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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? 3