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EU Days
The Single Currency
Joining the Euro
 Introducing the Euro
 Economic and monetary union (EMU) comprises various stages.
 The main objective of Stage One, which began in 1990, was the
complete liberalisation of capital movements under Article 56 of the EC
Treaty.
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 In Stage Two, which began on 1 January 1994, the Member States
implemented measures enabling them to achieve the convergence
targets necessary in order to enter Stage Three of EMU and
guaranteed the independence of their central banks. The process of
coordinating economic policies and ensuring multilateral surveillance of
progress with convergence began in the course of Stage Two. The
Member States were called on to do all they could to avoid excessive
public deficits.
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Joining the Euro
 In Stage Two the Member States had to take measures to
free their central banks of political interference. Central
banks are now responsible for monetary policy and, as
such, determine interest rates in the euro zone. They were
also prohibited from financing a budget deficit affecting the
European institutions, the governments of the Member
States or other authorities, be they regional or local, and
from granting loans to state-owned companies.
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 Stage Three of EMU began on 1 January 1999 with the
launch of the euro on financial markets. Under the
accession treaty, the new Member States went straight into
Stage Three of EMU on 1 May 2004.
Joining the Euro
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What you must show before entering the Euro Zone
 Price stability, measured according to the rate of inflation in the three
best performing Member States;
 Long-term interest rates close to the rates in the countries with the
best inflation results;
 An annual budget deficit which does not exceed 3% of gross
domestic product (GDP) and total government debt which does not
exceed 60% of GDP or which is falling steadily towards that figure;
 Stability in the exchange rate of the national currency on exchange
markets The exchange-rate mechanism of the European Monetary
System requires this stability to be demonstrated and sustained for two
years.
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Why did the Euro appear?
 Needed to reduce uncertainty and volatility of
currencies
 needed to bring national monetary and fiscal
policies more together
 needed to reduce use of exchange rate as macro
tool
 Needed to control money expansion within
member states
 needed to control expansion on money stock v
competitive de-valuations
 Started with ERM
Convergence Criteria
 amount of money owed by a government - known as
the budget deficit, has to be below 3% of Gross
Domestic Product (GDP) - the total output of the
economy.
 The total amount of money owed by a government,
known as the public debt, has to be less than 60% of
GDP. The public debt is the cumulative total of each
year's budget deficit.
 Countries should have an inflation rate within 1.5% of
the three EU countries with the lowest rate. This was
supposed to push down inflation rates and lead to
more stable prices.
 Long-term interest rates must be within 2% of the three
lowest interest rates in EU.
 Exchange rates must be kept within "normal"
fluctuation margins of Europe's exchange-rate
mechanism.
UK’s 5 tests
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The UK's five tests
These are the five economic tests on UK entry to the euro as outlined by The Treasury in
1997.
Convergence
The Treasury sees the first test, the need for the UK economy to come together with the
euro zone economy, as the "touchstone" towards a successful single currency.
And it says it must converge in a "sustainable and durable" way.
It says that to be passed, the UK economy must:
have converged with Europe
be shown to have converged
show convergence capable of being sustained
have sufficient flexibility to adapt to change and unexpected economic events
5 Tests
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The UK's five tests
In the past, the UK's economic cycle has been both more volatile than others in
the EU, reflecting different economic policies, oil price rises and German
unification.
Are business cycles and economic structures compatible so that we and
others could live comfortably with euro interest rates on a permanent basis?
This also been affected by differences in the UK economy such as trade
patterns, oil, company finance and the housing market
Setting out the five tests, the government said a period of stability - via low
inflation and controls on spending - would be needed in order to promote
sustainable and durable convergence with the rest of the European Union.
5 tests
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Flexibility
The Treasury says the success or otherwise of the euro depends on business and the workforce
being flexible.
The economy, it says, must have "the ability to adjust to change".
If problems emerge is there sufficient flexibility to deal with them?
It says this is because of the "inevitable loss of domestic control over monetary policy" and the risk of
future economic turbulence.
Firms would need to be flexible in terms of pricing and margins, and in their business strategy.
Wage bargaining in the labour market must be "realistic and take account of developments in
productivity".
Employees would need to increase their skills in order to adapt to change in the job market
5 tests
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Investment
The Treasury believes that a successful single currency would:
Would joining EMU create better conditions for firms making long-term decisions to invest in Britain?
create an attractive area - with low inflation and stability - for firms to invest
be a complement to the Single Market, boosting competition and providing new opportunities for
companies
The Treasury says the euro could, if successful, help to reduce the risk of poor investment
performance by reducing instability.
Investment could be boosted by the reduction of transaction costs and exchange rate uncertainty, it
says.
And more transparent pricing - with companies able to compare prices between countries much more
easily - could also encourage investment.
But the Treasury says entering the single currency before the UK economy has sufficiently converged
with the euro zone would discourage investment.
5 tests
 Financial services
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 The Treasury says joining the euro would affect the financial services
industry "more profoundly and more immediately" than other sectors of
the economy.
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 What impact would entry into EMU have on the competitive position of
the UK's financial services industry?
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 It says whether the UK joins the euro or not, the City of London's
strengths "should help it to thrive".
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 The test centres on whether the introduction of the euro would be
advantageous for the sector and whether the sector is fully prepared
for the introduction of the single currency in the UK.
The Euro?
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Fixed exchange rates from 1999
Started 2002
Transaction costs
reduce uncertainty
transparency of prices
encourage mergers
BUT what of initial costs?
Role of ECB
loss of control of economic/political decisions
problems with expansion
5 tests
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Employment and growth
This is the "fundamental" test, says the Treasury.
Will joining EMU promote higher growth, stability and a lasting increase in
jobs?
Joining the euro could "enhance both growth and employment prospects".
But without sufficient convergence and flexibility, "the resulting turbulence could
considerably damage them".
The Treasury will have to decide as it assesses the tests the potential effect on
jobs and growth from joining the euro. In 2003 Gordon Brown announced that
the UK did NOT then meet the 5 tests
Gains and Losses
 Gains? – one catalogue price, one bank account,
less formalities, stability, enhanced competition as
prices remain stable, integrated bond markets,
stricter discipline in tax issues
 BUT Loss of economic sovereignty
 Asymmetric shocks
 Lack of convergence – two speed Union? Different
labour market regulations
 Different growth rates
 What if one country gets out of synch?
 What if monetary flexibility required?
Gains and Losses
 Structural differences between countries – we
export 52% to EU, Germany 56%, France 63%
 Different housing market – mortgage debt in UK =
57% of GDP, 33% within rest of EU
 More vulnerability to oil price hikes?
 Can it be sustained as enlargement continues?
 Can Regional Policy cope
 Can the poorer nations be accommodated?
Will it survive?
 Will probably depend on?
Competitiveness on economy (price/nonprice), spare capacity, financial resources,
Knowledge of market, distribution systems,
strength/stability of Euro, affect of joining
Euro on macroeconomic management, loss
of sovereignty, implications for UK business,
price at which we join (ERM memories).
Single Currency – Quick Re-cap
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Fixed exchange rates from 1999
Started 2002
Transaction costs
reduce uncertainty
transparency of prices
encourage mergers
BUT what of initial costs?
Role of ECB
loss of control of economic/political decisions
problems with expansion
Re-cap 2
 Trade diversion - switch purchases to high-cost
supplier
 Will trade creation grow? – replace high cost
domestic production with imports from a more
efficient EU partner?
 If economic welfare is to increase the EU needs to
(a) be as efficient as outside producers (b) be
aware of demand and supply curve inelasticity of
the commodities affected by the CET
Re-cap 3
 Membership based on meeting convergence criteria and
accepting political rules
 Price stability – no more than 1.5% above average of three
best performing members
 Interest Rates – no more than 2% above average of the
three member states with lowest inflation rates in previous
year. Long term rates convergence.
 Gov deficit – no more than 3% of GDP.
 Public Sector Debt Control – must not exceed 60% of GDP
 Independent Central Bank
 Euro a powerful currency, greater parity with $, integration
of financial markets, greater market liquidity, sounder fiscal
policy
Re-cap-continued
 Gains? – one catalogue price, one bank account,
less formalities, stability, enhanced competition as
prices remain stable, integrated bond markets,
stricter discipline in tax issues
 BUT Loss of economic sovereignty
 Asymmetric shocks
 Lack of convergence – two speed Union? Different
labour market regulations
 Different growth rates
 What if one country gets out of synch?
 What if monetary flexibility required?
Some other problems?
 Structural differences between countries – we
export 52% to EU, Germany 56%, France 63%
 Different housing market – mortgage debt in UK =
57% of GDP, 33% within rest of EU
 More vulnerability to oil price hikes?
 Can it be sustained as enlargement continues?
 Can Regional Policy cope
 Can the poorer nations be accommodated?
Deciding factors?
 Will probably depend on?
Competitiveness on economy (price/nonprice), spare capacity, financial resources,
Knowledge of market, distribution systems,
strength/stability of Euro, affect of joining
Euro on macroeconomic management, loss
of sovereignty, implications for UK business,
price at which we join (ERM memories).
Competitiveness