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EU Days The Single Currency. Joining the Euro Introducing the Euro Introducing the Euro Economic and monetary union (EMU) comprises various stages. Economic.

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Presentation on theme: "EU Days The Single Currency. Joining the Euro Introducing the Euro Introducing the Euro Economic and monetary union (EMU) comprises various stages. Economic."— Presentation transcript:

1 EU Days The Single Currency

2 Joining the Euro Introducing the Euro Introducing the Euro Economic and monetary union (EMU) comprises various stages. Economic and monetary union (EMU) comprises various stages. The main objective of Stage One, which began in 1990, was the complete liberalisation of capital movements under Article 56 of the EC Treaty. The main objective of Stage One, which began in 1990, was the complete liberalisation of capital movements under Article 56 of the EC Treaty. In Stage Two, which began on 1 January 1994, the Member States implemented measures enabling them to achieve the convergence targets necessary in order to enter Stage Three of EMU and guaranteed the independence of their central banks. The process of coordinating economic policies and ensuring multilateral surveillance of progress with convergence began in the course of Stage Two. The Member States were called on to do all they could to avoid excessive public deficits. In Stage Two, which began on 1 January 1994, the Member States implemented measures enabling them to achieve the convergence targets necessary in order to enter Stage Three of EMU and guaranteed the independence of their central banks. The process of coordinating economic policies and ensuring multilateral surveillance of progress with convergence began in the course of Stage Two. The Member States were called on to do all they could to avoid excessive public deficits.

3 Joining the Euro In Stage Two the Member States had to take measures to free their central banks of political interference. Central banks are now responsible for monetary policy and, as such, determine interest rates in the euro zone. They were also prohibited from financing a budget deficit affecting the European institutions, the governments of the Member States or other authorities, be they regional or local, and from granting loans to state-owned companies. In Stage Two the Member States had to take measures to free their central banks of political interference. Central banks are now responsible for monetary policy and, as such, determine interest rates in the euro zone. They were also prohibited from financing a budget deficit affecting the European institutions, the governments of the Member States or other authorities, be they regional or local, and from granting loans to state-owned companies. Stage Three of EMU began on 1 January 1999 with the launch of the euro on financial markets. Under the accession treaty, the new Member States went straight into Stage Three of EMU on 1 May Stage Three of EMU began on 1 January 1999 with the launch of the euro on financial markets. Under the accession treaty, the new Member States went straight into Stage Three of EMU on 1 May 2004.

4 Joining the Euro What you must show before entering the Euro Zone What you must show before entering the Euro Zone Price stability, measured according to the rate of inflation in the three best performing Member States; Price stability, measured according to the rate of inflation in the three best performing Member States; Long-term interest rates close to the rates in the countries with the best inflation results; Long-term interest rates close to the rates in the countries with the best inflation results; An annual budget deficit which does not exceed 3% of gross domestic product (GDP) and total government debt which does not exceed 60% of GDP or which is falling steadily towards that figure; An annual budget deficit which does not exceed 3% of gross domestic product (GDP) and total government debt which does not exceed 60% of GDP or which is falling steadily towards that figure; Stability in the exchange rate of the national currency on exchange markets The exchange-rate mechanism of the European Monetary System requires this stability to be demonstrated and sustained for two years. Stability in the exchange rate of the national currency on exchange markets The exchange-rate mechanism of the European Monetary System requires this stability to be demonstrated and sustained for two years.

5 Why did the Euro appear? Needed to reduce uncertainty and volatility of currencies Needed to reduce uncertainty and volatility of currencies needed to bring national monetary and fiscal policies more together needed to bring national monetary and fiscal policies more together needed to reduce use of exchange rate as macro tool needed to reduce use of exchange rate as macro tool Needed to control money expansion within member states Needed to control money expansion within member states needed to control expansion on money stock v competitive de-valuations needed to control expansion on money stock v competitive de-valuations Started with ERM Started with ERM

6 Convergence Criteria amount of money owed by a government - known as the budget deficit, has to be below 3% of Gross Domestic Product (GDP) - the total output of the economy. amount of money owed by a government - known as the budget deficit, has to be below 3% of Gross Domestic Product (GDP) - the total output of the economy. The total amount of money owed by a government, known as the public debt, has to be less than 60% of GDP. The public debt is the cumulative total of each year's budget deficit. The total amount of money owed by a government, known as the public debt, has to be less than 60% of GDP. The public debt is the cumulative total of each year's budget deficit. Countries should have an inflation rate within 1.5% of the three EU countries with the lowest rate. This was supposed to push down inflation rates and lead to more stable prices. Countries should have an inflation rate within 1.5% of the three EU countries with the lowest rate. This was supposed to push down inflation rates and lead to more stable prices. Long-term interest rates must be within 2% of the three lowest interest rates in EU. Long-term interest rates must be within 2% of the three lowest interest rates in EU. Exchange rates must be kept within "normal" fluctuation margins of Europe's exchange-rate mechanism. Exchange rates must be kept within "normal" fluctuation margins of Europe's exchange-rate mechanism.

7 UKs 5 tests The UK's five tests The UK's five tests These are the five economic tests on UK entry to the euro as outlined by The Treasury in These are the five economic tests on UK entry to the euro as outlined by The Treasury in Convergence Convergence The Treasury sees the first test, the need for the UK economy to come together with the euro zone economy, as the "touchstone" towards a successful single currency. The Treasury sees the first test, the need for the UK economy to come together with the euro zone economy, as the "touchstone" towards a successful single currency. And it says it must converge in a "sustainable and durable" way. And it says it must converge in a "sustainable and durable" way. It says that to be passed, the UK economy must: It says that to be passed, the UK economy must: have converged with Europe have converged with Europe be shown to have converged be shown to have converged show convergence capable of being sustained show convergence capable of being sustained have sufficient flexibility to adapt to change and unexpected economic events have sufficient flexibility to adapt to change and unexpected economic events

8 5 Tests The UK's five tests The UK's five tests In the past, the UK's economic cycle has been both more volatile than others in the EU, reflecting different economic policies, oil price rises and German unification. In the past, the UK's economic cycle has been both more volatile than others in the EU, reflecting different economic policies, oil price rises and German unification. Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis? Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis? This also been affected by differences in the UK economy such as trade patterns, oil, company finance and the housing market This also been affected by differences in the UK economy such as trade patterns, oil, company finance and the housing market Setting out the five tests, the government said a period of stability - via low inflation and controls on spending - would be needed in order to promote sustainable and durable convergence with the rest of the European Union. Setting out the five tests, the government said a period of stability - via low inflation and controls on spending - would be needed in order to promote sustainable and durable convergence with the rest of the European Union.

9 5 tests Flexibility Flexibility The Treasury says the success or otherwise of the euro depends on business and the workforce being flexible. The Treasury says the success or otherwise of the euro depends on business and the workforce being flexible. The economy, it says, must have "the ability to adjust to change". The economy, it says, must have "the ability to adjust to change". If problems emerge is there sufficient flexibility to deal with them? If problems emerge is there sufficient flexibility to deal with them? It says this is because of the "inevitable loss of domestic control over monetary policy" and the risk of future economic turbulence. It says this is because of the "inevitable loss of domestic control over monetary policy" and the risk of future economic turbulence. Firms would need to be flexible in terms of pricing and margins, and in their business strategy. Firms would need to be flexible in terms of pricing and margins, and in their business strategy. Wage bargaining in the labour market must be "realistic and take account of developments in productivity". Wage bargaining in the labour market must be "realistic and take account of developments in productivity". Employees would need to increase their skills in order to adapt to change in the job market Employees would need to increase their skills in order to adapt to change in the job market

10 5 tests Investment Investment The Treasury believes that a successful single currency would: The Treasury believes that a successful single currency would: Would joining EMU create better conditions for firms making long-term decisions to invest in Britain? Would joining EMU create better conditions for firms making long-term decisions to invest in Britain? create an attractive area - with low inflation and stability - for firms to invest create an attractive area - with low inflation and stability - for firms to invest be a complement to the Single Market, boosting competition and providing new opportunities for companies be a complement to the Single Market, boosting competition and providing new opportunities for companies The Treasury says the euro could, if successful, help to reduce the risk of poor investment performance by reducing instability. The Treasury says the euro could, if successful, help to reduce the risk of poor investment performance by reducing instability. Investment could be boosted by the reduction of transaction costs and exchange rate uncertainty, it says. Investment could be boosted by the reduction of transaction costs and exchange rate uncertainty, it says. And more transparent pricing - with companies able to compare prices between countries much more easily - could also encourage investment. And more transparent pricing - with companies able to compare prices between countries much more easily - could also encourage investment. But the Treasury says entering the single currency before the UK economy has sufficiently converged with the euro zone would discourage investment. But the Treasury says entering the single currency before the UK economy has sufficiently converged with the euro zone would discourage investment.

11 5 tests Financial services Financial services The Treasury says joining the euro would affect the financial services industry "more profoundly and more immediately" than other sectors of the economy. The Treasury says joining the euro would affect the financial services industry "more profoundly and more immediately" than other sectors of the economy. What impact would entry into EMU have on the competitive position of the UK's financial services industry? What impact would entry into EMU have on the competitive position of the UK's financial services industry? It says whether the UK joins the euro or not, the City of London's strengths "should help it to thrive". It says whether the UK joins the euro or not, the City of London's strengths "should help it to thrive". The test centres on whether the introduction of the euro would be advantageous for the sector and whether the sector is fully prepared for the introduction of the single currency in the UK. The test centres on whether the introduction of the euro would be advantageous for the sector and whether the sector is fully prepared for the introduction of the single currency in the UK.

12 The Euro? Fixed exchange rates from 1999 Fixed exchange rates from 1999 Started 2002 Started 2002 Transaction costs Transaction costs reduce uncertainty reduce uncertainty transparency of prices transparency of prices encourage mergers encourage mergers BUT what of initial costs? BUT what of initial costs? Role of ECB Role of ECB loss of control of economic/political decisions loss of control of economic/political decisions problems with expansion problems with expansion

13 5 tests Employment and growth Employment and growth This is the "fundamental" test, says the Treasury. This is the "fundamental" test, says the Treasury. Will joining EMU promote higher growth, stability and a lasting increase in jobs? Will joining EMU promote higher growth, stability and a lasting increase in jobs? Joining the euro could "enhance both growth and employment prospects". Joining the euro could "enhance both growth and employment prospects". But without sufficient convergence and flexibility, "the resulting turbulence could considerably damage them". But without sufficient convergence and flexibility, "the resulting turbulence could considerably damage them". The Treasury will have to decide as it assesses the tests the potential effect on jobs and growth from joining the euro. In 2003 Gordon Brown announced that the UK did NOT then meet the 5 tests The Treasury will have to decide as it assesses the tests the potential effect on jobs and growth from joining the euro. In 2003 Gordon Brown announced that the UK did NOT then meet the 5 tests

14 Gains and Losses Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, stricter discipline in tax issues Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, stricter discipline in tax issues BUT Loss of economic sovereignty BUT Loss of economic sovereignty Asymmetric shocks Asymmetric shocks Lack of convergence – two speed Union? Different labour market regulations Lack of convergence – two speed Union? Different labour market regulations Different growth rates Different growth rates What if one country gets out of synch? What if one country gets out of synch? What if monetary flexibility required? What if monetary flexibility required?

15 Gains and Losses Structural differences between countries – we export 52% to EU, Germany 56%, France 63% Structural differences between countries – we export 52% to EU, Germany 56%, France 63% Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU More vulnerability to oil price hikes? More vulnerability to oil price hikes? Can it be sustained as enlargement continues? Can it be sustained as enlargement continues? Can Regional Policy cope Can Regional Policy cope Can the poorer nations be accommodated? Can the poorer nations be accommodated?

16 Will it survive? Will probably depend on? Will probably depend on? Competitiveness on economy (price/non- price), spare capacity, financial resources, Knowledge of market, distribution systems, strength/stability of Euro, affect of joining Euro on macroeconomic management, loss of sovereignty, implications for UK business, price at which we join (ERM memories).

17 Single Currency – Quick Re-cap Fixed exchange rates from 1999 Fixed exchange rates from 1999 Started 2002 Started 2002 Transaction costs Transaction costs reduce uncertainty reduce uncertainty transparency of prices transparency of prices encourage mergers encourage mergers BUT what of initial costs? BUT what of initial costs? Role of ECB Role of ECB loss of control of economic/political decisions loss of control of economic/political decisions problems with expansion problems with expansion

18 Re-cap 2 Trade diversion - switch purchases to high-cost supplier Trade diversion - switch purchases to high-cost supplier Will trade creation grow? – replace high cost domestic production with imports from a more efficient EU partner? Will trade creation grow? – replace high cost domestic production with imports from a more efficient EU partner? If economic welfare is to increase the EU needs to (a) be as efficient as outside producers (b) be aware of demand and supply curve inelasticity of the commodities affected by the CET If economic welfare is to increase the EU needs to (a) be as efficient as outside producers (b) be aware of demand and supply curve inelasticity of the commodities affected by the CET

19 Re-cap 3 Membership based on meeting convergence criteria and accepting political rules Membership based on meeting convergence criteria and accepting political rules Price stability – no more than 1.5% above average of three best performing members Price stability – no more than 1.5% above average of three best performing members Interest Rates – no more than 2% above average of the three member states with lowest inflation rates in previous year. Long term rates convergence. Interest Rates – no more than 2% above average of the three member states with lowest inflation rates in previous year. Long term rates convergence. Gov deficit – no more than 3% of GDP. Gov deficit – no more than 3% of GDP. Public Sector Debt Control – must not exceed 60% of GDP Public Sector Debt Control – must not exceed 60% of GDP Independent Central Bank Independent Central Bank Euro a powerful currency, greater parity with $, integration of financial markets, greater market liquidity, sounder fiscal policy Euro a powerful currency, greater parity with $, integration of financial markets, greater market liquidity, sounder fiscal policy

20 Re-cap-continued Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, stricter discipline in tax issues Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, stricter discipline in tax issues BUT Loss of economic sovereignty BUT Loss of economic sovereignty Asymmetric shocks Asymmetric shocks Lack of convergence – two speed Union? Different labour market regulations Lack of convergence – two speed Union? Different labour market regulations Different growth rates Different growth rates What if one country gets out of synch? What if one country gets out of synch? What if monetary flexibility required? What if monetary flexibility required?

21 Some other problems? Structural differences between countries – we export 52% to EU, Germany 56%, France 63% Structural differences between countries – we export 52% to EU, Germany 56%, France 63% Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU More vulnerability to oil price hikes? More vulnerability to oil price hikes? Can it be sustained as enlargement continues? Can it be sustained as enlargement continues? Can Regional Policy cope Can Regional Policy cope Can the poorer nations be accommodated? Can the poorer nations be accommodated?

22 Deciding factors? Will probably depend on? Will probably depend on? Competitiveness on economy (price/non- price), spare capacity, financial resources, Knowledge of market, distribution systems, strength/stability of Euro, affect of joining Euro on macroeconomic management, loss of sovereignty, implications for UK business, price at which we join (ERM memories).

23 Competitiveness


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