why convergence criteria

8/3/2019 Why Convergence Criteria

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Why Convergence Criteria?

ECONOMIC AND MONETARY UNION

(EMU)


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Optimal Currency Area

The Optimal Currency Area theory was behind the

European Single Currency argument. It requires:

1. An absence of asymmetric shocks

2. A high degree of labour mobility and wage

flexibility

3. Centralised fiscal policy

Thus, there is a convergence criteria for

establishing Eurozone to meet conditions above.


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Economic benefits ofEMU

Removes exchange rate uncertainty on intra-EMU trade

Avoids competitive devaluations

Eliminates transaction costs Increases price transparency

Low and stable inflation and interest rates

Promotes international specialisation andimproves EU competitiveness

Boosts the EUs international economic profile


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Economic risks ofEMU

Short term deflation

Can one monetary policy fit all?

Loss ofeconomic sovereignty? Asymmetric shocks? especially ifSEM and

EMU lead to specialisation.

Lack ofreal economic convergence Burden ofadjustment on wages and prices -

flexible enough?


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The path to Euro

Werner Report proposes EMU by 1980

1979 European Monetary System - ERM, ECU

1989 Delors Report 3 stage approach to EMU 1993 Maastricht Treaty EMU framework and

timetable

1992-3 ERM (Exchange Rate Mechanism) crises

1.1.99 - fixing ofexchange rates

1.1.02 notes and coins in circulation


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Convergence Criteria

(Maastricht criteria)

For European Union member states to enter

the third stage ofEuropean Economic and

Monetary Union (EMU) and adopt the euro as

their currency

The 4 main criteria are based on Article 121(1)

ofthe European Community Treaty.


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The purpose ofsetting the criteria is to

maintain the price stability within the

Eurozone.


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Monetary criteria

Inflation no more than 1.5 percentage pointsabove the average ofthe 3 countries with the

lowest rates Long term interest rates no more than 2

percentage points above the average ofthe 3countries with the lowest rates

Exchange rate has joined ERM II (Exchange RateMechanism) for previous 2 years and not devaluedits currency


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Fiscal criteria

National budget deficit less than

3% GDP

National debt less than 60% ofGDP

or heading in the right direction


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12 member states form the Euro-zone all pre-2004 member states

UK and Denmark opt-outDanish referendum: February 2000

53% against

Sweden remains out: September2003 no vote


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European Central Bank (ECB)

Independent and supranational

Primary objective is price stability

Responsibility for monetary policy i.e.interest and exchange rate policy.

Fiscal policy remains national but Growth

and Stability Pact to stop member statesundermining ECB


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/S rate: Jan 1999 - July 2006

0.7

0.8

0.9

1

1.1

1.2

1.3

1.4

Jan-99 M S

Jan-00 M S

Jan-01 M S

Jan-02 M S

Jan-03 M S

Jan-04 M S

Jan-05 M S

Jan-06 M

Source: European Central Bank


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March 2005

Stability and Growth Pact reforms

3% budget deficit/60% debt thresholdsremain

relevant factors to enable memberstates to avoid excessive deficitprocedures e.g. economic cycle, structural reform, research

and development, public investment, etc

Countries have longer time to correctexcessive deficit 2 years. Can be extendedfurther.


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0

10

20

30

40

50

60

70

80

Aut

98

Spr

99

Aut

99

Spr

00

Aut

00

Spr

01

Aut

01

Spr

02

Aut

02

Spr

03

Aut

03

Spr

04

Aut

04

%

Eurozone Denmark Sweden UK

Source: Eurobarometer

Support for the single currency, 1998-

2004


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UK - not on the agenda in short or

medium term Political parties

Labour in favour in principle but some dissenters

Conservatives mostly Eurosceptic some pro

Liberal Democrats the most pro Businesses divided

Foreign investors more pro

Big companies more pro than anti

Small companies more anti than pro Public opinion

Heavily anti how deeply held?


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Sweden and Denmark

Referenda defeat pushed membership back

Some more positive attitudes to membership

emerging but: Politicians wary offurther defeats

Difficult to justify given consistently better

performance ofoutsider economies in recent

years


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GDP growth

0

1

2

3

4

5

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Eurozone UK Sweden Denmark

GDP per head, 2005 (EU15 =100)

0 50 100 150

UKDenmarSwedenEurozonBelgiumGermanGreece

SpainFranceIreland

ItalyNetherlAustria

PortugaFinland

0

5

10

15

1995 2000 2005

Unemployment (%)

Denmark Sweden UK Eurozone Germany France Italy

0

0.5

1

1.5

2

2.5

3

3.5

UK

Swed

en

Denm

ark

Eurozone

Germany

Fran

ceItaly

Spain

Inflation (%) - annual average rate 2004/12

Economic performance inside and outside the

eurozone


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Convergence criteria - 2003

Inflation

(%)

Budget

deficit/GDP

Debt/GDP Interest

(%)Cyprus 4.3 -5.2 60.3 4.6

Czech 0.0 -8.0 30.7 4.1

Estonia 1.6 0.0 5.4 6.4

Hungary 4.6 -5.4 57.9 6.5

Latvia 2.5 -2.7 16.7 5.1

Lithuania -0.9 -2.6 23.3 5.1

Malta 1.3 -7.6 66.4 5.8Poland 0.7 -4.3 45.1 5.9

Slovakia 8.5 -5.1 45.1 4.9

Slovenia 5.9 -2.2 27.4 5.5


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Inflation

(%)

Budget

deficit/GDP

Debt/GDP Interest

(%)Cyprus 2.4 -5.2 72.6 5.8

Czech 2.8 -4.8 37.8 5.0

Estonia 3.4 0.5 4.8 4.5

Hungary 6.9 -5.5 59.7 8.4

Latvia 6.8 -2.0 14.6 5.0

Lithuania 1.2 -2.6 21.1 4.6

Malta 3.7 -5.1 72.4 4.7Poland 3.5 -5.6 47.7 7.2

Slovakia 7.7 -3.9 44.2 5.1

Slovenia 3.9 -2.3 30.9 4.8


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Inflation

(%)

Budget

deficit/GDPDebt/GDP Interest (%)

Cyprus 2.0 -2.4 70.3 X 5.16

Czech 1.6 -2.6 30.5 3.51

Estonia 4.1x 1.6 4.8 3.98

Hungary 3.5X -6.1 X 58.4 6.60X

Latvia 6.9X 0.2 11.9 3.88

Lithuania 2.7X -0.5 18.7 3.70

Malta 2.5 -3.3 74.7X 4.56

Poland 2.2 -2.5 42.5 5.22

Slovakia 2.8X -2.9 34.5 3.52

Slovenia 2.5 -1.8 29.1 3.18

Source: national governments and Eurostat:X = above threshold value

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