EMU and the euro ' ' ' for dummies

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EMU and the euro . . . (for dummies?)

• Presentation by Nigel Nagarajan
• Student Orientation 2009 Euro Challenge
• Miami-Florida European Union Center of Excellence
• January 22nd, 2009

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What are we going to cover today?

• What is EMU?
• What are the costs and benefits of having a
  single currency?
• What economic benefits derive from the single
  market?
• How is economic policy made in a monetary union?
• Will EMU break up?

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What EMU isnt

• Sorry to disappoint you, but . . .

. . . EMU is not a bird!
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What does EMU stand for?

• Does EMU stand for
• European Monetary Union?
• Or
• Economic and Monetary Union?

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EMU vs. the euro area

• EMU is a Treaty objective shared by all 27 EU
  Member States
• The euro is a reality for 16 Member States (the
  euro area)
• What about the E in EMU?

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What are the three parts of EMU?
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Which countries are in the euro area?

• Euro area Austria, Belgium, Cyprus, Finland,
  France, Germany, Greece, Ireland, Italy,
  Luxembourg, Malta, Netherlands, Portugal,
  Slovakia, Slovenia, Spain.
• EU Member States obliged to adopt the euro
  eventually Bulgaria, Czech Republic, Estonia,
  Hungary, Latvia, Lithuania, Poland, Romania,
  Sweden.
• EU Member States with an opt out from adopting
  the euro Denmark, United Kingdom.

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How does a country join the euro?

• A Member State must fulfill the convergence
  criteria laid down by the Maastricht Treaty
• Low inflation
• Low interest rates
• Low government deficit
• Low government debt
• Stable exchange rate (ERM II)

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What are the benefits of the euro? And the costs?

• CITIZENS benefit from greater price transparency,
  which should stimulate competition and reduce
  prices and from the elimination of currency
  exchange costs
• For BUSINESSES it is easier to make investment
  decisions (no exchange rate risk)
• The ECONOMY benefits from price stability, and
  lack of exchange rate risk

Countries that adopt the euro can no longer
change their INTEREST RATE or their EXCHANGE
RATE. In a monetary union, you cannot have an
INDEPENDENT MONETARY POLICY.
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The challenge of asymmetric shocks
(1) Federal fiscal system
(2) High labour mobility
Fiscal transfers ? Taxes ?
Real world example of a single currency area
Fiscal transfers ? Taxes ?
Euro area less good at coping with shocks?
Asymmetric shock oil prices ?. Affects Texas and
Massachusetts differently.
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The benefits of EU membership the single market

• Larger market ? more competition
• More competition ? more choice, lower prices for
  consumers
• More competition ? promotes efficiency
• Larger market ? firms can exploit economies of
  scale

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The single market economies of scale

• Larger firms enjoy cost advantages over smaller
  firms (e.g. purchasing, marketing)
• EU firms can produce for a market of 500m
  consumers
• And pass on lower costs to consumers
• This should encourage economic efficiency and
  stimulate economic growth

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The euro and the single market

• The euro eliminates currency transactions costs
• Leads to greater price transparency ? price
  convergence
• Eliminates exchange rate uncertainty ?
  stimulates investment
• Euro leads to increased trade and investment
  flows

One market, one money
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Economic policy in EMU
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Economic policy making - the euro area and the US
Monetary policy
ECB President Jean-Claude Trichet
Federal Reserve Chairman Ben S. Bernanke
Fiscal policy
Treasury Secretary Henry M. Paulson
Economic policy co-ordination more difficult?
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EMU and the financial crisis
this is an equal-opportunities economic crisis,
and the euro area is in it just as deep as
America, Britain and the rest. The Economist,
January 15th, 2009

• US and euro area economies connected by strong
  trade, investment links
• European banks invested heavily in US sub-prime
  mortgages
• Euro area has less flexible economy than US,
  with lower productivity growth less resilient?
• Some euro area economies had housing bubbles
• European consumers less indebted than US

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EMU and the financial crisis

• Crisis exposes persistent divergences in EMU
• One size fits all monetary policy problematic?
• Countries need to use fiscal stimulus, just as
  in US
• But difficult to coordinate fiscal response of
  16 Member States
• Break-up of EMU?

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The financial crisis how should Europe respond?
ECB cuts interest rates to 2
European Economic Recovery Plan governments
enact fiscal stimulus packages
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The financial crisis how should Europe respond?
Speed up economic reforms (Lisbon Strategy)
http//ec.europa.eu/growthandjobs/index_en.htm
Make the single market work better (especially
for Services)
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Conclusions

• The launch of the euro was a tremendous
  achievement for the EU
• But EMU is still a work in progress (especially
  for the E part)
• How will EMU cope with its first recession?
• Will the crisis lead to the break up of EMU or
  will it encourage countries to speed up reforms?
• Can you have a monetary union without a complete
  economic union? Political union?