EMU involves Policy harmonisation to remove obstacles to factor mobility A more marked and wider range of common policies especially in relation to macroeconomic policy Irrevocably fixed ID: 633716
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Slide1
Economic and monetary union (EMU)Slide2
EMU involves …
Policy harmonisation
to remove obstacles to factor
mobility
A more
marked and wider range of common policies, especially in relation to macroeconomic
policy
Irrevocably fixed
exchange rates or, as in the case of the EU, a single
currency
A common
monetary policy – that is, one interest rate and exchange rate policy determined by a single Central
Bank
Some pooling
of foreign exchange
reserves
Possible inter-state
transfers to offset economic
distortions arising
from
EMU Slide3
A bit of theory
To be an EMU the EU needs to be an Optimal Currency Area
This means that there has to be:
an absence of
asymmetric
shocks
a
high degree of labour mobility and wage flexibility
a centralised
fiscal policy that can redistribute resources to member countries performing
poorly Slide4
The road to EMU
EMU is long standing objective
Starting in 1970s
Evolved from European Monetary System (EMS) (a semi-fixed exchange rate system)
EMS often unstable but was platform for EMU
Led to Maastricht Treaty – three stage approachSlide5
Three stage approach
Stage
One
(from 1
July
1990) the
removal of all remaining obstacles to capital
flows
the participation of all member states’ currencies in the ERM and greater
policy
co-ordination
and convergence of economic
performance
Stage
Two
(from 1
January
1994) creation
of the European Monetary Institute (EMI), a transitional institution intended to
be
replaced by the European Central Bank (ECB). During this stage, any central bank that was not already independent of its national government, was to become
independent
Stage Three
(from1
January 1999)
the
irrevocable fixing of participating currencies. The European System of Central Banks (ESCB), composed of the European Central Bank and independent national banks, took over responsibility for monetary and exchange rate policySlide6
Convergence is key
Nominal convergence
Real convergence
Institutional convergenceSlide7
Costs and benefits of EMU
Benefits
elimination
of intra-EU transaction costs lower
interest
rates
uniform interest
rates
removal of exchange rate
uncertainty in intra-EMU trade
aids development of a genuine
SEM
removes the option of competitive devaluations between EU statesfinancial integrationeconomic cushioning from domestic political instabilitycreates a new international currency to represent the EU’s combined economic weight
Costs
short term
deflation
loss of the exchange rate as a tool of national economic
policy
loss of power to set interest rates and control the supply of
money
potential problems related to a lack of ‘real’ convergence and potential policy
conflicts
the inappropriateness of one monetary policy for so many
states Slide8
EMU – the first decade
A mixed record due to:
The
ineffectiveness of the Stability and Growth Pact (SGP) as a bulwark against fiscal
profligacy
The
unwillingness of some member states
to take
the necessary
micro-economic reform Slide9
The Euro crisis (from 2009)
Failure to reform and inadequate convergence was core to crisis
As was ill-designed system
Deterioration of public and current account balances Portugal, Greece, Ireland and Spain
Contagion in system as banking crisis turned into public debt crisisSlide10
The Euro crisis (from 2009)
Expose fault lines in Euro
Austerity vs. growth
Application of
G
erman ordo-liberalism – not easily transferable
EU growth fell and unemployment rose sharplySlide11
Main problems of EU as an OCA
Labour mobility is limited across the
EU
There is a home bias in capital
markets
Wage and prices tend to be inflexible
downwards
There is no substantive internal fiscal transfer
mechanism
Business cycles are not fully synchronised across the
e
urozone
Economic structures across the EU are still divergent Slide12
EU had co-ordination problem
This led to:
Excessive borrowing
Conflict over responsibility over bail
outs
Divergent macro-economic
policies
Divergent economic growth
patterns
The implications of trade imbalancesSlide13
Solutions
Short term
Quantitative easing
Bail out
Financial assistance
Long term
Economic reforms
Reform of EMU
Fiscal centralisation