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© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Chapter 17
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Chapter 17 The European Monetary Union 2
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition The Long Road to Maastricht and to the Euro 3 On 13 July 2010 the Council of the European Union approved Estonias request to join the euro area on 1 January Estonia duly joined the euro area on that date and the euro replaced the kroon at a fixed conversion rate of 1 = EEK There will be a two-week period when both currencies are in circulation, with change normally provided in euro.
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition The Maastricht Treaty A firm commitment to launch the single currency by January 1999 at the latest. A list of five criteria for admission to the monetary union. A precise specification of central banking institutions. Additional conditions mentioned (e.g. the excessive deficit procedure). 4
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition The Maastricht Convergence Criteria Inflation: –not to exceed by more than 1.5 per cent the average of the three lowest inflation rates among EU countries. Long-term interest rate: –not to exceed by more than 2 per cent the average interest rate in the three lowest inflation countries. ERM membership: –at least two years in ERM without being forced to devalue. Budget deficit: –deficit less than 3 per cent of GDP. Public debt: –debt less than 60 per cent of GDP: Note: Observed on 1997 performance for decision in
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Convergence Criteria: Inflation convergence 6
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Convergence Criteria Long-Term Interest Rate: easy to bring inflation down in 1997 and then let go again. ERM Membership: need to convince the exchange markets. Historically, all big inflation episodes born out of runaway public deficits and debts. Hence requirement that house is put in order before admission. Problem No. 1: –a few years of budgetary discipline do not guarantee long-term discipline Problem No. 2: articifial ceilings. 7
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Debt and Deficit in
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Architecture of the monetary union 9
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition A Tour of the Acronyms N countries with N National Central Banks (NCBs) that continue operating but with no monetary policy function. A new central bank at the centre: the European Central Bank (ECB). New Governor Mario Draghi (Super Mario in Italy) from November 2011 The European System of Central Banks (ESCB): the ECB and all EU NCBs (N=27). The Eurosystem: 11 countries made up the euro area when the euro was introduced in There are now 17 members, the newest being Estonia, Slovakia, Cyprus and Malta. 10
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition How Does the Eurosystem Operate? Objectives: –What is it trying to achieve? Instruments: –What are the means available? Strategy: –How is the system formulating its actions? 11
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Objectives The Maastricht Treatys Art : The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community […]. In the pursuit of price stability, the ECB aims at maintaining inflation rates below, but close to, 2% over the medium term. Article 2. The objectives of European Union are a high level of employment and sustainable and non-inflationary growth. 12
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Scope of monetary policy ECB Long-run neutrality of money It is widely agreed that in the long run – after all adjustments in the economy have worked through – a change in the quantity of money in the economy will be reflected in a change in the general level of prices. But it will not induce permanent changes in real variables such as real output or unemployment. This general principle, referred to as "the long-run neutrality of money", underlies all standard macroeconomic thinking. Real income or the level of employment are, in the long term, essentially determined by real factors, such as technology, population growth or the preferences of economic agents. Inflation – a monetary phenomenon In the long run a central bank can only contribute to raising the growth potential of the economy by maintaining an environment of stable prices. It cannot enhance economic growth by expanding the money supply or keeping short-term interest rates at a level inconsistent with price stability. It can only influence the general level of prices. 13
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Inflation record 14
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Instruments The Euro OverNight Index Average (Eonia) is the overnight reference rate in the Euro zone 15
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Independence and Accountability Arguments for central bank independence: –governments tend not to resist to the printing press temptation –the Bundesbank has set an example. But misbehaving governments are eventually punished by voters. Independence removes central banks from such pressure. A democratic deficit? 16
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Redressing the Democratic Deficit In return for their independence, central banks must be held accountable: –to the public –to elected representatives. Example: the Bank of England is given an inflation target by the Chancellor. It is free to decide how to meet the target, but must explain its failures (the letter) 17
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3 rd Edition Independence and Transparency 18
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