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Європейський монетарний союз Лекція 6 European Monetary Union In 1998 eleven EU member-states had met the convergence criteria, and the Eurozone came into existence with the official launch of the Euro on 1 January 1999. Greece qualified in 2000 and was admitted on 1 January 2001. Physical coins and banknotes were introduced on 1 January 2002. Slovenia qualified in 2006 and was admitted on 1 January 2007. Slovakia also qualified and was admitted on the 1 January 2009 bringing total Eurozone membership to its current level of over 325 million people and fourteen member states: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Slovakia, Slovenia, Spain In addition, Montenegro uses Euro as its currency. So do three European microstates: Monaco, San Marino and Vatican (they concluded agreement with the EU permitting them to use Euro as their currency and mint coins). SEVERAL INTERESTING FACTS Non-member states with formal euro agreements Monaco San Marino Vatican City Monaco, San Marino, and Vatican City also use the euro, although they are officially neither Eurozone members nor members of the EU. Likewise, Montenegro and Kosovo, which used to have the German mark as their de facto currency, also adopted the euro without having entered into any legal arrangements with the EU explicitly permitting them to do so. Kosovo uses the euro instead of the Serbian dinar, mainly for political reasons. Adoption of Euro (as of the end of 2009) Currency Central rate Code Official target date Expected target date British pound GBP — Opt-out Opt-out Bulgarian lev BGN 1.95583 — 2013 Czech koruna CZK — — 2015 Danish krone DKK 7.46038 Opt-out Opt-out Estonian kroon EEK 15.6466 — 1 July 2010 or by 1 January 2011 Hungarian forint HUF — — 2014 Latvian lats LVL 0.702804 — 2013 Lithuanian litas LTL 3.45280 — 2013 Polish złoty PLN — 2012 2013 or 2014 Romanian leu RON — 2014 2014 Swedish krona SEK — — — As of 1 December 2002, North Korea has replaced the U.S. dollar with the euro as its official currency for international trading. (Its internal currency, the won, is not convertible and thus cannot be used to purchase foreign goods). Cuba had announced the same in 1998 and Syria followed North Korea in 2006 The fourteen countries of the European Union that do not use the euro are: Denmark, Sweden, the United Kingdom, Bulgaria, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania and Slovakia. Denmark and the United Kingdom obtained special derogations in the original Maastricht Treaty of the European Union. Both countries are not legally required to join the Eurozone unless their governments decide otherwise, either by parliamentary vote or referendum. Sweden did not, and is technically obliged to introduce the euro at some point in the future. However, the EU has made public that they have no intention to enforce this with regard to Sweden. Cyprus will adopt the euro on 1 January 2008. A formal letter of application was submitted on 13 February 2007. The final decision was taken by the EU finance ministers (Ecofin) on 10 July 2007 and the conversion rate was fixed at 0.585274 CYP. On May 16, 2007 the European Commission backed by the European Central Bank gave its green light for the introduction in January 2008.The new currency will only be used in the government-controlled areas of the Republic: de facto state, the Turkish Republic of Northern Cyprus, will keep on using the new Turkish lira. Since joining the EU the Czech Republic has adopted a fiscal and monetary policy that aims to align its macroeconomic conditions with the rest of the European Union. Currently, the most pressing issue is the large Czech fiscal deficit. Originally, the Czech Republic aimed for entry into the ERM II in 2008 or 2009, but the current government has officially dropped the 2010 target date, 2013 has been suggested as the earliest changeover date. Maastricht Convergence Criteria Convergence criteria (also known as the Maastricht criteria) are the criteria for European Union member states to enter European Economic and Monetary Union (EMU) and adopt the euro. They assist to establishing conditions required by optimal currency area theory. The four main criteria are based on Article 121(1) of the European Community Treaty. Those member countries who are to adopt the euro need to meet the following criteria: 1. Inflation rate No more than 1.5 percentage points higher than the 3 best-performing member states of the EU (based on inflation). 2. Government finance: a) Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases. b) Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace. 3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devaluated its currency during the period. 4. Long-term interest rates: The nominal long-term nterest rate must not be more than 2 percentage points higher than the 3 best-performing member states (based on inflation). European Exchange Rate Mechanism The ERM is based on the concept of fixed currency exchange rate margins, but with exchange rates variable within those margins. Before the introduction of the euro, exchange rates were based on the ECU, the European unit of account, whose value was determined as a weighted average of the participating currencies. A grid (known as the Parity Grid) of bilateral rates was calculated on the basis of these central rates expressed in ECUs, and currency fluctuations had to be contained within a margin of 2.25% on either side of the bilateral rates In 1999, ERM II replaced the original ERM. The Greek and Danish currencies were part of the system, but as Greece joined the euro in 2001, the Danish krone was left as the only participant member. Currencies in ERM II are allowed to float within a range of ±15% with respect to a central rate against the euro. As of 1 May 2004, the ten National Central Banks (NCBs) of the new member countries became party to the ERM II Central Bank Agreement. The national currencies themselves will become part of the ERM II at different dates, as mutually agreed. The Estonian kroon, Lithuanian litas, and Slovenian tolar were included in the ERM II on 28 June 2004; the Cypriot pound, the Latvian lats and the Maltese lira on 2 May 2005; the Slovak koruna on 28 November 2005. The currencies of the three largest countries which joined the European Union on 1 May 2004 (the Polish zloty, the Czech koruna, and the Hungarian forint) are expected to follow eventually. Plans for Bulgaria are to apply for ERM II membership in 2007 and to commit to its rules regardless of the European Commission decision, while Romania plans to join ERM in 2010-2012 Country Reference value Inflation rate (HICP) annual government deficit to GDP gross government debt to GDP ERM II membership max 3.2% max. 3% max. 60% 2% 0.04% 55.9% Bosnia and Herzegovina 1.5% 0.35% 34% Bulgaria 0.3% -3.2% 14.1% Croatia 1% 2.2% 40.8% Czech Republic -0.6% -1.4% 28.1% Denmark 0.6% -3.9% 30% since 1 January 1999 3.6% Estonia -2.1% -0.4% 3.4% since 28 June 2004 7.23% Hungary 4.2% 4.8% 76.9% Iceland 9.7% -5.19% 103% Latvia -1.2% -1.1% 19.5% since 2 May 2005 13.51% Lithuania 1% -3.2% 15.6% since 28 June 2004 14.5% Macedonia 3.2% 0.6% 39.5% Montenegro 1.7% Norway 1.2% -17.27% 53% Poland 3.8% -2.5% 44.5% 6.1% Romania 4.3% -2.9% 13.6% 9.13% Serbia 7.3% 0.48% 37% Sweden 1.8% -2.7% 35.5% Switzerland -0.8% Turkey 5.08% -1.3% 38.8% United Kingdom 1.1% 7.1% 55.5% Albania min. 2 years Long-term interest rate max 6.5% 7.08% 4.5% 7.45% 38% 3.25% 2.25% 3.34% Monetary and Fiscal Background of EMU Possible scenarios of monetary union design a) MONETARY ARRANGEMENT - minimalist monetary arrangement in which the member states agree to operate a fixed exchange rate system - in fact an exchange rate union - maximalist monetary arrangement where the member states decide to get rid of the separate national currencies in favour of one union currency, the supply of which is controlled from the centre, the union money supply authority would also control interest and exchange rates a currency union. b) FISCAL ARRANGEMENT - minimalist fiscal arrangement would leave the raising of taxes and the spending of them in national hands. However tax structures and rates would be harmonised, as a necessary condition for the elimination of competitive distortions in connection with the common market aspect of the arrangement. Nevertheless some control over national budget deficits and debt levels would have to be imposed - in a maximalist fiscal arrangement the whole system of taxing and spending would be centralised and, in conjunction with this, there would be a centralised system of borrowing and a federal budget deficit (or surplus). The process of monetary integration - “road map” in 1992 in Maastricht Treaty There were at least four possible scenarios Minimal monetary + minimal fiscal arrangement Maximal monetary + minimal fiscal arrangement Minimal monetary + maximal fiscal arrangement Maximal monetary + maximal fiscal arrangement Maastricht model of EMU selected a maximalist monetary arrangement, together with a minimalist fiscal arrangement Monetary arrangement = full centralization of monetary policies represented by European Central Bank (established 1998) and the System of European Central Banks Fiscal arrangement = fiscal coordination, regulated by Stability and Growth Pact (adopted 1997 in Amsterdam, reformed in 2005) EUROPEAN CENTRAL BANK The ECB was established by EU in 1998 and is located in Frankfurt, the largest financial centre in the Eurozone European system of central banks (ESCB) = the ECB plus all the national Central Banks (NCBs) of the EMU member states ECB and ESCB is responsible for monetary policy covering the 13 member countries of the Eurozone The primary objective of the ECB and the ESCB is "to maintain price stability" within the Eurozone, in other words to keep inflation low. The present target is to keep inflation below, but close to, 2%. Second to this objective, the key tasks of the ECB and ESCB are to define and implement the monetary policy for the eurozone, support the economic policies of the member states, conduct foreign exchange operations (and take care of the foreign reserves of the ESCB) and promote smooth operation of the banking payment system The ECB has the exclusive right to authorize emission of banknotes to set interest rates for the Eurozone National Central Banks can issue euro coins but the amount must be authorized by the ECB beforehand The ECB has independence from any European or national institution and also holds financial independence by means of a separate budget drawn from national central banks (NCB). Governance of ESCB President of ECB first President of the Bank was Wim Duisenberg, the former president of De Nederlandsche Bank, who was succeeded in November 2003 by Jean-Claude Trichet, former head of Banque de France. Governing Council Executive Board General Council Governing Council the supreme decision making body of the ECB composed of the members of the executive board and the governors of the NCBs responsible for taking decisions on monetary policy, interest rates and the reserves of the ESCB in other matters, such as authorization the issue of banknotes in advising other institutions on draft legislation Governing Council meets at least ten times a year and can only be attended by members and the Council President and Commission President In voting each member has one vote (the Council and Commission presidents do not vote) and decisions are taken by a simple majority The Executive Board is responsible for the implementation of monetary policy defined by the Governing Council and the day-to-day running of the bank. In this it issues decisions to NCBs and may also exercise powers delegated to it by the Governing Council comprised of the President of ECB, a vice president and four other members. They are all appointed by common accord of the eurozone governments for a nonrenewable eight year term. By an understanding arrived at in 2005, four of these six seats are currently reserved for the Eurozone's four big central banks of France, Germany, Italy and Spain. General Council body dealing with transitional issues of euro adoption, for example fixing the exchange rates of currencies being replaced by the euro, (continuing the tasks of the former European Monetary Institute, predecessor of ECB) It exists until all states adopt the euro, at which point it would be dissolved. It is composed of the President and vice president of ECB together with the governors of all the NCBs of the EU. STABILITY AND GROWTH PACT the Stability and Growth Pact (SGP) is an agreement by European Union member states related to their conduct of fiscal policy monetary policy centralization – ECB responsibility fiscal coordination by SGP – Commission and Council of Ministers responsibility SGP consists of fiscal monitoring, and sanctions against offending members the pact was adopted in 1997, so that fiscal discipline would be maintained and enforced in the EMU Member states adopting the euro have to meet the Maastricht convergence criteria, and the SGP ensures that they continue to observe them The actual criteria that member states must respect: - annual budget deficit no higher than 3% of GDP (this includes the sum of all public budgets, including municipalities, regions, etc) - national debt lower than 60% of GDP or approaching that value. Excessive deficit procedure First step – establishing excessive deficit If the Commission identifies excessive budget deficit of some Member State of the EMU (exceeding 3% of GDP), it prepares the report and recommendation for the Council of Ministers. The Council then decides by qualified majority of all Member States of the EU (including the states not participating in EMU and the Member State of EMU that is evaluated by the report), whether the budget deficit, considering all circumstances, can be classified as an excessive one. The Member States could take into account all aspects of an economic situation of a country considered, e.g. the GDP growth trends. If the real GDP decreased in a given period at least by 2%, the budgetary deficit is considered exceptional and no sanctions are proposed. If there is a growth of the real GDP or its decline not exceeding some critical value (recently 0.75%), it is expected that the Council of Ministers will declare the budget deficit as the excessive one and initiate a penalization procedure. Second step - decision about sanctions After the budget deficit of a particular country is declared by the Council as the excessive one and if the country in question does not take credible steps of restoring feasible situation (deficit not exceeding 3% of GDP), the Council decides again, this time about sanctions. In this round only members of the EMU participate in voting, without the country in question. In this case the voting quota is a majority of two thirds of the weighted votes of the EMU members, excluding the votes of representative of the Member State concerned. Sanctions: They first take the form of a non-interest-bearing deposit with the Commission (fixed component equal to 0.2% of GDP and a variable one linked to the size of the deficit). Annual amount of the deposit might not exceed 0.5% of GDP. If the excessive deficit is not corrected after two years, the deposit is as converted into a fine. The Council may decide to abrogate some or all of the sanctions, depending on the progress made. The fines imposed are not reimbursable. Interest on the deposit and the yield from fines is distributed among Member States without an excessive deficit, in proportion to their share in the total GNP of eligible Member States. The stability and growth pact does not work the Council of Ministers failed to apply sanctions against France, Italy and Germany, despite punitive proceedings being started when dealing with Portugal (2002) and Greece (2005) The pact has proved not to be enforceable against big countries such as France and Germany, which, ironically, was the biggest promoter of it when it was created. These countries have run "excessive" deficits under the pact definition for some years. Government finances Past breach periods for deficit Country annual government deficit to GDP Reference value gross government debt to GDP min. -3% max. 60% Austria -1.9% 62.4% 1995-1997 Germany -1.7% 68.9% 1994; 1996; 2003-2006 France -3.0% 66.9% Italy -1.9% 104% Luxembourg -1.8% 7.9% Netherlands -1.2% 51.2% Belgium -0.3% 90% Spain +0.9% 40.0% Portugal -2.2% 63.5% Finland +2.8% 39.7% Ireland +0.1% 27.2% Greece -2.6% 91.0% Slovenia -1.9% 29.9% Sweden +2.2% 47.6% -4% 44.1% Denmark +3.9% 30.0% Cyprus -2.1% Malta Deadline for compliance for deficit Past breach periods for debt Deadline for compliance for debt 2003- ? 2007 2003- ? 2003-2007 2005 2003- ? 2003- 2007 2003- ? 2004-2005 2005 2003- ? 2002; 2005-2006 2002; 2008 2005- ? 2003-2006 2006 2003- ? 2006 2007 65% 2004-2006 2006 2004- ? -2.6% 65.9% 2004-2006 2006 2004- ? Estonia +1.4% 3.6% Latvia -1.0% 11.3% Lithuania -0.6% 18.9% -2% 44% 2004- 2007 Hungary -4.9% 59.9% 2004- 2008 Czech Republic -3.2% 31.5% 2004- 2008 Slovakia -3.1% 34.3% 2004- 2007 Romania -2.5% 20.3% Bulgaria +3.1% 29.9% Eurozone -2.4% 70.5% 2003- NA EU27 -2.3% 63.2% 2003- NA United Kingdom Poland The reasons that larger countries have not been punished include their influence and large number of votes on the Council of Ministers, which must approve sanctions In March 2005, the EU Council relaxed the rules to respond to these criticisms and to make the pact more enforceable Fiscal coordination remains to be the weakest part of the EMU project