FEATURES OF ECONOMIC UNION

• Single market for persons, goods, services and capital

• High level of co-ordination of economic policy

- esp. central control of fiscal policy

• Greater role for competition policies

• Structural Funds

- transfer of funds to weaker countries

FEATURES OF MONETARY UNION

• Total and irreversible convertibility of currencies

• Complete liberalisation of capital movements

• Full integration of banking and other financial markets

• Elimination of margins of fluctuation and irrevocable locking of exchange rates (implying a single currency)    

MAASTRICHT CRITERIA

• Level of inflation to be within 1.5% of 3 lowest member countries

• Level of long term interest rates to be within 2% of 3 lowest inflation countries

• Budget deficit to be less than 3% of GDP

• National debt to be less than 60% of GDP

• Any country proposing to join to have been member of ERM for two years prior to entry

 

ADVANTAGES OF EMU• Symbolic of overall union

• Would reduce transaction costs for business

• Would eliminate uncertainty due to exchange rate adjustments facilitating trade

• Individual countries do not have to hold reserves as all are pooled

• Would encourage more co-ordination of economic policies

• Beneficial effects on efficiency

• Currency would become international reserve asset

• Help to reduce interest rates

• Help to reduce inflation

• Could facilitate overall growth and employment in Community    

POSSIBLE DISADVANTAGES

• Considerable loss in national sovereignty

• Effects might not be equally spread throughout Community

• Possible difficulties in dealing with crisis situations

• No guarantees in relation to stability of currency in relation to other world currencies

• Special problems for Ireland (in relation to UK and US currencies)

 

PROGRESS TO EMU

Stage 1 (1990-1994)    

• Completion of Internal Market

• Provision of structural funds

• Enforcement of Competition Policy

• Participation of all countries in ERM

• Stabilisation of exchange rate movements

Exchange Rate Crisis (1992-1993)

PROGRESS TO EMU (con)

Stage 2 (1994 - 1997)  

• Continuation of market liberalisation

• New round of funding

• More economic convergence

• Starting procedures for new Central Bank

• Further narrowing of currency bands

PROGRESS TO EMU (con)

Stage 3

• Beginning Jan. 1999  

• Introduction of Euro

• ESCB and ECB now in operation

• Monetary Committee to be dissolved

EMI

Interim arrangement (1994 – 1998) managed by council consisting of a President and Governors of Central Banks located in Frankfurt    

Three Tasks

• To facilitate convergence by strengthening co-ordination of monetary policies

• Responsible for overseeing operation of ERM: EMCF to be dissolved

• Required to prepare all the procedures and methods of control necessary when final stage was to arrive

 

ESCB

• Assigned the task of defining and implementing monetary policy of community

• Foreign exchange reserves of member states to be centralised with ESCB

• Collaborative structure of NCB's and ECB

• Subject to review by European Court of Justice

• ECB has exclusive right to issue notes, engage in open market operations, impose minimum reserve requirements, carry out foreign exchange operations etc.

• Primary objective is price stability  

EUROPEAN CENTRAL BANK (ECB)

• Decision-making body of Euro-zone  

• Design of ECB  

• Maastricht Treaty and EMI (founded 1994)

• ECB (founded 1998)

• European System of Central Banks

• Executive Board and Governing Council of ECB

 

EUROPEAN CENTRAL BANK (Con)

• Responsibilities of ECB  

• to maintain price stability

• to support "the general economic policies of the Community"

• independent of national governments and Central Banks

• may not lend to any Community institution or government

• will be concerned with one overriding objective of price stability  

MONETARY POLICY IN EMU

• Control of inflation targeting

• Control of money supply

• Government Borrowing

- Central Bank

- Commercial Banks

- Abroad

- Non-bank public

 

FISCAL POLICY IN EMU

• Stability Pact

- governments not to incur deficit over 3% GDP

- over medium-term budgets to be close to balanced or in surplus

- fines for deficits in excess of 3% but for exceptional cases

 • Could be major problems in the case of a sudden shock

such as a recession  

MACROECONOMIC POLICY COORDINATION

• Since 1998 the ECB has managed to keep inflation to about 2% p.a.

- however actual inflation has varied considerably between member states with inflation much higher in Ireland, Greece and the Netherlands and lower in Germany

- variations in economic performance much greater with sharp slowdown eveident in Germany, France and Italy and boom conditions In Ireland, Greece and Spain

- fears that in future ECB policy could be geared more to the interest of stronger economies such as Germany and France with inflation more difficult to control

- fears that because fiscal policy can be be more effectively used in a common monetary zone that it could thereby be used irresponsibly by some governments

FISCAL POLICY AND CROWDING OUT EFFECTS

• One of the limitations on conventional fiscal policy is that attempts to increase government spending in an attempt to stimulate economic activity can lead to increase in interest rate(due to increased demand by Government for money to fund expansion)

• The consequent rise in interest rate can then depress private sector borrowing and spending

• Thus the crowding out effect is the reduction in private sector spending that counterbalances increased government spending

• Crowding out (and crowding in) effects - when significant can considerably reduce effectiveness of fiscal policy

• However in a common monetray zone because interest rate increases are likely to be greatly restricted fiscal policy potentially can be much more effective in each member country

GROWTH AND STABILITY PACT

• Set up in 1996 with a decision to

- limit budget deficits of Eurozone members to no more than 3% GDP

in a given year

- public debt/GDP ratio not to exceed 60%

- larger deficits temporarily allowed to combat severe recessions

- complicated system of penalties to be imposed on countries who

break terms of agreements

- problems in major economies of France and Germany - where recent

budget recent deficits exceeeded 3% led to temporary abandonment

of rules

EXCHANGE RATE POLICY IN EMU

• Euro and ECU

    - responsibility for exchange rate policy

- provision for formal agreements linking Euro to other currencies

 In the final stage Monetary Committee to be dissolved and replaced by an Economic and Financial Committee  

• The Euro as a Global Currency  - importance for trade

- importance for reserves

EMU AND IRELAND

• Other Options

- setting an effective exchange rate target

- return to sterling link

- free floating

 

• Political Benefits to Ireland  

- decision making

- economic support

EMU AND IRELAND (Con)

• Economic Benefits  - completing internal market - price transparency - reduced transactions costs - reduction in exchange rate uncertainty - scale economies  

• Economic Costs  - transition costs - difficulty in adjusting to shocks - loss of fiscal autonomy - loss of economic independence - loss of unemployment/inflation trade-off