The Euro

PAU Economics Blog – 8th February 2010.
The Euro
                                                            
The members are:
Austria   Belgium  Cyprus  Finland  France  Germany  Greece  Ireland  Italy
Luxembourg  Malta  Netherlands  Portugal  Slovakia  Slovenia  Spain

Though a recent report on the official EU website did not actually mention Greece the content of the piece suggested that it might be possible for a country to ‘operate’ outside the Euro zone, even though it is a member. This is not a rule of the EMU and is an embarrassment to what is the second strongest currency in the world.
So, what has caused the Commission to ask such a question?

Put bluntly there is trouble within the PIIGS! That is Portugal, Ireland, Italy Greece and Spain all of whom are experiencing problems meeting the criteria to operate within the Euro Zone and their governments now face some difficult decisions to address substantial fiscal deficits.

The case of Greece

Greece has a current account deficit of almost 14% of GDP and that is set to rise even further. We have to ask how a member state can attempt to resolve the problem and keep within the rules. The other economies who use the single currency do not want to see many harsh deflationary policies as intra-Euro zone trade is a very important determinant of their own economic success.

The Greek Government can no longer devalue the currency. That is not allowed and they face productivity falls and resilient consumer spending. The EU continues to pay its normal subsidies to Greece, all of which have been agreed by The  Council of Ministers, so are  many of the ‘old’ routes out of a current account crisis are not available to the economists of Athens.
The other big problem facing Greece is a large public sector deficit. In 2007, it stood at 94% of GDP. (noticeably larger than  that of the post recession UK position). The size of the national debt is now starting to frighten international investors. The bond yield on Greek debt is increasing and that means investors will soon demand a higher interest rate to compensate for the decreased credit worthiness of the Greek economy. This is important because if Greece credit worthiness decreases, it will be more difficult to attract capital flows to buy Greek government debt. It is a genuine example of what some UK politicians have been saying might happen here.

How then can the Greek government address the pressures on its economy caused by its substantial current account deficit?

It can no longer reduce, or devalue its currency, so making exports more competitive – that is not allowed by the rules of The European Monetary Union. Prices are rising in Greece and one of its main sources of income, tourism, is experiencing a noticeable increase in brochure prices – it remains to be seen if this will deter UK and other holiday makers.
They will certainly have to address consumer spending in their drive to reduce the current account deficit. They will also have to reduce the demand for imports as there is insufficient income to buy them.
Another area of concern for both the Greek government and officials in Brussels is the decline in ‘Greek Competitiveness’. There has been a decline in the demand for exports and this may yet force Greek firms to consider ways of becoming more efficient.  It could be that taxes will rise, government will be cut and public sector industries nationalised. However, the current government is Socialist and may not want to impose policy reactions that will impact adversely on the poorer members of the population. Then there is the case of corruption and also the ‘management’ of the islands – the latter does make Greece a special case.

The Basics of the EMU  
    
What you must show before entering the Euro Zone
 Price stability, measured according to the rate of inflation in the three best performing Member States;
 Long-term interest rates close to the rates in the countries with the best inflation results;
 An annual budget deficit which does not exceed 3% of gross domestic product (GDP) and total government debt which  does not exceed 60% of GDP or which is falling steadily towards that figure;
 Stability in the exchange rate of the national currency on exchange markets. The exchange-rate mechanism of the  European Monetary System requires this stability to be demonstrated and sustained for two years.

Why did it start?
 Needed to reduce uncertainty and volatility of currencies
 needed to bring national monetary and fiscal policies more together
 needed to reduce use of exchange rate as macro tool
 Needed to control money expansion within member states
 needed to control expansion on money stock v competitive de-valuations
 Started with ERM

Convergence Criteria
 Amount of money owed by a government - known as the budget deficit, has to be below 3% of Gross Domestic Product  (GDP) - the total output of the economy.
 The total amount of money owed by a government, known as the public debt, has to be less than 60% of GDP. The public  debt is the cumulative total of each year's budget deficit.
 Countries should have an inflation rate within 1.5% of the three EU countries with the lowest rate. This was supposed  to push down inflation rates and lead to more stable prices.
 Long-term interest rates must be within 2% of the three lowest interest rates in EU. 
 An independent Central Bank.

Exchange rates must be kept within "normal" fluctuation margins of Europe's exchange-rate mechanism
Gains and Losses
 Gains? – one catalogue price, one bank account, less formalities, stability, enhanced competition as prices remain   stable, integrated bond markets, stricter discipline in tax issues
 BUT Loss of economic sovereignty
 Asymmetric shocks
 Lack of convergence – two-speed Union? Different labour market regulations
 Different growth rates
 What if one country gets out of synch?
 What if monetary flexibility required?
 Structural differences between countries – we export 52% to EU, Germany 56%, France 63%
 Different housing market – mortgage debt in UK = 57% of GDP, 33% within rest of EU
 More vulnerability to oil price hikes?
 Can it be sustained as enlargement continues?
 Can Regional Policy cope
 Can the poorer nations be accommodated?

Will it survive?
Will probably depend on
*Competitiveness on economy (price/non-price), spare capacity, financial resources,
*Knowledge of market, distribution systems, strength/stability of Euro,
* The affect of joining Euro on macroeconomic management, loss of sovereignty, implications for UK business, price at which  we join (ERM memories)

The future
 Slovenia now a member
 Cyprus and Malta
 Then Slovakia, Hungary
 Then Baltic States
 By next decade probably UK and Sweden outside it – Denmark tracks it anyway
 Mostly now ‘on hold’ till recession over

Other PAU Resources
When teaching or studying the EMU why not use one of the Specification specific text books published by PAU, or the Unit Guides for 3 and 4, or Revision Guides. You might also like to consider attending a Teacher Day, Student Day, or our National Teacher Conference where the importance of the EU in global trade will be part of the proceedings.
 

Extra Power point presentation on competiveness and sustainability in Euro Zone