The European Union: Will it Survive?

1
The European UnionWill it Survive?

• Team 3
• Steven Griggs
• Tom Marbach
• Peter McGee

2
Outline

• History of the European Union Monetary
  Unification
• Model of Optimum Currency Areas
• European Development of An Optimum Currency Area
• Issue/Solution to Present EU
• Summary

3
1969 Currency Crisis

• European leaders meet in Hague to discuss the
  European Monetary Unification
• Eliminate intra-European exchange rate movements
• Centralize EU monetary policy decisions
• Lower remaining trade barriers within Europe
• Why?
• Enhance Europes role in the world monetary
  system
• Turn the European Union into a truly unified
  market

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1971 - 73

• Germany, Luxembourg, the Netherlands, and others
  establish an informal joint float against the US
  Dollar known as the snake
• 1973 Bretton Woods agreement falls apart
• Hope of freeing monetary policy by going to a
  floating exchange rate
• Increase market stability through a managed float
  system

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1979

• 1979 Eight original participants began
  operating a formal network of mutually pegged
  exchange rates.
• France, Germany, Italy, Belgium, Denmark,
  Ireland, Luxembourg, and the Netherlands
• DM is the reserve currency
• Credibility Theory Germany is know for keeping
  low inflation targets thus, unified counties
  will have low inflation rates

6
1989 Jacques Delors Economic Monetary Union

• National currencies replaced by a single currency
  managed by a sole central bank on behalf of all
  EU members
• Stage 1 all EU members join EMS exchange rate
  mechanism
• Stage 2 exchange rate margins narrowed by
  certain macro economic policy decisions placed
  under centralized control
• Stage 3 replace national currency with single
  currency, vesting monetary policy decisions in
  the ESCB (similar to the US Federal Reserve)

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1990 German Reunification Pressures

• Spain, Portugal, and United Kingdom join
• German Reunification Pressures
• Policy to rebuild E. Germany
• Inflation rate increased dramatically
• Germany resisted interest rate increases
• Speculative attacks on currencies
• 1992 United Kingdom and Italy leave EU, Italy
  returns in 1993

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1991 Maastricht Treaty

• Delors Stage 1 1/1/94
• Delors Stage 2 1/1/99
• Harmonize social policy
• Work force safety
• Consumer protection
• Immigration rules
• Centralized foreign and defense policy

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Why Maastricht Treaty ?

• Single EU currency would produce a greater degree
  of market integration
• Necessary complement to the plan for unifying EU
  markets
• Germanys management of EMS monetary policy had
  placed a one-sided emphasis on German
  macroeconomic goals
• Provide complete freedom of capital movements
  within the EU
• Guarantee of political stability in Europe

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Admittance CriteriaMaastricht Convergence
Criteria

• The country's inflation rate must be no more that
  1.5 above the average of the lowest three EU
  member states
• Maintained a stable exchange rate within the ERM
  without devaluing on its own initiative
• Public debt that is below or approaching a
  reference level of 60 of its GDP
• On going monitoring of criteria 3 and 4 by the
  European Commission

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1992 EU Initiative

• Eliminate Differences in
• Government standards
• Government regulations
• Government licenses and purchasing practices
• National tax structure
• Health and safety regulations
• Customs for differing tax rates and regulations

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1993 -

• Establishment of key policy safety valves
• Exchange rate margins were widened to 15
• Established generous provisions for extending
  credit from strong to weak currency members
• Adopting exchange controls to reduce the
  possibility of speculative attacks that had
  threatened the EMS in the 1970s

13
1997 Stability and Growth Pact

• Sets out the medium-term budgetary objective of
  positions close to balanced or in surplus.
• Sets out the timetable for imposition of
  financial penalties

14
1998

• Most countries meet the convergence criteria
• UK and Denmark exercise privileges to stand apart
  from EMU
• Sweden fails to satisfy the exchange-rate
  criterion
• Greece fail to qualify on any criteria

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European System of Central Banks

• Similar to the Federal Reserve Member Banks
• Six-member ECB executive board
• Heads of the national central banks
• ESCB members are political appointees
• Exchange rate policy ultimately in the hands of
  the political authorities
• ESCB has the right to reject politicians
  exchange rate objectives if these threaten price
  stability

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Theory of Optimum Currency Areas

• Cost and benefits depend on how well integrated
  its economy is with those of its potential
  partners
• Fixed exchange rates are most appropriate for
  areas closely integrated through international
  trade and mobility of the factors of production

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Optimum Currency Areas Benefits
Monetary Efficiency Gain

• Monetary Efficiency Gain
• Savings that arise from floating rates
• Uncertainty
• Confusion
• Calculation
• Transaction costs

GG
Close economic integration leads to inter-network
price stability
Degree of Economic Integration
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Optimum Currency Areas Costs
Economic Stability Loss

• Economic Stability Loss
• Giving up ability to use exchange rate and
  monetary policy stability of output and
  employment
• Under fixed exchange rates monetary policy has no
  power to affect domestic output
• Reduce economic stability loss due to output
  market disturbances

LL
Degree of Economic Integration
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Optimum Currency Area Decisions
Gain or Loss

• Variability in their product markets makes
  countries less willing to enter fixed exchange
  rate areas
• After the 1973 oil shocks countries were
  unwilling to revive the Bretton Woods system of
  fixed exchange rates
• Fixed rate of exchange best serve the economic
  interests of each of its members when the degree
  of economic integration is high

GG
Loss Exceeds Gain
Gain Exceeds Loss
LL
?0
Degree of Economic Integration
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Optimum Currency Areas

• Degree of Economic Integration
• They trade a lot with each other
• There is high degree of labor mobility among them
• Economic shocks they face are highly correlated
  (systematic shocks)
• There exists a federal fiscal system to transfer
  fund to regions that suffer adverse shocks

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The European Union

• Trade
• EU members export fro 10 to 20 of their output
  to other EU members
• The US exports about 2 of its GNP to EU members
• Mobility of Labor
• The US has only small differences in the
  unemployment rate between regions because of
  almost complete mobility
• Europe has certain impediments to mobility
• Language
• Culture
• Regulations

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Considerations

• Similarity of economic structure
• Makes it easier for a member country to adjust to
  output market disturbances that affect it and its
  partners differently
• High volume of trade in similar products
• Important differences
• Northern Europe has greater capital assets and
  skilled labor than southern Europe with its
  larger pool of low-skilled labor
• Fiscal Federalism
• Redistribution of wealth
• Offset the economic stability loss due to fixed
  exchange rates

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Summary (to-date)

• Partner trade is less than 25 of member nations
  GNP
• Capital mobility is high
• Labor mobility is low
• Theory of the second best
• Liberalization of the capital markets can reduce
  efficiency of EU economies if the labor market
  continues to function poorly

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Summary

• Europe is not an optimum currency area
• Single currency has taken economic union beyond
  the limits of political union
• Larger EU countries remain highly unionized and
  subject to government employment regulations that
  inhibit labor mobility
• Without substantial fiscal federalism, the
  constraints of the Stability and Growth Pact will
  be especially painful

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Needs

• Complete mobility of the factors of production,
  labor and capital
• Reform fiscal systems
• Deepening political union

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EU Needs Met Through Federalization

• European Parliament
• Council of the European Union
• European Commission
• Court of Justice
• Court of Auditors
• European Central Bank
• Economic and Social Committee
• Committee of the Regions
• European Investment Bank
• European Ombudsman

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Will the European Union Survive

• Yes
• Capital is already highly mobile
• Globalization makes it a must
• Federalist system will eliminate barriers of
  labor mobility

European Union Will Survive, But It Will Take
Time for Total Transformation