EMU and the euro . . . EMU and the euro . . . (for dummies?)(for dummies?)

Presentation by Nigel NagarajanStudent Orientation – 2009 Euro Challenge

Miami-Florida European Union Center of Excellence January 22nd, 2009

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What are we going to cover today?What are we going to cover today?

• What is EMU?

• What are the costs and benefits of having a single currency?

• What economic benefits derive from the single market?

• How is economic policy made in a monetary union?

• Will EMU break up?

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What EMU What EMU isn’tisn’t

Sorry to disappoint you, but . . .

HELLO, MY NAME IS

Dromaius Novaehollandiae

. . . EMU is not a bird!

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What does EMU stand for?What does EMU stand for?

Does EMU stand for:

European Monetary Union?

Or:

Economic and Monetary Union?

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EMU vs. the euro areaEMU vs. the euro area

• EMU is a Treaty objective shared by all 27 EU Member States

• The euro is a reality for 16 Member States (“the euro area”)

• What about the “E” in EMU?

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What are the three parts of EMU?What are the three parts of EMU?

1) The euro – countries give up their own currency when they join the euro area. The ECB sets interest rates for the euro area (16)

2) The single market – all countries participate in the single market, with free movement of goods, services, capital and people (27)

3) Enhanced policy coordination – countries retain sovereignty over other economic policies but commit to coordinate more closely at the European level (27/16)

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Which countries are in the euro area?Which countries are in the euro area?

Euro area:Euro area: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain.

EU Member States obliged EU Member States obliged to adopt the euro to adopt the euro eventually:eventually: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Sweden.

EU Member States with an opt out from adopting the euro: Denmark, United Kingdom.

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How does a country join the euro?How does a country join the euro?

A Member State must fulfill the “convergence criteria” laid down by the Maastricht Treaty:

• Low inflation• Low interest rates• Low government deficit• Low government debt• Stable exchange rate (ERM II)

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What are the benefits of the euro? And the costs?What are the benefits of the euro? And the costs?

CITIZENS benefit from greater price transparency, which should stimulate competition and reduce prices and from the elimination of currency exchange costs

For BUSINESSES it is easier to make investment decisions (no exchange rate risk)

The ECONOMY benefits from price stability, and lack of exchange rate risk

Countries that adopt the euro can no longer change their INTEREST RATE or their EXCHANGE RATE. In a monetary union, you cannot have an INDEPENDENT MONETARY POLICY.

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Real world example of a Real world example of a single currency areasingle currency area

Fiscal transfers:

Fiscal transfers: Taxes: Taxes:

Texas: boomTexas: boom

Massachusetts: recessionMassachusetts: recession

(1) Federal fiscal (1) Federal fiscal systemsystem

Fiscal transfers:

Fiscal transfers:

Taxes:

Taxes:

(2) High labour (2) High labour mobilitymobility

Asymmetric shock: oil Asymmetric shock: oil prices prices . Affects Texas . Affects Texas and Massachusetts and Massachusetts differently.differently.

The challenge of asymmetric shocksThe challenge of asymmetric shocks

Euro area less Euro area less good at coping good at coping with shocks?with shocks?

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The benefits of EU membership – the single marketThe benefits of EU membership – the single market

• Larger market → more competition

• More competition → more choice, lower prices for consumers

• More competition → promotes efficiency

• Larger market → firms can exploit economies of scale

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The single market – economies of scaleThe single market – economies of scale

• Larger firms enjoy cost advantages over smaller firms (e.g. purchasing, marketing)

• EU firms can produce for a market of 500m consumers

• And pass on lower costs to consumers

• This should encourage economic efficiency and stimulate economic growth

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The euro and the single marketThe euro and the single market

• The euro eliminates currency transactions costs

• Leads to greater price transparency → price convergence

• Eliminates exchange rate uncertainty → stimulates investment

• Euro leads to increased trade and investment flows

“One market, one money”

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Economic policy in EMUEconomic policy in EMU

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Economic policy making - the euro area and the USEconomic policy making - the euro area and the US

Monetary policy

Federal Reserve Chairman

Ben S. Bernanke

ECB President

Jean-Claude Trichet

Fiscal policy

Treasury Secretary

Henry M. PaulsonEurogroup Finance Ministers

Economic policy co-ordination more Economic policy co-ordination more difficult?difficult?

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EMU and the financial crisisEMU and the financial crisis

“this is an equal-opportunities economic crisis, and the euro area is in it just as deep as America, Britain and the rest.” –

The Economist, January 15th, 2009

• US and euro area economies connected by strong trade, investment links

• European banks invested heavily in US sub-prime mortgages

• Euro area has less flexible economy than US, with lower productivity growth – less resilient?

• Some euro area economies had housing bubbles

• European consumers less indebted than US

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EMU and the financial crisisEMU and the financial crisis

• Crisis exposes persistent divergences in EMU

• “One size fits all monetary policy” problematic?

• Countries need to use fiscal stimulus, just as in US

• But difficult to coordinate fiscal response of 16 Member States

• Break-up of EMU?

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The financial crisis – how should Europe respond?The financial crisis – how should Europe respond?

ECB cuts interest rates to 2%

European Economic Recovery Plan – governments enact fiscal stimulus packages

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The financial crisis – how should Europe respond?The financial crisis – how should Europe respond?

Speed up economic reforms (Lisbon Strategy) http://ec.europa.eu/growthandjobs/index_en.htm

Make the single market work better (especially for Services)

2020

ConclusionsConclusions

• The launch of the euro was a tremendous achievement for the EU

• But EMU is still a work in progress (especially for the “E” part)

• How will EMU cope with its first recession? • Will the crisis lead to the break up of EMU

or will it encourage countries to speed up reforms?

• Can you have a monetary union without a complete economic union? Political union?