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Revision on European Monetary Union
The document discusses monetary unions and the Eurozone. It provides background on monetary unions, describes the stages of economic integration that can lead to a monetary union. It then focuses on the Eurozone, listing the current member countries and those that have not joined. Several charts show unemployment, debt levels, and other economic indicators for various Eurozone countries. The document also examines issues facing the Greek economy like high debt levels, fiscal austerity imposed by international lenders, and Greece's internal devaluation efforts.
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Intro to Monetary Union, its types, introduction of Euro, member nations as of 2017.
List of EU and Euro Area members, context of non-Euro nations, and their economic decisions.
Trends of economic convergence and divergence within Euro Area nations.
Exports, main markets, and real effective exchange rate impacts on competitiveness.
Benefits such as stability, reduced currency risk, enhanced competition, and investments.
Criteria for countries to join Euro include inflation, exchange rates, and fiscal health.
Definition and characteristics of an Optimal Currency Area according to Mundell.
Indicators that help economies thrive when entering a single currency, highlighting similarities.
Key problems include high unemployment, government debt, deflation risks, and socio-economic instability.
Long-term growth rates, GDP data, and economic resilience in the Euro Area through cycles.
Impact of economic depression on GDP and recovery in countries like Greece.
Statistics on unemployment rates across Euro area countries, highlighting crisis levels.
Analysis of deflation and inflation rates in Euro Zone countries, highlighting consumer price changes.
Comparative national debt across EU countries and implications for economic stability.
Trends in government bond yields, drawing comparisons among Euro Zone nations.
Overview of current account balances in Euro member countries, noting surpluses and deficits.
In-depth view of Greece's economic performance and challenges within the Euro area.
Key competitive disadvantages affecting the Greek economy and their implications.
Predictions about Greece’s debt sustainability and measures required for recovery.
Impact of austerity measures imposed on Greece's economy and public sentiment.
Internal devaluation strategies implemented in Greece as a response to financial crises.
Comparison of changes in relative unit labor costs among Euro Zone countries.
Arguments for and against Greece leaving the Euro Zone, weighing potential benefits and risks.
Risks associated with Greece potentially leaving the Euro Zone and implications for its economy.
Outlook for the Euro Area includes economic growth prospects and socio-political factors affecting stability.
Concluding thoughts and overview of the themes discussed regarding Monetary Union.
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Revision on European Monetary Union
- 1. Monetary Union Year 2Macro Revision
- 2. What is aMonetary Union? • Monetary union is a deeper form of integration 1. Free trade agreement 2. Customs union 3. Single market 4. Monetary union 5. Fiscal union / political union • The single European currency, the euro, was introduced in 1999 and came into common circulation in January 2002 • No country has yet left the Euro Area • As of May 2017, there are nineteen member nations • Of the 28 EU countries (the UK leaves in 2019), 9 are not part of the single currency including Denmark, Hungary, the Czech Republic and Poland
- 3. European Monetary Union Country Joined EU EuroZone Member? Country Joined EU Euro Zone Member? Austria 1995 Yes Italy 1957 Yes Belgium 1957 Yes Latvia 2004 Yes Bulgaria 2007 No Lithuania 2004 Yes Croatia 2013 No Luxembourg 1957 Yes Cyprus 2004 Yes Malta 2004 Yes Czech Republic 2004 No Netherlands 1957 Yes Denmark 1973 No (ERMII) Poland 2004 No Estonia 2004 Yes Portugal 1986 Yes Finland 1995 Yes Romania 2007 No France 1957 Yes Slovakia 2004 Yes Germany 1957 Yes Slovenia 2004 Yes Greece 1981 Yes Spain 1986 Yes Hungary 2004 No Sweden 1995 No Ireland 1973 Yes United Kingdom 1973 No (leaving EU) ERMII is a fixed exchange rate system for countries considering joining the Euro at some future point Denmark is the sole member of ERMII.
- 4. Context: Countries thathave not made a currency union Czech Republic Hungary Poland Norway Sweden USA Canada Currency unions tend to work best with a cluster of countries that have real economic convergence and high labour market flexibility – these nations have chosen not to form one The Czech Republic, Hungary and Poland all came into the EU in May 2004 but have opted to remain outside of the Euro Area and maintain instead a floating exchange rate with the Euro.
- 5. Some dynamic convergencefor non-Euro Area nations
- 6. But not forsome southern European EA members
- 7. Pattern of Exportsof Goods sold by Czech Republic
- 8. Czech Republic’s MainExport Markets
- 9. Real Effective ExchangeRate for Czech Republic 80 85 90 95 100 105 110 115 1/1/05 7/1/05 1/1/06 7/1/06 1/1/07 7/1/07 1/1/08 7/1/08 1/1/09 7/1/09 1/1/10 7/1/10 1/1/11 7/1/11 1/1/12 7/1/12 1/1/13 7/1/13 1/1/14 7/1/14 1/1/15 7/1/15 1/1/16 7/1/16 1/1/17 Effective Exchange Rate Index for Czech Republic Depreciation – makes Czech exports more price competitive
- 10. Potential advantages fromjoining the Euro Euro is more stable than smaller currencies Reduced currency risk makes it cheaper for smaller countries to borrow Currency risk Euro enhances the welfare gains from being in the single market – e.g. it encourages more cross border trade Trade Membership of Euro likely to stimulate inward investment in industries such as tourism, financial services, car- making Investment Euro increases price transparency which then helps consumers to find products at better prices Competition Shared currency cuts the costly conversion of money, it might also improve labour mobility within the single market Transactions Joining the single currency is a hugely significant economic and political choice and not one that countries will make without considering the likely benefits and the risks involved
- 11. Joining the Euro– Convergence Criteria • According to the rule, to join the single currency, a country must meet the following convergence criteria. 1. Stable prices: Inflation must not be more than 1.5% higher than the average in the three member countries with best price stability, i.e. lowest inflation. 2. Stable exchange rate: The national currency must have been stable relative to other EU currencies for a period of two years prior to entry into the monetary union 3. Sound government finances: • Total government debt must not exceed 60 per cent of GDP • The annual budget deficit must not be greater than 3 per cent of GDP 4. Interest rate convergence: The 5-year government bond interest rate must not be more than 2 per cent higher than the average of existing Euro Zone members
- 12. What is anOptimal Currency Area (OCA)? • According to Mundell, an OCA works best when 1. Countries are highly integrated with each other i.e. a high percentage of trade is with fellow currency union nations 2. Where each economy has a flexible labour market to cope with external shocks. Labour market flexibility might include: • Flexibility in real wages and salaries at different times in an economic cycle • Workers with adaptable skills to reduce the risk of structural unemployment • High geographical mobility within & between nations of a currency union • Flexible employment contracts including lots of short-term job contracts 3. When the effects of interest rate changes or a movement in the exchange rate have a broadly similar effect on businesses and households from country to country. 4. When member nations are willing to make fiscal transfers between each other, for example to help stabilize aggregate demand and provide financial support during difficult times
- 13. Real Economic Convergence •Some people believe that economies entering the single currency perform better in the long run if they are closer in a real sense – indicators include: 1. Trend growth of real GDP - linked to productivity growth & investment 2. Patterns of international trade in goods and services are relatively similar 3. Housing market structure e.g. levels of home ownership, reliance on mortgage finance, relative size of the rented housing sector 4. Policy response: Countries whose economies respond in a symmetrical way to a change in monetary policy e.g. when a central bank makes a change to policy interest rates 5. Vulnerability to external shocks: Countries who respond in a symmetrical way to external shocks such as changes in oil and gas prices and prices of other internationally-traded commodities. • Because the member nations of the Euro are different – this makes it virtually impossible for the ECB to find a ‘one-size fits all’ interest rate.
- 14. Key Problems Facingthe Euro Area Economy High structural unemployment + hysteresis effects High levels of government debt + high bond yields for some Risks from price deflation Persistently low aggregate demand / spare capacity Fragile banking sector (non- performing loans) Weak capital investment – some diverting to emerging Asia Big trade / current account imbalances Political tensions and ongoing refugee crisis Declines in subjective wellbeing + rise in poverty
- 15. Macro Developments inthe Euro Area Year 2 Macro
- 16. The Euro Zonehas experienced persistent slow growth -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 2010 2011 2012 2013 2014 2015 2016* 2017* 2018* 2019* 2020* GDPgrowthcomparedtopreviousyear EU Euro area Source: IMF World Economic Outlook
- 17. Economic Cycle inthe Euro Area 1500000 1700000 1900000 2100000 2300000 2500000 2700000 1/1/95 12/1/95 11/1/96 10/1/97 9/1/98 8/1/99 7/1/00 6/1/01 5/1/02 4/1/03 3/1/04 2/1/05 1/1/06 12/1/06 11/1/07 10/1/08 9/1/09 8/1/10 7/1/11 6/1/12 5/1/13 4/1/14 3/1/15 2/1/16 1/1/17 Real GDP for Euro Area
- 18. What an economicdepression looks like 70 75 80 85 90 95 100 105 110 115 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Real GDP Index Q4 2007 = 100 Germany Greece Ireland Spain
- 19. What an economicdepression looks like IMF Report on Greece, February 2017 Greece has not managed to return to sustainable growth, with output having contracted by more than 25 percent since 2008, investment down by more than 60 percent, and unemployment at the highest level in the euro-zone.
- 20. Unemployment is stillhigh in many euro area countries 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Unemploymentrate EU Euro area
- 21. 23.1% 18% 12.9% 11.5% 11.6% 10% 10% 9.3% 9.5% 8.7% 8.6% 8% 8.3% 7% 7.8% 0.0% 5.0% 10.0%15.0% 20.0% 25.0% Greece Spain Cyprus Italy Croatia Portugal France Latvia Euro area Finland Slowakia EU Lithuania Belgium Slovenia Unemployment rate Highest Unemployment Rates in the EU Data is for February 2017
- 22. 45.2% 41.5% 35.2% 30.4% 28.8% 25.4% 23.6% 16.7% 19.4% 19.1% 19.1% 20.4% 18.8% 20.2% 17.3% 0.0% 5.0% 10.0%15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0% Greece Spain Italy Cyprus Croatia Portugal France Bulgaria Euro area Slowakia Belgium Romania Luxembourg Finland EU Youth unemployment rate Highest Youth Unemployment Rates in the EU Data is for February 2017
- 23. May 2016 -Deflation in Many Euro Zone Countries 1.6 1 0.6 0.4 0.3 0.2 0 0 0 -0.1 -0.2 -0.2 -0.2 -0.3 -0.5 -0.6 -0.7 -0.8 -1.1 -1.9 -2.5 -2. -1.5 -1. -0.5 0. 0.5 1. 1.5 2. Belgium Malta Austria Portugal Finland Lithuania Estonio Germany France Euro area Netherlands Ireland Greece Italy Slovenia Luxembourg Slowakia Latvia Spain Cyprus Annual % Change in Consumer Prices for Euro Zone Countries, May 2016
- 24. Inflation in Europe(2nd Quarter 2017)
- 25. National (Sovereign) Debtin EU Countries 179% 132.6% 130.4% 107.8% 105.9% 99.4% 96.6% 89.3% 89.2% 84.6% 84.2% 83.5% 79.7% 75.4% 74.1% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% 120.0% 140.0% 160.0% 180.0% 200.0% Greece Italy Portugal Cyprus Belgium Spain France* United Kingdom Euro area Austria Croatia EU Slovenia Ireland Hungary National debt in relation to GDP Data is 4th quarter, 2016, Source: Eurostat
- 26. Gross Government Debtacross the EU When does government debt become unsustainable? Rogoff and Reinhardt argue that debt above 90% of GDP can have seriously negative effects on real economic growth rates.
- 27. Yield on ten-yeargovernment bonds 8.71% 3.78% 2.29% 2.27% 1.66% 0.92% 0.91% 0.78% 0.5% 0.37% 0.5% 0.25% 0.03% 0.49% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% Greece Portugal United States Italy Spain Ireland France Belgium Austria Finland Netherlands Germany Japan Luxembourg Yield
- 28. Current Account Balance(% of GDP) Germany and the Netherlands have further increased their already significant current account surpluses. The crisis countries have also moved into external surplus but for very different reasons.
- 29. The Greek Crisis Greeceinside the Euro Area
- 30. Greece in 2017 •Real output (GDP) has fallen by 25% since 2008 • Per capita incomes were Euro 18.6K in 2011, now 16K • Real consumption is 40% lower than pre-crisis • Unemployment has been above 20% for six years • Economy remains on the edge of price deflation • Private sector wages have fallen by more than 40% • Investment fell to 10% of GDP in 2014 v 27% in 2007 • Tourism is recovering strongly – having the Euro helps! • But economy has number of supply-side weaknesses • Interest rate on 10 year government debt = 7.4%
- 31. Competitive weaknesses forthe Greek economy Fragile banking system – limited funds for credit High rate of structural unemployment Low degree of economic diversification Narrow tax base + high tax avoidance Low productivity and innovation Shrinking and ageing population Most estimates find that Greece’s long run “trend” growth rate is low – perhaps around 1%. But it is almost impossible to estimate this when aggregate demand is so depressed. The economy has been de-industrializing for some years.
- 32. In February 2017,the International Monetary Fund predicted that Greece’s sovereign debt pile could climb to 275 per cent of GDP by 2060. They argue that Greece is currently unable to grow her way out of the crisis and that debt relief is inevitable. Under the deal struck in 2015, Greece is supposed to achieve a primary fiscal surplus before interest payments in 2018 of 3.5% and maintain this surplus for the medium term. Unsustainable fiscal debt?
- 33. • The TROIKAhas imposed fiscal austerity on Greece • TROIKA comprises the European Commission, ECB and IMF • Fiscal austerity has included: 1. Cuts in public sector pay and pensions 2. Rise in the retirement age 3. Large scale privatizations 4. Increases in VAT (to 24%) 5. Deep cuts in public sector employment “With the drachma, immediately better" says the hard left union fly poster on an Athens street. (Credit: Phil Holden) Imposed Fiscal Austerity on Greece
- 34. Internal devaluation inthe Greek economy • Internal devaluation is when a country attempts to improve competitiveness through lower wage costs and prices • This is an alternative to a currency depreciation / devaluation • In Greece there has been a significant reduction in labour costs – with private sector wages falling by 40% • A key evaluation point is that prices have not fallen much – because of sheltered oligopolistic sectors and high VAT • And Greece does not have a sufficiently large export sector that sells price-sensitive products to other countries. “In Greece economic policies of austerity, in conjunction with internal devaluation, have been adopted in an attempt to improve competitiveness, correct external deficits and promote export-led growth.” Source: https://dspace.lib.cranfield.ac.uk/bitstream/1826/11158/1/A_post-mortem_of_austerity-2016.pdf
- 35. Changes in relativeunit labour costs 80 90 100 110 120 130 140 1999 2001 2003 2005 2007 2009 2011 2013 2015 Greece Ireland Portugal Slovenia
- 36. Would the Greekeconomy be better off outside of the Euro Zone?
- 37. The case forGrexit Benefits • Chance of export-led growth from a devaluation • Higher import prices will help domestic producers • Greece able to inflate away some of their debts • Greece able to run an independent monetary policy • Negative real interest rates can provide a monetary stimulus to help Greece out of a deflationary trap • End to imposed fiscal austerity allowing the Greek government to increase their spending • Some countries such as Iceland have recovered well since their own financial crisis / currency devaluation
- 38. Risks from adisorderly Grexit Risks • Spike in inflation – affecting the poorest most • Risk that Greece will turn printing presses on – hyper-inflation? • Higher inflation will bring about increased interest rates • Risk of huge capital flight from banks – big risks for depositors • Likely to be another deep short term slump in real output • Devaluation comes with debt default - creditors are unlikely to lend to Greece again at an affordable interest rate • Greek export capacity is limited – modest gains from devaluation • Tourism has boomed with Euros - no guarantee this will continue • May involve leaving the EU and loss of key EU structural funds
- 39. Where next forthe Euro Area? • Politics takes centre stage in 2017 (Austria, Holland, France and Germany all have key elections) • Euro Area is showing stronger (cyclical) growth and falling unemployment with a reduced risk of deflation • Is this enough for countries to climb out of the debt crisis? • Banking systems remain fragile (especially in Italy) • Eurozone’s periphery is still in deep crisis • Need for structural economic reforms remains • Changing centre of global economic gravity is accelerating • Big risk is that hysteresis effects of collapse in investment, structural unemployment and impact of rising inequalities and socio-economic insecurity will damage Europe’s trend growth and the potential to raise living standards.
- 40.
Editor's Notes
- #12 Strong argument for saying that Club Med countries should not have been allowed into the Euro in 1999-2002. The monetary convergence criteria used as part of the Maastricht Treaty were fudged.
- #13 The Euro is flawed in the most basic sense - it is not an optimal currency area. There are 19 heterogeneous countries - contrast the economies of the Southern Med with nations in north-west Europe.
- #31 The Greek economy is rarely a few weeks or months away from another economic, financial or political crisis. Does Greece have a long-term future inside the Euro Zone? It is clear that, having enjoyed strong economic growth in the years following her accession to the European Union, Greece has struggled to emerge from deep economic problems in the aftermath of the Global Financial Crisis. Greece is a small open economy, her GDP accounts for less than 0.25% of world output and Greece is a relatively small country within the Euro Zone. But her difficulties pose systemic risks for the currency union.
- #37 Greece joined the Euro Area on 1 January 2001