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XXI. The Birth and Crisis of the Euro XXI.1 Euro – political or economic project? Some history • Post-war reconstruction and European integration – Joint control over basic startegic commodities (ESCS), agricultural production (CAP), strategic R&D (Euroatom) and liberalization and common (later internal) market (EHS) – European social model – European institutional structures • Economic success, political legitimacy • Circle of European politicians and intellectuals with clear goal, determined already during WWI – Federative state with pan-European legislative, judiciary and executive powers – Common currency was a political goal Way to EMU • Haag summitt (1969): Werner report – Neither common currency, neither European Central Bank • Break-up of B-W system 1971, European exchange rates management (Snake), EMS a ECU (1979) – EMR, parity grid, mandatory intervention, D-Mark supremacy – Economic and political reality in Europe (competitive devaluations) and globally (Plaza Agreement 1985, see L…) • Strong pro-federal political personalities (Jacques Delors as EC Chairman since 1986) Hanover summit 1988: road map to EMU – Delors Report • Clear-cut strategy, common currency still just one of the alternatives Political trigger: German unification 1990 • Concerns about economic power of unified Germany – DEM and Bundesbank will become decisive European currency and central monetary institution • Other EU countries, notably France: pressure on Germany to speed up the introduction of Euro • A political trade-off: support for German unification traded for German support to Euro – Economists, bankers and bureaucrats then simply had to find a solution – Problem: countries in question did not fulfill the necessary conditions for the efficiency of common currency (not optimal currency are, OCA) Solution- concept • Limitation: “impossible trinity“ • Three condition for internal market – Free capital flows – Stable exchange rates – Stable price level • Theory: on national level, only two policy tools can be pursued at once – Capital mobility is a definitional characteristic of internal market, so either policy, ensuing price stability (i.e. monetary policy) or policy, stabilizing ExR, had to be transferred on federal, European level • Recent difficult experience (1970s and 1980s): ExR volatility plus political will to create EMU: – ExR policy: irreversible fix Euro – Pan-European monetary policy ECB Solution- convergence • OCA similarity of economic (real and structural), but also cultural, historical a political characteristics of the countries in question – In 1990, it was clear that this will not be fulfilled in expected time horizon • Instead, nominal criteria substitute the real convergence – inflation, deficit, debt, interest – Maastricht criteria Solution- required policies • Creation of ECB • Stability and growth pact and Excessive debt procedure (SGP, EDP) – Out of original Maastricht criteria, two remained: 3% deficit/GDP, 60% debt/GDP • Long-term policies at EMU level, steering the member countries towards real and structural convergence Decisions • 1.7.1990: fully liberalized capital flows • December 1991: Maastricht summit • 1.1. 1994: start of European Monetary Institute (predecessor of ECB) • 1.1.1999: ECB assumes control over European monetary policy • 1.1.2002: termination of national currencies • Superficially, nominal convergence successful – Survival of EMS 1992 crisis, but problem of creative accounting – On the background of development and problems of whole EU (enlargement, institutional build-up, slow falling behind other important regions in the world, etc.) XXI.2 Euro at Ten (2009) Birthday in the shadow of the crisis • Transition 1999 - 2002 – Technically perfect – Population identified with Euro • ECB – top central bank of the world • SGP problem: breached by larger countries (D,F) in 2003 and adjusted • Start of 2009: very optimistic assessment of first 10 years (despite the global crisis), but also admitting the problems – Fiscal coordination as substitution for OCA – Information asymmetry – “Deficit bias” and free rider problem – How to interpret 3% deficit/GDP required ratio? Euro GDP growth, avg 1999-07 per capita comparable with US 3.0 % 2.5 2.0 1.5 1.0 0.5 0.0 HDP HDP p.c. Euro US UK JPN Variance of growth rates standard deviations (%): EU 15, US states 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1995 1996 1997 1998 1999 EU 15 •Zdroj: Eurostat, US BEA 2000 2001 2002 2003 2004 2005 2006 2007 50 států Unie & D.C. •Obr. 3 Euro 1998-07 stable growth and inflation HICP, EU12 25.0 20.0 15.0 10.0 5.0 0.0 1991 1993 AT BE 1995 DE 1997 ES FI 1999 FR 2001 GR IE 2003 IT 2005 LU NL 2007 PT HICP, EU 12 vs. US regions standard deviations EDP, EU12 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 AT BE DE ES FI FR 1990 GR 1998 IE 2007 IT LU NL PT Hidden risks – tricky nominal criteria • Exceptional period 2003 - 2007 – EMU performed well under good economic conditions • Since the fall of Lehman Brothers – – – – Most sever recession since WWII Asymmetric shocks for some countries Divergence instead of convergence Problem of nominal criteria • Vulnerability of peripheral economies: GR, E, P, IRL Government expenditures: 2000 vs. 2008 SGP not respected public finance deficits, % HDP 5 0 -5 -10 -15 2000 2001 2002 F 2003 D 2004 GR 2005 IRL 2006 I 2007 P 2008 E 2009 Unit labor costs Germany vs. peripheral countries 140 135 130 125 120 115 110 105 100 95 Mar00 Nov00 Jul01 Mar02 Nov02 D SA Jul03 Mar04 E SWDA Nov04 Jul05 GR SWDA Mar06 Nov06 Jul07 IRL NSA Mar08 P SA Nov08 Jul09 Unit labor costs other countries 140 135 130 125 120 115 110 105 100 95 Mar- Nov- Jul- Mar- Nov- Jul- Mar- Nov- Jul- Mar- Nov- Jul- Mar- Nov- Jul00 00 01 02 02 03 04 04 05 06 06 07 08 08 09 A SWDA I SA B SWDA E SWDA DK SWDA GR SWDA D SA IRL NSA F SWDA P SA REER a government expenditure: E REER and government expenditures: D BoP deficits Germany vs. peripheral countries 10.0 5.0 0.0 -5.0 -10.0 -15.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 D E GR IRL P Loss of share on export markets Germany vs. peripheral countries 110 100 90 80 70 2000 2001 2002 2003 2004 D E P 2005 GR 2006 2007 2008 Net investment position Germany vs. peripheral countries 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 -80 -90 -100 P E GR 2000 IRL 2008 D Difficult generalization, but … • Peripheral countries: common macroeconomic characteristic • Peripheral countries: extremely vulnerable to the effect of the crisis • Peripheral countries: „home-made“ asymmetric shocks – GR: creative accounting, public sector profligacy – IRL, E: price bubbles in real estate sector, impact on unsustainable debt of private banks (and different impact on the real economy) – P: large, over-ambitious infrastructure projects, general profligacy everywhere Is the Euro project successful? • Did Euro help to overcome the lasting economic problems of EU? – No, Europe is still lagging behind in competitiveness and productivity • Related question: did Euro support positive economic effect of the integration process? – Period 2002-2007 too short to judge – Euro help to more trade and faster growth – Euro as reserve currency, macroeconomic stability Is Euro efficient common currency? • Was Euro able to shelter ALL member countries against internal and external shocks? – Till the Greek crisis the answer was yes. – Different view today • Could Euro contribute to the crisis of peripheral countries? – Common low interest rate – cheap debt financing – Transfers (and SGP violation by decisive countries) provided a psychological effect that undermined fiscal discipline – Very slow REAL convergence (even divergence) Does Euro have a perspective? • May 2010 GR, September 2010 IRL, April 2011 P: debt unsustainable, need of external support (EMU, IMF) • Three possible scenarios: – Onward loss of confidence by markets, unwillingness to provide enough financial support from strong EMU countries (D), break-up – Market confidence restored, growth, decrease of indebtedness – “Muddling through“ – the most probable option: managed bankruptcy of some peripheral countries, emergence of slowly growing South, increasing gap with dynamic North, but political will is going to keep Euro project alive Conclusions • This is not Euro zone crisis – It is a crisis of some EMU countries … – … and it is a crisis of a political dimension of the European integration • Basic lesson: efficient Euro = deeper federalization • Not realistic in foreseeable time • Euro was a premature project … • … but will survive Literature to LXXI • de Grauwe (2005), P., Economics of Monetary Union. Oxford University Press. • European Commission (1990), One Money, One Market, European Economy, 44. • Issing, O. (2008), The Birth of Euro. CUP, Cambridge. • McKinnon, R. (1963), Optimum Currency Areas, American Economic Review 53 (717-725). • Pissani-Fery, J., Posen, A., eds. (2009), The Euro at Ten: The Next Global Currency? Peterson Institute for International Economics and Breughel, Washington.