1
EMU@10 and beyond: on the way to an enlarged euro area
Massimo SuardiEuropean Commission
Head of Unit - Monetary and exchange rate affairs -Directorate General Economic and Financial Affairs -
Conference – Common currency and its future –Lessons for the New Member States
Warsaw, 15 October 2008
European Commission
2
Outline
• EMU: The first ten years
• Achievements and challenges
• Lessons and policy agenda
• On the way to an enlarged euro area
• A sequenced process
• Many roads to the euro
• Progress with convergence
• Conclusions
3
EMU: The first ten years
4
The achievements of EMU
Price stability and low cost of borrowing
Elimination of intra-area exchange rate volatility
Increased trade and FDI ; financial integration
Strong job creation
Sounder fiscal positions
Greater resilience to external shocks
The euro is the 2nd global currency
5
Inflation performance has improved
Inf latio n perfo rm ance in the euro area
S ource : European Com m ission .
*Corresponds to the period s ince the sta rt o f Stage III o f E MU .
0
2
4
6
8
1 0
19 60s 19 70s 19 80s 199 0s 20 00s *
Av erage
Sta nda rddev ia tio n
6
Cost of borrowing fallen dramatically
Evolution of 10-year government bond yields (in percent, annual data)
2
4
6
8
10
12
14
16
18
20
22
24
2619
90
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Source: Eurostat
BE DE
IE GR
ES FR
IT NL
AT PT
FN LU
SI
7
EMU boosted FDI, trade and growth
The impact of the euro on:
0%5%
10%15%20%25%30%35%40%
FDI Trade Growth
min max
8
EMU promoted financial market integration
0%
20%
40%
60%
80%
100%
Home bias inequity markets
Cross borderholdings of euroarea long-termdebt securities
Share of domesticcredit institutionsin banks' assets
start of EMUMost recent data
9
More than 16 million jobs createdEmployment growth
ES
IE
NL
LU
US
AV
PTELEAITSE
FIDK
UK
FR
BEDE
AT
0
1
2
3
4
5
-1 0 1 2 3 41989-1998, % per annum
1999
-200
8, %
per
ann
um
Source: European Commission.
10
Fiscal positions improved
-6
-5
-4
-3
-2
-1
0
1995 1998 2007
% o
f GD
P
Cyclially-adjusted fiscalbalance
Fiscal balance
11
Increased resilience to shocks
Cumulated output loss due to recession
0
2
4
6
8
10
1980s 1990s 2000s
% o
f GD
P a
t ful
l cap
acity
utilis
atio
n
12
But not all expectations have been fulfilled
GDP growth is slow in some countries, due to unsatisfactory productivity performance
Rising divergences in competitiveness and large current account imbalances require correction
In general, structural reforms have been less ambitious and frequent than in the rest of the EU
Banking and financial markets are still predominately nationally organized and supervised
Not much progress in international representation
Weaknesses in public perception of the euro
13
Major external imbalances built up
Current account positions39
141 9 1310
-26 -43-9
-15 -97-25-12
-10-8-6-4-202468
NL DE FI AT BE IT FR IE PT ES EL
% o
f GD
P
Numbers indicate the absolute position, billions of euros
2007
Source: European Commission.
14
Driven by competitiveness developments
Cumulated change in relative unit labour cost
-15-10
-50
510
1520
IE PT EL ES IT NL FR BE FI AT DE
%
1999-2007
Source: European Commission.
15
The implementation of structural reform recommendations has disappointed in some
countries
1.0
1.5
2.0
Euro area Top 3 euro areaperformers
Denmark,Sweden, UK
Score on a scale from 0 to 3
16
Asymmetric impact of common external shocks
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
0 1 2 3 4 5 6 7 8 9 10
DEITIE
Euro/dollar exchange rate shock
(risk premium shock leading to 10% appreciation)
-0.3
-0.2
-0.1
0.0
0.1
0 1 2 3 4 5 6 7 8 9 10
DE
IT
IE
US slowdown (1% fall in private consumption and
investment by )
US slowdown (1% of GDP fall in private consumption
and investment)
(Source: QUEST III model simulations)
17
Lessons from EMU@10 for current and future euro area members (1 - challenges)
Price stability: equilibrium real appreciation complicates inflation control ; shorter history of anti-inflation policy and lower credibility ; conflict between fiscal and monetary authorities ; wage catching up
Effective adjustment capacity (incl. stabilisation):To deal with shocks without exchange rate instrument (but nominal exchange rate flexibility acts also as shock propagator, hence less ‘cost’ of giving up the XR instrument);
Relatively more frequent and persistent common shocks with asymmetric impact (exchange rates, terms of trade, shifting comparative advantages…); asymmetric shocks still possible (see Spain, Ireland, …)
Correction of large current account imbalances may require long and painful disinflation processes if coupled with stagnating productivity
EMU and financial integration help efficient resource allocation and allow for longer adjustment periods, but managing credit booms can be a challenge (already well before euro adoption)
Long-term challenges: sustain high potential growth (catching-up), in a context of ageing, globalisation (with more rapid shifts in comparative advantages)
18
Lessons from EMU@10 for current and future euro area members (2 – policy needs)
Improved budgetary control to reduce the risk of fiscal policy pro-cyclicality; budgetary frameworks in NMS are less developed and assessing cyclical component even more challenging
Flexible and integrated goods and factor marketsEffective supervision and regulation of financial markets ; NMS experience accelerated financial developmentSustainability of public finances Quality of public finances ; bias towards current expenditure in NMS
Growth-enhancing use of capital inflows ; NMS are receiving huge inflows, included EU funds; utilisation has differed a lot across NMS
More efficient use of labour resources (participation rates, structural unemployment, skill mismatches)
Business environment and investment climate (innovation, FDI, education, favour entry /exit of firms)
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The three policy pillars of EMU@10Domestic agenda
Deepening fiscal surveillance Broadening policy coordinationIntegrating structural reforms in policy coordination
External agendaConsidering benefits, responsibilities and risks of a global currency Enhancing the international role of the euro area
Effective governanceExploiting existing tools better A stronger role for the Eurogroup, but ECOFIN remains the ultimate decision makerStronger dialogue with other institutions and partners
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Looking ahead – on the way to an enlarged euro area
21European Commission
All EU Member States (except UK, DK) committed to join the euro under the Treaty
Need to achieve a high degree of sustainable convergence, based on fulfilment of criteria
Sequenced process – Member States have room for manoeuvre in managing their path towards the euro
Thorough preparation essential
Euro adoption an opportunity for reforms
Road to the euro – the starting position
22European Commission
Impressive real convergence
Uneven progress with nominal convergence
NMS are overall well placed to benefit from euro adoption from OCA (stabilisation) point of view
High and growing level of integration (trade, FDI, financial)Correlation of business cycles; similarity of structureRelatively flexible markets
Road to the euro – progress with convergence
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Many roads to the euro
European Commission
• No one-size-fits-all strategy• Exchange-rate policy is a matter of common interest (Art. 124) butsovereign choice of exchange rate regime:
Fixed exchange rate regimes (Estonia, Latvia, Lithuania, Bulgaria)
More flexible regimes (Czech Rep., Poland, Hungary, Romania)
Slovakia: ERM II, flexible regime
• In ERM II: Estonia, Lithuania, Latvia, Slovakia
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Catching-up is advancing, but remains long-term challenge GDP per capita in 2007 (in PPS, EU=100) and average change over the period 2004-2007
European Commission
2.5
7.9
6.1
0.4
5.8
8.2
2.3
5.7
3.9
0 10 20 30 40 50 60 70 80 90
CZ
EE
SK
HU
LT
LV
PL
RO
BG
25
NMS are well-integrated with EU/euro area economy…Share of intra-EU trade (exports plus imports)
European Commission
0
10
20
30
40
50
60
70
80
90
CZ SK LV PL EE HU RO LT BG
2002
2007
26
Structural convergence has advanced, but divergences remain
Economic size and labour distribution by sector of activity, 2005
0%
20%
40%
60%
80%
100%
avg 9 NMS EA-13 avg 8 NMS EA-13agriculture industry and construction services
GVA, % of GDP Employment, % of total
note: NMS are BG CZ EE LV LT HU PL SK (RO)
27
GDP growth rates(in %, y-o-y)
European Commission
-2
0
2
4
6
8
10
12
14
2002 2003 2004 2005 2006 2007 H1-08
BulgariaEstoniaLatviaLithuania
0
2
4
6
8
10
12
14
2002 2003 2004 2005 2006 2007 H1-08
Czech RepublicHungaryPolandRomaniaSlovakia
28
State of convergence - HICP inflationRising inflation pressures due to supply and demand factors
12-month average inflation (in %, y-o-y)
European Commission
-2
10
-2
0
2
4
6
8
10
12
14
16
18
2002 2003 2004 2005 2006 2007 2008
reference value BulgariaEstonia LatviaLithuania
0
2
4
6
8
2002 2003 2004 2005 2006 2007 2008
reference value Czech RepublicHungary PolandRomania Slovakia
29
Fiscal positionsExternal constraints seem to matter for fiscal performance
General government balance and government debt (in % of GDP; 2007)
European Commission
CZ
EE
LV
LT
HU
PLSK
BG
RO
-8
-6
-4
-2
0
2
4
6
0 10 20 30 40 50 60 70government debt (in % of GDP)
budg
et b
alan
ce (i
n %
of G
DP)
60%
-3%
30
Exchange rate developmentsvs. euro, monthly averages (index numbers, Jan 2007 = 100)
European Commission
70
80
90
100
110
120
1302002 2003 2004 2005 2006 2007 2008
BGNEEKLVLLTL
↓ depreciation
70
80
90
100
110
120
1302002 2003 2004 2005 2006 2007 2008
CZKHUFPLNRONSKK
↓ depreciation
31
Long-term interest rates12-month averages (in %, y-on-y)
European Commission
2
3
4
5
6
7
8
9
10
11
2002 2003 2004 2005 2006 2007 2008
reference valueBulgariaEstoniaLatviaLithuania
2
3
4
5
6
7
8
9
2002 2003 2004 2005 2006 2007 2008
10
11 reference valueCzech RepublicHungaryPolandRomaniaSlovakia
32
Financially-driven convergence – large capital inflows and extension of external balance sheets
European Commission
NMS - External debtin percentage of GDP
0
20
40
60
80
100
120
Average 9 NMS Baltics + BG CZ HU RO PL SK
2002
2007
Source: Eurostat and Commission services and ECB
Net capital inflows (surplus on the capital account and financial account of the BoP without reserves, % of GDP)
0
5
10
15
20
25
30
NMS-9 Fixers' Floaters'
2000 2007
33
Rapid financial deepening from a low base Domestic credit (in % of GDP)
European Commission
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2002 2003 2004 2005 2006 2007 H1-08
BulgariaEstoniaLatviaLithuania
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2002 2003 2004 2005 2006 2007 H1-08
Czech RepublicHungaryPolandSlovakiaRomania
34
Current account developmentsBalance on current transactions with rest of world (in % of GDP)
European Commission
-25%
-20%
-15%
-10%
-5%
0%2002 2003 2004 2005 2006 2007
BulgariaEstoniaLatviaLithuania
-25%
-20%
-15%
-10%
-5%
0%2002 2003 2004 2005 2006 2007
Czech RepublicHungaryPolandRomaniaSlovakia
35
NMS and the euro - Conclusions
• EMU@10 and beyond – building on the successes and meeting
the challenges
• Specific challenges for NMS. Achieving catching-up, nominal
convergence while preserving macro-financial soundness
• Euro area enlargement is ongoing; NMS have made
considerable progress on the road to the euro
• Policies need to be attuned to country-specific circumstances;
ownership and thorough preparation are key
• EMU@10 policy agenda will help • Short-term challenges: deal with fall-out from the financial crisis
European Commission
