits and broad economic policy guidelines. However, these arrangements cannot
be seen in a vacuum. There is a mission underlying these institutional arrangements, which both provides a
partial explanation for them and constrains the actors in the exercise of their powers under this regime. It is
that of securing price stability. (Chalmers et al.)
Article 128(3) TFEU
These activities of the Member States and the Union shall entail compliance with the following guiding principles:
stable prices, sound public finances and monetary conditions and a sustainable balance of payments.
Some critics have observed that it is highly unusual to entrench an economic objective in this way, so that it
becomes a constitutional imperative. Although the Treaties borrowed heavily from the successful post-War
German monetary model, they noted that traditionally the commitment to low inflation was not so
constitutionally entrenched there. The decision to control inflation is a political choice which invariably carries
both benefits and costs. There is also a concern about fighting yesterday’s wars. To be sure, concerns about
high inflation dominated debates in the 1970s and 1980s leading up to the decision to establish the euro. It is,
however, simply not possible to know what the most significant economic evil will be considered to be in the
future. To tie the Union’s objectives to one single issue, albeit a highly significant one, is thus both dogmatic
and holding the Union’s institutional arrangements open to fortune.
the convergence criteria
– the annual government deficit should not exceed 3 per cent of GDP and the total government debt should
not exceed 60 per cent of GDP;
– an annual rate of inflation not more than 1.5 percentage points above the three best performing Member
States;
– participation within the exchange rate mechanism for at least two years, without devaluing against the euro;
– long-term nominal interest rates that are not more than 2 percentage points above the three best performing
states in terms of price stability.
Although there are some slight differences, the obligations of Denmark, the United Kingdom and the states
‘with a derogation’ are similar:
• the free movement of capital rules apply fully to them;
• the euro is not legal tender within their jurisdictions; they are not bound by measures concerning use of the
euro and they do not take part in the tasks of the European System of Central Banks (the network of central
banks that administers the euro);
• whilst a finding can be made that they have an excessive deficit, they cannot be required to take steps to
remedy it or be sanctioned for failing to do so;
• they are guided by the broad economic policy guidelines unless these relate specifically to the euro area.
These states are also denied certain entitlements. They do not take part in the governing arrangements of the
European Central Bank or the appointment of its members. This is uncontroversial. As the euro states do not
run their monetary policy, there is no reason why they should contribute to the running of the monetary policy
of the euro states. More controversial is their exclusion from the Euro Group. Established as an informal group
in 1999, this comprises the finance ministers of the euro states, the ECB and the Commission. This group
discusses questions related to the specific responsibilities these all share in relation to the single currency. The
Euro Group is seen as extremely powerful. It meets before the Council meets, and is seen as an ante-chamber
for discussing all questions of economy policy within the Union, pre-empting decisions that might subsequently
be taken in the Council. It is also the place where most political feedback or pressure is placed on the European
Central Bank by
finance ministers over its interest rate policies. The first President of the Group, Jean-Claude Juncker, publicly
stated in 2005 that in his view inflation was under control and warned the ECB that a rise in interest rates could
hit growth in the euro-zone. There is a dual concern, therefore. The Group could, first, decide matters over
which other states are entitled to a voice under the Treaty arrangements, notably on coordination of economic
policy. Secondly, it could erode institutional arrangements, most notably by putting pressure on the ECB, which
might have negative effects for the whole Union and not just the euro-zone. It was initially accepted by the
other states, notably the United Kingdom, on the condition that the Euro Group remain informal. It has,
however, been, granted a formal status and recognised by the Lisbon Treaty. It remains to be seen whether
this affects its power. (Chalmers et al.)
The PROBLEMS with the provisions of the TEU and the TFEU and the negotiations on the Treaty on
Stability, Coordination and Governance in the Economic and Monetary Union in 2012.
The recent financial crisis in the Eurozone, made it clear that despite the Stability and Growth Pact
(SGP) stipulated in the TFEU, some Member States could no longer service their public debt and
needed bailout. This put a tremendous pressure on the Eurozone countries to analyse the effectivity
of the then existing rules and to agree on the possibility of an ever closer fiscal policy. The questions
raise were (i) why did the (early) warning system of the SGP fail (i.e.: the problem of gathering
information) and (ii) how to convince the Member States to cooperate in their expending policies
(i.e. the problem of enforcement). Both questions strike the roots of state sovereignty, therefore
need caution.
ad (i) The problem of gathering information.
In a democratic market system, the markets have to have information in two ways: (a) they have to
know and be able to evaluate the real figures of public debts and (b) they have to have information
about what the governments would do in case of excessive public deficits. This means that the
markets valuation matters. (see the problems of borrowing from the market in the event of excessive
deficit, described above).
For this reason Member States were to report annually on their budget situations and the
Commission was to evaluate them thereby enabling the Council to make decisions on these issues
individually. It seems that the responses of the Commission were not always taken seriously.
Markets need information on the possible reaction of the governments in cases of excessive deficits.
The expectation of a potential bailout or a creditable sign that the government would not bailout is
very important. Generally it could be said, that the government is causing problems to the market
with bailing out. This often happens since politicians are elected for shorter terms, than the period of
any crisis. Therefore accountability (voters rights) should be even more important in fiscal policy
issues.
It should be noted however, that governments, on the other hand, need the room for
manouvre in cases of fiscal policy, since this is the core facilities of their politics. And
also, voters may well be biased and force beneficiary decisions at the expense of next
generations. (e.g. public support of welfare state issues financed not by tax but by
credits, which are to be serviced by future generations).
No information results in higher interest rates. Although the SGP had no provisions on government
bailout, in fact it punished the continuous excessive deficits (see Protocol XII of the TFEU), in reality,
this was what happened (see e.g. the Greek case).
ad (ii) The problem of enforcement
Here the question is what sort of system allows that market plays according to the rules and the
government is regulated.
First generation of fiscal rules.
a. expenditure caps rule
b. exit clause or allow the suspension of fiscal rule when the economy is especially weak
(original version of Stability and Growth Pact in the EU foresaw the automatic suspension if
economic growth was lower than -2% of GDP)
c. to make the balanced budget rule based on the economic cycle, so that the government is
allowed to run deficits when the economy is weak but also has to run surpluses when the
economy is strong (Sweden, Norway)
Second generation of fiscal rules = Debt break rule.
a. Any deviation from the target of the (balanced or suspended) budget rule goes into an
adjustment account, and if the adjustment account has a deficit of more than 6% of last
year’s spending, it has to be corrected within three years (Swiss rule 2004 + German debt
break rule of 2010).
This notion is based on the economic cycle and in deep crisis with an absolute
majority of Bundestag votes may suspend the rule (= “exit clause”), while the
Bundestag must also pass an amortisation plan to repay the extra amount.
b. need to combine it with an expenditure cap. It requires the definition of detailed targets and
subtargets and not just an overall expenditure cap. However such would require a political
agreement on priorities of the government and will not be easy to achieve.
Such provisions are inserted in most of the Constitutions of the Member States.
The Fiscal Compact of 2012
Therefore for a better enforcement of the fiscal policy the Treaty on Stability, Coordination and
Governance in the Economic and Monetary Union was negotiated among the Member States in
2012. (The Fiscal Compact).
This Treaty was agreed to strengthen the economic pillar of the Economic and Monetary Union by
adopting a set of rules intended to foster budgetary discipline through a fiscal compact, to
strengthen the coordination of economic policies and to improve the governance of the euro area,
thereby supporting the achievement of the European Union's objectives for sustainable growth,
employment, competitiveness and social cohesion.
The Treaty applies in full to Member States whose currency is the euro. Member States with
derogations may join the Treaty.
In fact, the UK and the Czech Republic are the only Member States who did not sign the Treaty, and
that is why it did not become the part of the TEU and the TFEU but remained as a separate covenant.
This Treaty entered into force in January 2013.
The most important article is as follows: (further articles stipulate some conditions, of course...)
TITLE III: Fiscal Compact
Article 3.
1. The Contracting Parties shall apply the following rules, in addition and without prejudice to
the obligations derived from European Union law:
a) The budgetary position of the general government shall be balanced or in surplus.
b) The rule under point a) shall be deemed to be respected if the annual structural
balance of the general government is at its country-specific medium-term objective as
defined in the revised Stability and Growth Pact with a lower limit of a structural
deficit of 0.5 % of the gross domestic product at market prices. The Contracting
Parties shall ensure rapid convergence towards their respective medium-term
objective. The time frame for such convergence will be proposed by the Commission
taking into consideration country-specific sustainability risks. Progress towards and
respect of the medium-term objective shall be evaluated on the basis of an overall
assessment with the structural balance as a reference, including an analysis of
expenditure net of discretionary revenue measures, in line with the provisions of the
revised Stability and Growth Pact.
c) The Contracting Parties may temporarily deviate from their medium-term objective
or the adjustment path towards it only in exceptional circumstances as defined in
paragraph 3.
d) Where the ratio of government debt to gross domestic product at market prices is
significantly below 60 % and where risks in terms of long-term sustainability of public
finances are low, the lower limit of the medium-term objective specified under point
b) can reach a structural deficit of at most 1.0 % of the gross domestic product at
market prices.
e) In the event of significant observed deviations from the medium-term objective or
the adjustment path towards it, a correction mechanism shall be triggered
automatically. The mechanism shall include the obligation of the Contracting Party
concerned to implement measures to correct the deviations over a defined period of
time.