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Converging on the Euro
A genuine case of making the grade?
On 25 March 1998, the European Commission announced which of those countries that wished
to join the Euro in 1999 had made the Euro grade. How did the Commission reach its
conclusions?
The Maastricht Treaty of 1991 led to the setting up of the European Monetary Institute
(EMI) (the forerunner of the European Central Bank), which quickly established the various
criteria that had to be met by member states, if they wished to be eligible to join the euro in
1999. These so called ‘convergence criteria’ involved clearly specified targets for inflation,
budget deficits, national debt and interest rates. In addition to such targets, membership of the
exchange rate mechanism (ERM) was also made a necessary requirement.
So who made it? The table below details all 15 EU members (even those not applying for
membership to the euro) and the reference values they had to meet.
Table 1
Performance of EU Member States in relation to Convergence Criteria for EMU
Inflation
(%)
Budget
balance
(% of GDP)
Debt
(% of GDP)
Change from
previous year
Jan
1998
Long-term ERM band
interest rate
(+/– %)
1996
1997
1997
–3.0
60.0
1997
1996
1995
Join euro
in 1999?
Jan
April
EC Recommendations
1998
1998
25/3/98
Reference
value
2.7
Germany
1.4
–3.8
–2.7
61.3
0.8
2.4
7.8
5.6
15
Yes
France
1.2
–4.2
–3.0
58.0
2.4
2.9
4.2
5.5
15
Yes
Italy
1.8
–6.8
–2.7
121.6
–2.4
–0.2
–0.7
6.7
15
Yes
UK
1.8
–4.1
–1.9
53.4
–1.3
0.8
3.5
7.0
free floating
No
Spain
1.8
–4.4
–2.6
68.8
–1.3
4.6
2.9
6.3
15
Yes
Netherlands
1.8
–2.3
–1.4
72.1
–5.0
–1.9
1.2
5.5
15
Yes
Belgium
1.4
–3.2
–2.1
122.2
–4.7
–4.3
–2.2
5.7
15
Yes
Sweden
1.9
–3.3
–0.8
76.6
–0.1
–0.9
–1.4
6.5
free floating
No
Austria
1.1
–3.8
–2.5
66.1
–3.4
0.3
3.8
5.6
15
Yes
Denmark
1.9
–1.6
0.7
65.1
–5.5
–2.7
–4.9
6.0
15
No
Finland
1.2
–2.6
–0.9
58.0
–1.8
–0.4
–1.5
5.9
15
Yes
Portugal
1.8
–3.2
–2.5
62.0
–3.0
–0.9
2.1
6.2
15
Yes
Greece
5.2
–7.4
–4.0
108.7
–2.9
1.5
0.7
9.8
15
No
Ireland
1.2
–1.1
0.9
66.3
–6.4
–9.6
–6.8
6.2
15
Yes
Luxembourg
1.4
1.8
1.7
6.7
0.1
0.7
0.2
5.6
15
Yes
7.8
What were the criteria and how were the reference values set?
Inflation
The percentage change in the harmonised indices of consumer prices (HICP)
over the past 12 months. (The HICP was introduced in 1997).
Reference value: a country’s inflation should not exceed 1.5 percentage points
above the simple arithmetic average of the inflation rates of the three member
states with the lowest inflation rates.
When the European Commission made its recommendations (on 25/3/98) about
which countries should join the euro in January 1999, it used the inflation figures
in January 1998. In that month, the three lowest inflation countries were Austria
(1.1 per cent), France (1.2 per cent) and Ireland (1.2 per cent). Using the average
of these three (i.e. 1.2 per cent) and adding 1.5 per cent, gave a reference value
of 2.7 per cent. Only Greece’s inflation exceeded this value.
Deficit
General government (central plus local) budget deficit as a percentage of GDP.
Reference value: a country’s budget deficit should not exceed 3 per cent of GDP.
Only Greece’s budget deficit exceeded this value (although some countries only
managed to achieve a deficit of 3 per cent or below by taking one-off measures,
such as a special tax in Italy, and counting privatisation receipts in Germany).
Debt
General government gross debt (i.e. accumulated deficits) as a percentage of
GDP.
Reference value: a country’s government debt should not exceed 60 per cent of
GDP.
Only 4 countries had debts that did not exceed 60 per cent (France, Finland,
Luxembourg and the UK). However, the Maastricht Treaty allows countries to
exceed this value as long as the debt is ‘sufficiently diminishing and approaching
the reference value at a satisfactory pace.’ Only Germany had debts that were not
diminishing at a pace that the Commission regarded as satisfactory, but since
this was explained by the continuing high costs of German reunification and
given that German government debt was predicted to fall in 1998, even Germany
was considered to meet the debt criterion.
On the public finances criteria, therefore, (i.e. government deficit and government debt), only
Greece was considered to de ineligible to proceed to monetary union on 1/1/99.
Interest rates Long-term interest rates (10-year government bonds).
Reference value: a country’s long-term interest rate should be no more than 2
percentage points above the average of the long-term interest rates of the three
countries with the lowest inflation rate.
The three lowest inflation countries were Austria, France and Ireland, with longterm interest rates of 5.6 per cent, 5.5 per cent and 6.2 per cent respectively,
giving an average of 5.8 per cent and hence a reference value of 7.8 per cent. All
but Greece had long-term interest rates below this reference value.
2
Exchange rates Countries should be in the ERM prior to adopting the euro.
Reference value: fluctuations of each country’s exchange rate within the ERM
should not have exceeded ±2¼ per cent for two years prior to the decision in
March 1998 about qualifying for monetary union.
The UK and Denmark were exercising their right (under the Maastricht Treaty)
to opt out from joining the euro in 1999, and the UK was ineligible anyway
because of being outside the ERM. Sweden had never been in the ERM and, like
the UK, had experienced considerable exchange rate volatility. Greece only
joined the ERM in March 1998. Of the remaining 11 countries, only Italy,
Ireland and Finland failed to meet the ERM reference value. The Commission
regarded these three as being sufficiently close to the reference value as to
qualify them for membership of the single currency. Finland had joined the
ERM in October 1996 and Italy had rejoined in November 1996, but both had
displayed sufficient stability throughout the two-year reference period. The Irish
punt was revalued by 3 per cent on 16/3/98, but had remained above its central
rate in the ERM throughout the two-year period.
All member states except Greece, Sweden and the UK met the criteria for membership of the
single currency (with Sweden and the UK only failing on the exchange rate criterion). Denmark
(and the UK) exercised their opt out, and thus the European Commission recommended that the
remaining 11 countries should proceed to monetary union on 1 January 1999, which they duly
did. Greece subsequently satisfied the criteria and joined the euro in January 2001.
??
1.
Explain the significance of identifying and meeting convergence criteria prior to
introducing the euro?
2.
Can you think why the EMI selected the convergence criteria of inflation, budget
balance, debt and interest rates, and not some other?
3.
Kenneth Clarke, the UK Conservative Chancellor over much of the period when
the selection of convergence criteria was being discussed, argued that flexible
labour markets should also be a convergence goal. Why might he argue this and
what difficulties might there be in specifying such a goal?
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