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THE RUN-UP TO
THE EURO II:
EMU/EU
ENLARGEMENT
Week 6
Ch.7
• Additional Material:
• Gros, D. “The Maastricht Criteria after
Enlargement: Old Rules for New Members?”
• Material for individual / group presentations
• Convergence reports material (more later)
WHICH FLOOR ARE WE
ENLARGING?!
• EU is a three-floors building:
• First floor: Customs Union (1957)
• Second floor: Economic Union / Single Market
(1993)
• Third floor: Monetary Union (1999)
• Countries joining the EU actually join the first and
the second floor.
• To be more precise, they join the first floor way
before joining the second (Association
agreements, and so on).
• EU enlargement = enlargement of the single
market
The waves of enlargements
• 1957: Italy, Germany, France and BENELUX
countries.
• 1973: Uk,Ireland and Denmark
• 1986: Spain, Portugal and Greece (1981)
• 1995: Austria, Finland and Sweden
• 2004-2007: former communist countries + Malta
and Cyprus
• If Maastrich criteria regulate the entry into the
third floor (EMU), what supervises the accession
to the second one (EU) ?
The Copenaghen criteria
• 1) The political criterion: stable institutions able to
guarantee democracy, rule of law, human rights and
tolerance towards minorities.
• 2) The economic critierion: an established market
economy able to cope with market forces and competitive
pressure inside the Economic Union
• 3) The “acquis communitarie” criterion: the country
must be able and ready to accept and implement all the
obligations deriving from membership (harmonization of
law and regulations, and so on).
• The European Council opens the negotiations if and only if
criterion 1 is met, and the country becomes Candidate
State.
The EU accession situation today
•
•
•
•
• There are 2 and a half Candidate States…..
Croatia: Candidate State since 2004
Macedonia: Candidate State since 2005
Turkey: negotiations opened in December 2004
but interrupted two years later mainly because of
situation in Cyprus
• There are 4 and a half Potential Candidate
States…
Albania, Bosnia-Herzegovina, Montenegro, Serbia
and Kosovo.
…what about other European states?!
• Switzerland: referendum rejected EU membership
in 1992
• Norway: negative vote in 1972 and 1994
• Iceland: member of European Free Trade Area
(asked for EMU membership last month after
going bankrupt)
• Among the many former Soviet Republics, only
Ukraine might maybe have a reasonable chance
to become one day EU member.
A LOOK AT EU-27: GDP
NATIONAL SHARES OF EU-27 PIL
GERMANY
UK
FRANCE
ITALY
SPAIN
NETHERLANDS
BELGIUM
SWEDEN
AUSTRIA
POLAND
POPULATION
NATIONAL SHARES OF EU-27 POPULATION
GERMANY
FRANCE
UK
ITALY
SPAIN
POLAND
ROMANIA
NETHERLANDS
GREECE
• Germany, France, Uk and Italy represent:
• - 65,4% of EU-27 economy
• - 53,5% of EU-27 population
• If we also include Spain, then:
• - 73,7% “
“
“
• - 62,3% “
“
“
ONE WORD ON EU ACCESSION
• Beginning of the 90s: former communist
European nations begin their journey to market
economy
• How long did the journey had to be?!
• Shock therapy: instantaneous. (Poland, Czech
Republic and Slovakia, Estonia, Latvia)
• Gradualism: (Romania, Hungary, Lithuania)
• Shock therapy countries had a rapid output
growth and quicker transition, but more
inequality and unemployment.
• Gradualist countries recovery was much slower,
but with a lower degree of inequality and
unemployment.
• Anyway, they all are into EU now with different
economic situation (Poland, Czech Republic,
Estonia a step ahead of others, Bulgaria and
Romania still lagging behind).
• Four of them (Slovenia, Cyprus,Malta and
Slovakia) already joined the Euro in 2007,2008
and 2009.
What about the remaining eight? When will they
take the steps to the third floor ?
• Let alone the fact that they are obliged to (they
signed up the obligations when entering EU), let’s
verify that it is in their best interest anyway.
ONE LESSON WE KNOW
•
•
•
•
•
•
•
•
If there is free capital movement
If countries are very integrated
if they want to maintain exchange rate stability
…the most appropriate thing is to share a
common currency.
• IF’s check:
1) It is part of their membership in the single
market.
2) Look at table 1, pag.3, Gros paper.
3) Sure they do. Too much volatility and
uncertainty in the value of their currency might
jeopardize their catch-up process.
….anyway, what exchange rate systems
(“monetary regime”) do they have at the
moment?
• Estonia, Lithuania, Latvia: EMS II
• Czech Rep, Romania, Poland: floating exchange
rates
• Bulgaria and Hungary: fixed or semi-fixed
exchange rates
• How different were their macroeconomic
performances so far (BEFORE THE CRISIS)?
• Floaters = low inflation, balanced current
account, high public debt.
• Fixers = high inflation, high current account
deficit, low public debt.
• Who tells me why?
Here’s why….
• Fixers must somehow keep the interest rate at
the same level of the economy they fixed their
currency to (euro).
• EU interest rates have been low, and thus does
not fit the macroconditions of those economy
which, being in the middle of their catching-up
process, are experiencing high growth.
• Hence: higher growth, higher inflation, higher
current account deficit (because of inflation and
growth), lower debt (because of inflation).
• Although appealing for some features (debt and
growth), sooner or later it contrasts the first and
most important Maastricht crtieria.
• In fact, for instance, Lettonia failed EMU
accession in 2007 because of inflation.
HOW IS THE CRISIS CHANGING ALL
THAT?
• In the last 3 months we have been observing
huge depreciations of Easter European members
of EU (and non-EU-members)
• Poland = - 23.2%
• Russia = -24.2%
• Hungary= -13%
• Czech Rep= -13.9%
• Romania= -11.8%
• Ukraine =-27.2%
• What’ s happening?!
Something similar to 1997 Far East crisis
• Private and public sector has heavily indebted in
foreign currency:
- private sector: mortgages were more
convenient abroad (especially in Sweden)
- public sector: current account deficit (on
average around 10% of GDP; in Bulgaria 25%).
In other word: internal savings were not enough to
cover the needed (private and public)
investment.
- The crisis has triggered capital outflows
(headquarters are withdrawing funds).
- Depreciation of the currency
- Nominal value of the debt increases (because
it is denominated in foreign currency, whose
value has increased, following depreciation of
national currency)
- Rating agencies (Moody’s and Standard and Poor)
are downgrading sovereing rating
- This, in turn, increases interest rate on debt
issuing (countries’risk profile has worsened).
- This is exactly what happened in one recent
(regional) financial crisis: July 2th 1997,
originated in Thailand.
Differences and consequences
• Most of debt is towards EMU banks. Some
economists are beginning to call this situation
“the European subprime”.
• Austria: credits towards those countries are
equivalent to 70% of national GDP (Belgium
25%, Sweden 20%, Italy 10%).
• This danger is maybe over-emphasized.
• Possible solution: speed-up EMU membership (so
to curb self-fulfilling depreciation expectations).
• But in order to do that we need to soften the
third Maastricht criterion (two years “waiting
room” into EMS II).
Are Maastricht criteria still adequate
after 17 years (1992-2009)?
Criterion on interest rate:
Yes. Preventing arbitrage opportunities after
exchange rates are locked is a ever-lasting need.
• Criterion on debt/deficit:
Past (and future) discussion on the 3% and 60%
figures.
See also Gros paper (pages 10-17).
What about exchange rates and inflation?
Let’s work out a framework which helps us
rationalize the situation.
Balassa-Samuelson effect
• Are in for some more
math….?
 
E
NE

 E
 NE
  E  (1   )( A  A )
• If ANE > AE :
• - if E = 0 -- NE > E
• - if NE =E - E
--- new comers’
currency
•
appreciate
must
• You can’t have both.
• Hungary last year. In order to allow inflation to
go down, they abandoned any form of limitations
to the exchange rate.
However…(there is always an
“however” in economics….)
• 1) Maastricht does not actually bind
NE =E
• There is a spread of 1.5% of tolerance.
• It means that the productivity growth differential
can be as big as 2.1%.
• ANE > AE = 1.5 / (1-α)
• 2) E is not actually = 0
• There are bands of fluctuations.
• How large do this bands have to be?!
• a) Large enough to accomodate for productivity
growth differentials (considered that inflation rate
cannot diverge that much)
• b) Large enough to be credible (don’t repeat the
mistake of EMS I….they set too narrow bands for
Italy and Uk and they dropped out, with a loss of
credibility of the whole system)
So….
• The application of Maastricht criteria to new
member states actually presents some new
problem:
• 1) On the inflation-exchange rate side.
• 2) On the public finance side.
• 1), we have seen, is not as bad as might seem at
first glance
• 2) …probably is more of a problem for those who
are already in the EMU…..and we’ll talk about
that next week (SGP and reform).
Presentations
• European Commission Convergence Report –
December 2006 – PLEASE LOOK FOR MORE
UPDATED VERSIONS.
ON THE ADMISSION TO EMU – 7 countries (Czech
Rep, Estonia, Latvia, Hungary,Poland, Sweden).
You will be assessed on:
• How clearly you present the
countries’situation to a non-economist.
• How you infer the future pespectives for
EMU accession
• How you elaborate on the data you had
been analysing, and the way you make
your own remarks and draw your own
conclusions.
• Each presentation cannot exceed 30
minutes, including five minutes for
discussion.
• Timing….?