Euro – Benefits, Costs and Risks

Juraj Karpišwww.INESS.sk

karpis@iness.sk

Topics

• EU and Euro

• Benefits as NBS sees them

• Risks and costs as I see them

• Is there an alternative?

I know that• Slovakia agreed before entering EU to adopt Euro in the

future • We don’t have an official opt-out option as Denmark or

UK have or de facto opt – out (after NO in 2003 referendum) of Sweden

• The majority of Slovaks support Euro

So the question is not IF but WHEN

50 years of EU, two different views about future direction:

Centralization There should follow deeper

integration: one constitution, one currency,

common foreign policy, common defense, harmonized taxes, central governement.

Goal: European Super-state

CompetitionEU should only grant

freedom of movement of :

• people• goods• services• capital

Goal: free trade and cooperation in Europe

Benefits of Euro according to NBS

Direct (immediate):• Abolishing exchange rate risks 0,02% GDP• Lower costs of capital• Lower transaction costs - 0,36% GDP • Transparency of prices Indirect (long-term)• Higher volume of international trade (allows

deeper specialization)• Increased direct investments• Faster growth, higher living standards

I would add: • PR for Slovakia – it’s a good sign that

Slovakia is ABLE to adopt Euro• Hard limits for irresponsible politicians –

“Maastricht leash”

Costs and risks according to NBS

• One time expenses for currency change 0,3 to 0,8% GDP

• Loss of some bank profits and temporary higher costs of banks

• Loss of independent monetary policy as a tool for stabilizing economy

• Probably slightly higher inflation rate

NBS: Benefits are much higher than costs =>

Euro ASAP

Problems• Euro is a political construct, has not its own

history and is not a choice of consumers

• Currency change is a complicated process and it is impossible to quantify its effect with precision

• Factors that we can quantify (or we think that we can) are not necessarily more important than factors that we are not able to quantify

• Costs and benefits can be reasonably used only when we talk about individuals not about nation. Costs and benefits are not evenly distributed. Some people will bear costs, other benefits.

Is Euro a Condition for Strong Economic Growth?Real Growth of GDP

Euro Area CountriesF – France, G – Germany, I-Italy

Noneuro Area Countries S-Sweden, UK – United Kingdom,

D - Denmark

0

1

2

3

4

5

1999

2000

2001

2002

2003

2004

2005

2006

2007

F

G

I

0

1

2

3

4

5

1999

2000

2001

2002

2003

2004

2005

2006

2007

S

UK

D

Costs and Risks as I see them:

Heavy wallets!

Costs and Risks as I see them:

• Lack of real convergence – therefore inflationary pressures – depreciation of savings

• Monetary policy not suited for Slovak Business Cycle • Centralization – all eggs in one ECB basket, less

currency competition and flight opportunities• Arbitrariness in setting final exchange rate - impact on

wealth of Slovak citizens • The biggest countries ignore Stability pact therefore in

the future we might bear the risks of costly pension systems of the biggest euroarea countries (ITA, DE, FR)

Euro is in the long term inflationary • Hindering of currency

competition which forced national central banks to behave responsibly or else flight to other currencies

• Probable future pressure on expansive monetary policy to cover deficits of costly social systems of biggest euro areal countries

• Euro makes fiscal free riding possible

• Easier coordination in monetary expansion between world CBs

Stability pact – does anyone care?

• The biggest countries of euroarea ignore the Stability pact’s criteria

• Greece entered the euro-area with the help of phony statistics

Problems Ahead

Fiscal deficits as a % of GDP in the largest euro-countries

-8,0

-3,0

2,0

1999 2000 2001 2002 2003 2004 2005 2006 2007

% H

DP

FG

I

Where is the Convergence?

Price level and GDP per capita in Slovakia as % of EU average

GDP per capita Relative Price level

In 27 months 20%

Vývoj kurzu SKK/EUR od 1.1.2004 do 26.3.2007

32,878

41,08

Centrálna parita pri vstupe do

ERMII 28.11.2005; 38,455

Nová centrálna parita; 19.3.2007;

35,4424

31

33

35

37

39

41

43

2.1.

2004

2.3.

2004

2.5.

2004

2.7.

2004

2.9.

2004

2.11

.200

4

2.1.

2005

2.3.

2005

2.5.

2005

2.7.

2005

2.9.

2005

2.11

.200

5

2.1.

2006

2.3.

2006

2.5.

2006

2.7.

2006

2.9.

2006

2.11

.200

6

2.1.

2007

2.3.

2007

Which means:

Convergence of price levels only by the way of absolute price increases

Higher inflation

+

Negative real interest rates

=

Devaluation of citizen’s SKK savings

Euro Introduction

0

2

4

6

8

10

12

Inflation HICP in Percent YOY

Example of Slovenia – will we follow?

Loss of control over monetary policy

• Does they know (executive board ECB) what currency we need?• Control in the hands of people, on which Slovak won’t have any

influence • No feedback – probability that you meet Mr. Trichet in the streets of

your town is by magnitude lower than the probability that you meet Mr. Sramko

• We will have to accept monetary policy of ECB which will be dictated by the needs of biggest countries – do we need lower interest rates when we grow double digit a year? (base rate 4.25% vs. 4,0%)

Is there an alternative?

Let them compete ! Parallel circulation – legalize the use of other currencies in Slovakia as a legal tender (EUR, USD, SFR others) and let the people choose

- exchange risk eliminated, lower transaction costs

Conclusion

• Euro as a tool for further political integration, moves control further from citizen – it is a way of centralization

• Lack of real convergence – risk of higher inflation and saving devaluation

• The biggest countries don’t fulfill the Maastricht criteria – inflationary risks in the future

• Loss of control over monetary matters

Therefore we should wait or not enter at all.

Thank You

www.INESS.sk

karpis@iness.sk