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Economic and monetary union (EMU) Economic and monetary union (EMU)

Economic and monetary union (EMU) - PowerPoint Presentation

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Economic and monetary union (EMU) - PPT Presentation

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

economic emu exchange policy emu economic policy exchange convergence monetary rate stage central european system crisis interest rates bank

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Presentation Transcript

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