EU DaysEU Days

The Single CurrencyThe Single Currency

Joining the EuroJoining the Euro Introducing the EuroIntroducing the Euro Economic and monetary union (EMU) comprises various stages.Economic and monetary union (EMU) comprises various stages. The main objective of The main objective of Stage OneStage One, which began in 1990, was the , which began in 1990, was the

complete liberalisation of capital movements under Article 56 of the EC complete liberalisation of capital movements under Article 56 of the EC Treaty.Treaty.

   In In Stage TwoStage Two, which began on 1 January 1994, the Member States , which began on 1 January 1994, the Member States

implemented measures enabling them to achieve the convergence implemented measures enabling them to achieve the convergence targets necessary in order to enter Stage Three of EMU and targets necessary in order to enter Stage Three of EMU and guaranteed the independence of their central banks. The process of guaranteed the independence of their central banks. The process of coordinating economic policies and ensuring multilateral surveillance of coordinating economic policies and ensuring multilateral surveillance of progress with convergence began in the course of Stage Two. The progress with convergence began in the course of Stage Two. The Member States were called on to do all they could to avoid excessive Member States were called on to do all they could to avoid excessive public deficits.public deficits.

  

Joining the EuroJoining the Euro

In Stage Two the Member States had to take measures to In Stage Two the Member States had to take measures to free their central banks of political interference. Central free their central banks of political interference. Central banks are now responsible for monetary policy and, as banks are now responsible for monetary policy and, as such, determine interest rates in the euro zone. They were such, determine interest rates in the euro zone. They were also prohibited from financing a budget deficit affecting the also prohibited from financing a budget deficit affecting the European institutions, the governments of the Member European institutions, the governments of the Member States or other authorities, be they regional or local, and States or other authorities, be they regional or local, and from granting loans to state-owned companies.from granting loans to state-owned companies.

   Stage ThreeStage Three of EMU began on 1 January 1999 with the of EMU began on 1 January 1999 with the

launch of the euro on financial markets. Under the launch of the euro on financial markets. Under the accession treaty, the new Member States went straight into accession treaty, the new Member States went straight into Stage Three of EMU on 1 May 2004. Stage Three of EMU on 1 May 2004.

Joining the EuroJoining the Euro What you must show before entering the Euro ZoneWhat you must show before entering the Euro Zone    Price stability,Price stability, measured according to the rate of inflation in the three measured according to the rate of inflation in the three

best performing Member States; best performing Member States; Long-term interest ratesLong-term interest rates close to the rates in the countries with the close to the rates in the countries with the

best inflation results; best inflation results; An annual budget deficitAn annual budget deficit which does not exceed 3% of gross which does not exceed 3% of gross

domestic product (GDP) and domestic product (GDP) and total government debttotal government debt which does not which does not exceed 60% of GDP or which is falling steadily towards that figure; exceed 60% of GDP or which is falling steadily towards that figure;

Stability in the exchange rateStability in the exchange rate of the national currency on exchange of the national currency on exchange markets The exchange-rate mechanism of the European Monetary markets The exchange-rate mechanism of the European Monetary System requires this stability to be demonstrated and sustained for two System requires this stability to be demonstrated and sustained for two yearsyears..

  

Why did the Euro appear?Why did the Euro appear?

Needed to reduce uncertainty and volatility of Needed to reduce uncertainty and volatility of currenciescurrencies

needed to bring national monetary and fiscal needed to bring national monetary and fiscal policies more togetherpolicies more together

needed to reduce use of exchange rate as macro needed to reduce use of exchange rate as macro tooltool

Needed to control money expansion within Needed to control money expansion within member statesmember states

needed to control expansion on money stock v needed to control expansion on money stock v competitive de-valuationscompetitive de-valuations

Started with ERMStarted with ERM

Convergence CriteriaConvergence Criteria amount of money owed by a government - known as the amount of money owed by a government - known as the

budget deficit, has to be below 3% of Gross Domestic budget deficit, has to be below 3% of Gross Domestic Product (GDP) - the total output of the economy. Product (GDP) - the total output of the economy.

The total amount of money owed by a government, The total amount of money owed by a government, known as the public debt, has to be less than 60% of known as the public debt, has to be less than 60% of GDP. The public debt is the cumulative total of each GDP. The public debt is the cumulative total of each year's budget deficit. year's budget deficit.

Countries should have an inflation rate within 1.5% of Countries should have an inflation rate within 1.5% of the three EU countries with the lowest rate. This was the three EU countries with the lowest rate. This was supposed to push down inflation rates and lead to more supposed to push down inflation rates and lead to more stable prices. stable prices.

Long-term interest rates must be within 2% of the three Long-term interest rates must be within 2% of the three lowest interest rates in EU. lowest interest rates in EU. 

Exchange rates must be kept within "normal" fluctuation Exchange rates must be kept within "normal" fluctuation margins of Europe's exchange-rate mechanism.margins of Europe's exchange-rate mechanism.

UK’s 5 testsUK’s 5 tests The UK's five testsThe UK's five tests These are the five economic tests on UK entry to the euro as outlined by The Treasury in These are the five economic tests on UK entry to the euro as outlined by The Treasury in

1997.1997.    Convergence Convergence    The Treasury sees the first test, the need for the UK economy to come together with the euro The Treasury sees the first test, the need for the UK economy to come together with the euro

zone economy, as the "touchstone" towards a successful single currency.zone economy, as the "touchstone" towards a successful single currency.    And it says it must converge in a "sustainable and durable" way.And it says it must converge in a "sustainable and durable" way.    It says that to be passed, the UK economy must:It says that to be passed, the UK economy must:    have converged with Europe have converged with Europe be shown to have converged be shown to have converged show convergence capable of being sustained show convergence capable of being sustained have sufficient flexibility to adapt to change and unexpected economic events have sufficient flexibility to adapt to change and unexpected economic events   

5 Tests5 Tests The UK's five testsThe UK's five tests    In the past, the UK's economic cycle has been both more volatile than others in In the past, the UK's economic cycle has been both more volatile than others in

the EU, reflecting different economic policies, oil price rises and German the EU, reflecting different economic policies, oil price rises and German unification.unification.

   Are business cycles and economic structures compatible so that we and Are business cycles and economic structures compatible so that we and

others could live comfortably with euro interest rates on a permanent basis?others could live comfortably with euro interest rates on a permanent basis? This also been affected by differences in the UK economy such as trade This also been affected by differences in the UK economy such as trade

patterns, oil, company finance and the housing marketpatterns, oil, company finance and the housing market    Setting out the five tests, the government said a period of stability - via low Setting out the five tests, the government said a period of stability - via low

inflation and controls on spending - would be needed in order to promote inflation and controls on spending - would be needed in order to promote sustainable and durable convergence with the rest of the European Union.sustainable and durable convergence with the rest of the European Union.

  

5 tests5 tests    Flexibility Flexibility    The Treasury says the success or otherwise of the euro depends on business and the workforce The Treasury says the success or otherwise of the euro depends on business and the workforce

being flexible.being flexible.    The economy, it says, must have "the ability to adjust to change".The economy, it says, must have "the ability to adjust to change".    If problems emerge is there sufficient flexibility to deal with them?If problems emerge is there sufficient flexibility to deal with them? It says this is because of the "inevitable loss of domestic control over monetary policy" and the risk of It says this is because of the "inevitable loss of domestic control over monetary policy" and the risk of

future economic turbulence.future economic turbulence.    Firms would need to be flexible in terms of pricing and margins, and in their business strategy.Firms would need to be flexible in terms of pricing and margins, and in their business strategy.    Wage bargaining in the labour market must be "realistic and take account of developments in Wage bargaining in the labour market must be "realistic and take account of developments in

productivity".productivity".    Employees would need to increase their skills in order to adapt to change in the job marketEmployees would need to increase their skills in order to adapt to change in the job market

5 tests5 tests Investment Investment    The Treasury believes that a successful single currency would:The Treasury believes that a successful single currency would:    Would joining EMU create better conditions for firms making long-term decisions to invest in Britain?Would joining EMU create better conditions for firms making long-term decisions to invest in Britain? create an attractive area - with low inflation and stability - for firms to investcreate an attractive area - with low inflation and stability - for firms to invest be a complement to the Single Market, boosting competition and providing new opportunities for be a complement to the Single Market, boosting competition and providing new opportunities for

companiescompanies    The Treasury says the euro could, if successful, help to reduce the risk of poor investment The Treasury says the euro could, if successful, help to reduce the risk of poor investment

performance by reducing instability.performance by reducing instability.    Investment could be boosted by the reduction of transaction costs and exchange rate uncertainty, it Investment could be boosted by the reduction of transaction costs and exchange rate uncertainty, it

says.says.    And more transparent pricing - with companies able to compare prices between countries much more And more transparent pricing - with companies able to compare prices between countries much more

easily - could also encourage investment.easily - could also encourage investment.    But the Treasury says entering the single currency before the UK economy has sufficiently But the Treasury says entering the single currency before the UK economy has sufficiently

converged with the euro zone would discourage investment.converged with the euro zone would discourage investment.

5 tests5 tests Financial services Financial services    The Treasury says joining the euro would affect the financial services The Treasury says joining the euro would affect the financial services

industry "more profoundly and more immediately" than other sectors of industry "more profoundly and more immediately" than other sectors of the economy.the economy.

   What impact would entry into EMU have on the competitive position of What impact would entry into EMU have on the competitive position of

the UK's financial services industry?the UK's financial services industry? It says whether the UK joins the euro or not, the City of London's It says whether the UK joins the euro or not, the City of London's

strengths "should help it to thrive".strengths "should help it to thrive".    The test centres on whether the introduction of the euro would be The test centres on whether the introduction of the euro would be

advantageous for the sector and whether the sector is fully prepared advantageous for the sector and whether the sector is fully prepared for the introduction of the single currency in the UK.for the introduction of the single currency in the UK.

The Euro?The Euro?

Fixed exchange rates from 1999Fixed exchange rates from 1999 Started 2002Started 2002 Transaction costsTransaction costs reduce uncertaintyreduce uncertainty transparency of pricestransparency of prices encourage mergersencourage mergers BUT what of initial costs?BUT what of initial costs? Role of ECBRole of ECB loss of control of economic/political decisionsloss of control of economic/political decisions problems with expansionproblems with expansion

5 tests5 tests Employment and growth Employment and growth    This is the "fundamental" test, says the Treasury.This is the "fundamental" test, says the Treasury.    Will joining EMU promote higher growth, stability and a lasting increase in Will joining EMU promote higher growth, stability and a lasting increase in

jobs?jobs? Joining the euro could "enhance both growth and employment prospects".Joining the euro could "enhance both growth and employment prospects".    But without sufficient convergence and flexibility, "the resulting turbulence But without sufficient convergence and flexibility, "the resulting turbulence

could considerably damage them".could considerably damage them".    The Treasury will have to decide as it assesses the tests the potential effect on The Treasury will have to decide as it assesses the tests the potential effect on

jobs and growth from joining the euro. In 2003 Gordon Brown announced that jobs and growth from joining the euro. In 2003 Gordon Brown announced that the UK did NOT then meet the 5 teststhe UK did NOT then meet the 5 tests

  

Gains and LossesGains and Losses

Gains? – one catalogue price, one bank account, Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, prices remain stable, integrated bond markets, stricter discipline in tax issuesstricter discipline in tax issues

BUT Loss of economic sovereigntyBUT Loss of economic sovereignty Asymmetric shocksAsymmetric shocks Lack of convergence – two speed Union? Different Lack of convergence – two speed Union? Different

labour market regulationslabour market regulations Different growth ratesDifferent growth rates What if one country gets out of synch?What if one country gets out of synch? What if monetary flexibility required?What if monetary flexibility required?

Gains and LossesGains and Losses

Structural differences between countries – we Structural differences between countries – we export 52% to EU, Germany 56%, France 63% export 52% to EU, Germany 56%, France 63%

Different housing market – mortgage debt in UK = Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU57% of GDP, 33% within rest of EU

More vulnerability to oil price hikes?More vulnerability to oil price hikes? Can it be sustained as enlargement continues?Can it be sustained as enlargement continues? Can Regional Policy copeCan Regional Policy cope Can the poorer nations be accommodated?Can the poorer nations be accommodated?

Will it survive?Will it survive?

Will probably depend on?Will probably depend on?

Competitiveness on economy (price/non-Competitiveness on economy (price/non-price), spare capacity, financial resources,price), spare capacity, financial resources,

Knowledge of market, distribution systems, Knowledge of market, distribution systems, strength/stability of Euro, affect of joining strength/stability of Euro, affect of joining Euro on macroeconomic management, loss Euro on macroeconomic management, loss of sovereignty, implications for UK business, of sovereignty, implications for UK business, price at which we join (ERM memories).price at which we join (ERM memories).

Single Currency – Quick Re-capSingle Currency – Quick Re-cap

Fixed exchange rates from 1999Fixed exchange rates from 1999 Started 2002Started 2002 Transaction costsTransaction costs reduce uncertaintyreduce uncertainty transparency of pricestransparency of prices encourage mergersencourage mergers BUT what of initial costs?BUT what of initial costs? Role of ECBRole of ECB loss of control of economic/political decisionsloss of control of economic/political decisions problems with expansionproblems with expansion

Re-cap 2Re-cap 2

Trade diversion - switch purchases to high-cost Trade diversion - switch purchases to high-cost suppliersupplier

Will trade creation grow? – replace high cost Will trade creation grow? – replace high cost domestic production with imports from a more domestic production with imports from a more efficient EU partner?efficient EU partner?

If economic welfare is to increase the EU needs to If economic welfare is to increase the EU needs to (a) be as efficient as outside producers (b) be (a) be as efficient as outside producers (b) be aware of demand and supply curve inelasticity of aware of demand and supply curve inelasticity of the commodities affected by the CETthe commodities affected by the CET

Re-cap 3Re-cap 3

Membership based on meeting convergence criteria and Membership based on meeting convergence criteria and accepting political rulesaccepting political rules

Price stability – no more than 1.5% above average of three Price stability – no more than 1.5% above average of three best performing membersbest performing members

Interest Rates – no more than 2% above average of the Interest Rates – no more than 2% above average of the three member states with lowest inflation rates in previous three member states with lowest inflation rates in previous year. Long term rates convergence.year. Long term rates convergence.

Gov deficit – no more than 3% of GDP.Gov deficit – no more than 3% of GDP. Public Sector Debt Control – must not exceed 60% of GDPPublic Sector Debt Control – must not exceed 60% of GDP Independent Central BankIndependent Central Bank Euro a powerful currency, greater parity with $, integration Euro a powerful currency, greater parity with $, integration

of financial markets, greater market liquidity, sounder fiscal of financial markets, greater market liquidity, sounder fiscal policypolicy

Re-cap-continuedRe-cap-continued

Gains? – one catalogue price, one bank account, Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as less formalities, stability, enhanced competition as prices remain stable, integrated bond markets, prices remain stable, integrated bond markets, stricter discipline in tax issuesstricter discipline in tax issues

BUT Loss of economic sovereigntyBUT Loss of economic sovereignty Asymmetric shocksAsymmetric shocks Lack of convergence – two speed Union? Different Lack of convergence – two speed Union? Different

labour market regulationslabour market regulations Different growth ratesDifferent growth rates What if one country gets out of synch?What if one country gets out of synch? What if monetary flexibility required?What if monetary flexibility required?

Some other problems?Some other problems?

Structural differences between countries – we Structural differences between countries – we export 52% to EU, Germany 56%, France 63% export 52% to EU, Germany 56%, France 63%

Different housing market – mortgage debt in UK = Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU57% of GDP, 33% within rest of EU

More vulnerability to oil price hikes?More vulnerability to oil price hikes? Can it be sustained as enlargement continues?Can it be sustained as enlargement continues? Can Regional Policy copeCan Regional Policy cope Can the poorer nations be accommodated?Can the poorer nations be accommodated?

Deciding factors?Deciding factors?

Will probably depend on?Will probably depend on?

Competitiveness on economy (price/non-Competitiveness on economy (price/non-price), spare capacity, financial resources,price), spare capacity, financial resources,

Knowledge of market, distribution systems, Knowledge of market, distribution systems, strength/stability of Euro, affect of joining strength/stability of Euro, affect of joining Euro on macroeconomic management, loss Euro on macroeconomic management, loss of sovereignty, implications for UK business, of sovereignty, implications for UK business, price at which we join (ERM memories).price at which we join (ERM memories).

CompetitivenessCompetitiveness