Transcript Slide 1

Chapter 17
© Baldwin&Wyplosz 2009 The Economics of European Integration, 3rd Edition
Chapter 17
The European
Monetary Union
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The Long Road to Maastricht and to the Euro
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The Maastricht Treaty
• A firm commitment to launch the single currency by January 1999
at the latest.
• A list of five criteria for admission to the monetary union.
• A precise specification of central banking institutions.
• Additional conditions mentioned (e.g. the excessive deficit
procedure).
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The Maastricht Convergence Criteria
• Inflation:
– not to exceed by more than 1.5 per cent the average of the three
lowest inflation rates among EU countries.
• Long-term interest rate:
– not to exceed by more than 2 per cent the average interest rate in the
three lowest inflation countries.
• ERM membership:
– at least two years in ERM without being forced to devalue.
• Budget deficit:
– deficit less than 3 per cent of GDP.
• Public debt:
– debt less than 60 per cent of GDP:
•
Note: Observed on 1997 performance for decision in 1998.
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Convergence Criteria: Inflation convergence
10.00
5.00
0.00
1991
France
Spain
Belgium
Greece
1992
1993
1994
1995
1996
1997
1998
Italy
Germany
Portugal
average of three lowest + 1.5%
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Convergence Criteria: Interest rates and ERM
• Long-Term Interest Rate: easy to bring inflation down in 1997 and
then let go again.
• ERM Membership: need to convince the exchange markets.
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Convergence Criteria: Budget Deficit and Debt
• Historically, all big inflation episodes born out of runaway public
deficits and debts.
• Hence requirement that house is put in order before admission.
• Problem No. 1:
– a few years of budgetary discipline do not guarantee long-term
discipline
• Problem No. 2: articifial ceilings.
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Debt and Deficit in 1998
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Architecture of the
monetary union
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A Tour of the Acronyms
• N countries with N National Central Banks (NCBs) that continue
operating but with no monetary policy function.
• A new central bank at the centre: the European Central Bank
(ECB).
• The European System of Central Banks (ESCB): the ECB and
all EU NCBs (N=27).
• The Eurosystem: the ECB and the NCBs of euro area member
countries (N=16).
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The System
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How Does the Eurosystem Operate?
• Objectives:
– What is it trying to achieve?
• Instruments:
– What are the means available?
• Strategy:
– How is the system formulating its actions?
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Objectives
• The Maastricht Treaty’s Art. 105.1:
‘The primary objective of the ESCB shall be to maintain price
stability. Without prejudice to the objective of price stability, the
ESCB shall support the general economic policies in the Community
[…].’
• Article 2. The objectives of European Union are a high level of
employment and sustainable and non-inflationary growth.
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Objectives (cont.)
• Does the Eurosystem have a target?
“In the pursuit of price stability, the ECB aims at maintaining inflation
rates below, but close to, 2% over the medium term.
”
• Leaves room for interpretation:
– where below 2 per cent?
– what is the medium term?
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Instruments
• Remember the channels of monetary policy:
–
–
–
–
longer run interest rates
credit
asset prices
exchange rate.
• These are all beyond central bank control.
• Instead it can control the very short-term interest rate: European
Over Night Index Average (EONIA).
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Instruments (cont.)
• The Eurosystem controls EONIA by establishing a ceiling, a floor
and steering the market in-between.
• The floor: the rate at which the Eurosystem accepts deposits (the
deposit facility).
• The ceiling: the rate at which the Eurosystem stands ready to lend
to banks (the marginal lending facility).
• In-between: weekly auctions (main refinancing facility).
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EONIA & Co.
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6
5
4
3
2
1
0
Jan-99
Jan-00
EONIA
Jan-01
Jan-02
Deposit rate
Jan-03
Jan-04
Marginal lending
Jan-05
Jan-06
Main refinancing
Source: ECB
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The Two-Pillar Strategy
• The monthly Eurosystem’s interest rate decisions (every month)
rests on two pillars.
• Economic analysis:
– broad review of economic conditions:
• growth, employment, exchange rates, abroad.
• Monetary analysis:
– evolution of monetary aggregates (M3, etc.).
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Comparison With Other Strategies
• The US Fed:
– legally required to achieve both price stability and a high level of
employment
– does not articulate an explicit strategy.
• Inflation-targeting central banks (Czech Republic, Poland,
Sweden, UK, Hungary):
– announce a target (e.g. 2% HICP in the UK), a margin (e.g. ±1%)
and a horizon (2–3 years)
– compare inflation forecast and target, and act accordingly.
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Independence and Accountability
• Arguments for central bank independence:
– governments tend not to resist to the ‘printing press’ temptation
– the Bundesbank has set an example.
• But misbehaving governments are eventually punished by
voters.
• Independence removes central banks from such pressure.
• A democratic deficit?
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Redressing the Democratic Deficit
• In return for their independence, central banks must be held
accountable:
– to the public
– to elected representatives.
• Example:
• the Bank of England is given an inflation target by the
Chancellor. It is free to decide how to meet the target, but
must explain its failures (the ‘letter’)
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Independence and Transparency
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The Eurosystem’s Weak Accountability
• The Eurosystem must report to the EU Parliament.
• The Eurosystem’s President must appear before the EU
Parliament when requested, and does so every quarter.
• The EU Parliament cannot change the Eurosystem’s
independence and has limited public visibility.
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The Record So Far
• A difficult period:
– an oil shock in 2000
– September 11 in 2001
– Oil prices to record level and US financial crisis start in mid-2007
• Result:
– Inflation almost always above 2% but close to target and lower than
perceived
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Inflation record: eurozone
Euro Area Inflation
3.5
3
2.5
2
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
1.5
1
0.5
0
Source: Eurostat
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Growth record: eurozone
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Exchange rate: from too weak to too strong?
ECB reference exchange rate, US dollar/Euro
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: ECB
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Asymmetries: some evidence of decrease
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Lasting inflation differentials
• Issue of lasting inflation differentials
– Lower than average in: Germany, France and Finland
– Higher than average: Ireland, Spain, Portugal, Netherlands and Italy
• Possible causes:
–
–
–
–
–
Catching up in productivity levels
Wrong starting conversion rates
Autonomous wage and price setting
Policy mistakes, such as fiscal expansion
Asymmetric shocks, such as oil price effects
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New EU members and EMU
• Obligation to meet the 5 convergence criteria
• Yearly publication of ‘Convergence Reports’ to assess how they
meet the convergence criteria
• Whilst Slovenia, Malta, Cyprus and Slovakia are members,
Lithuania was rejected and the rest are still to meet criteria
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