The Monetary policy of Portugal &
European Monetary Union (EMU)
Is the EMU an effective source in
securing Portugal’s economy with
respects to other members in the EMU?
Brief Introduction
• The purpose of this power point is talk about the role of Portugal in
the European monetary union. Taken that Portugal is part of the
EMU, the discussion on EMU and Portuguese monetary policy are
interrelated. I must stress that on the limitations of the power point
slides and on this discussion, it is almost impossible to cover
everything between these mentioned Monetary policy’s within this
presentation. Furthermore, it is important to discuss the role of the
EMU and its purpose to the many countries involved in this
agreement. Finally, conclusive results will show that the power of
the European Monetary Union was to establish a centralized policy,
in which it forms a combined effort to create sustainable economic
growth, harmonization and unification of the European
communities.
EMU Brief introduction
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As of January 1998, 15 of the 27 countries that form the European Union agreed to
have a common currency, the euro, and a common monetary policy. Portugal along 14
other countries agreed to the standards and processes in which they must agree on to
be part of this union. First and foremost, the foundations of EMU were set in discussion
in December of 1991 when the Maastricht Treaty was put forward for approval by the
membered countries. This treaty was adopted in November 1992, although, a currency
crisis was in affect. The essence of the treaty was based on the formality of the
European Union and to adopt a primary, single currency. This common currency, the
euro, would be distributed and issued by the European Central Bank (ECB) and the ECB
would conduct the monetary policy for the countries using the common currency. As a
result, the countries were required to give up their control over the monetary policy.
Finally, the members of the EMU, like Portugal, had to have met the four convergence
criteria's of the Maastricht Treaty; Fiscal deficits, price stability, interest rates, exchange
rate. This will be discussed further in the presentation. In addition, it is required that
there be legal compatibility for the central bank to join the monetary union in the form
of freedom from political interference and factors of compatibility, such as; balance of
payments, integration of markets, and unit labor cost without setting specific numerical
goals. The final decision is strictly political. Then the EMU was formally launched on
January 1, 1999 with 11 countries. Greece joined two years later.
The Maastricht criteria
• 1. Fiscal deficits: Government deficit must not exceed 3% of
country’s GDP and total government debt must not exceed 60% of
GDP. Declining debt level is acceptable.
• 2. Price stability: Inflation rate of country over the previous year
must not exceed by more than 1 1/2 percentage points the average
inflation rates of the 3 member states with the lowest inflation
rates.
• 3. Interest rates: Long-term nominal interest rate must not exceed
by more than 2 % points the average of long-term interest rates of
the 3 member states with the lowest interest rates
• 4. Exchange Rate: must have remained within the fluctuation
margin (± 15 percent since 1992-93 Exchange rate crisis) and must
not have faced severe tensions for at least the last 2 years before
entry.
Effects of EMU
• Improved economic efficiency
– Introduction of one currency has eliminated risk
associated with exchange rate changes within the
euro area
– Reduced transaction costs associated with
conversions of currencies.
– Taking advantage of inflationary rates and the
effects of rising prices.
Effects of EMU
• Use of one currency has encouraged
development of integrated financial markets
– In 2008, volume of bonds denominated in euros
exceed that of dollar bonds for the first time ever
– Share of euro in international reserves held by
countries has increased over the past decade
– The monetary system main main objective was to
reduce the volatility of exchange rates between
the currencies of the European economic
community.
Effects of EMU
• Disadvantages
– Loss of independence of monetary policy
– Lacking ability to implement different monetary
policies in the absence of full factor mobility may
lead to loss of a country's international
competitiveness. This is indeed is the case for
Greece, Spain, Italy, and Portugal in the 2008
crisis.
Transmission mechanism of monetary
policy of the EMU
• The central bank, as the sole issuer of banknotes and sole
provider of bank reserves, is the monopoly supplier of the
monetary base. Credit institutions need base money in
order to meet the public demand for currency, to clear
interbank balances (Cheque’s, transfers, etc.) and to fulfill
minimum reserve requirements. The base money can be
traded by the credit institutions within the interbank
money market: those having excess funds lend to those
who have a shortage of funds, at a given interest rate.
• By virtue of this monopoly, the central bank sets the
conditions at which banks borrow from it.
• A change in money market interest rates induced by the
central bank ultimately influence developments in output
variables and prices.
The role of the European central bank
and the euro
• The treaty creating the monetary union establishes price stability as
the primary objective in the euro area. The governing council of the
ECB adopted a quantitative definition of price stability in 1998.
• Bank notes and coins were introduced on January 1, 2002
• The collapse of the economy in 2008 led to a rethinking of
monetary policy frameworks.
• The ECB acceded to the people’s demand for economic security by
delivering stable prices, in a context of steady income progression
and moderate real fluctuations.
• Decision-making body for monetary policy
• Distributes the Euro to countries that need it and excess reserves
from countries are distributed to countries that have low reserves
or low money supply.
• With the EMU, all existing central banks had become instruments of
ECB.
Portugal’s influence
• Part of the EMU and EU
• In 1998, joined the EMU, and the euro begin circulating
in January 2002. Before they had used escudos, which
was traded at poor exchange rates.
• At the turn of the millennium , the economy appeared
to falter, with a widening gap in GDP per capita.
• The budget deficit increased to 6% in 2005
• The private sector, traditional goods, business services,
and technology was growing at a higher sustainable
pace in 2007
Portugal’s monetary policy &
eurosystem
• The Banco de Portugal is an integral part that
aims to maintain price stability within the
euro system. Thus protecting the purchasing
power of the euro, as it was said in the treaty
of Maastricht, was established within the
European community.
• Contribute to community objectives that
include high level of employment and
sustainable and non-inflationary growth.
Current economic crisis in Portugal
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Due to the stagnating growth of debt from the euro zone (i.e. Portugal, Greece,
Italy, Spain, and Ireland), created large amounts of money supply in what they call,
a European debt crisis.
There is high demand for cash circulation however the markets are responding
with hesitation because of the notion that they can’t pay back their recent debts.
A bailout was issued by private sector investors. Due to the contagion effect, it was
imperative that the EU focused there efforts on Portugal.
Portugal signed a $110 bailout agreement with the EU and IMF. The EMU had
committed its efforts to rebuild the debt crisis in Portugal by cutting salaries for
public sector workers.
The EMU places a huge role from diverting an domino effect on the other
countries involved in the EMU.
The financial soundness is growing within Portugal and the EMU as higher levels of
risk starts to panic the markets. The bailout plan may cause moral hazard problems
in the case that the bailout money is used insufficiently. Mentioned earlier, the
political aspect is essentially in creating the best possible choices for the economy.
The Essence of the EMU with Portugal
• Economic integration
– Common currency allows for easier trading links
– Faster movements of goods, services, capital, and labor
– In economic downturns, Portugal gains supports from its
European neighbors in contrast provides economic wealth.
– The benefits of the euro causes free trading and stable
exchange rates. This provides a greater effort for
Portuguese businesses to be seen in the markets today.
That said, free trade agreements account for 90% of the
economic integration with the countries involved in the
EMU.
The Essence of the EMU with Portugal
• Because the Portuguese economy is connected with the European Union,
source of funding and trade have provided a great deal of attention within
the markets.
• Portugal's current economy is facing the first stage of the economic
domino-slinky effect of a steady European debt crises. With the bailout
plan for Portugal, a lot of economic decisions are made to continuing
prospering economically.
• The process of the EU is the most highly integrated regional entity with
the greatest wealth and intra-system trade. The intended function of the
EU is to create a uniform system, including currency, that facilitates the
most frictionless and efficient transfer of goods, services, people, and
factors of production while limiting the risks of currency conversion and
fluctuations arising from vastly different countries.
• Essentially, with respect to the debt as a percentage of GDP,
unemployment levels, tax rates and industrial policies change frequently
during the current European crisis.
Final Conclusions
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Portugal’s economy requires the essence of the EMU. This protection provides stability and unification
with its trade partners in the euro zone. Essentially, the euro, has provided an easier access for the
Portuguese economy to grasp to current movements of trades and to keep up with the markets.
I would say the process of EMU is effective however, the political aspect is solely based on the decisions of
Portugal. Currently, Portugal is in a tight struggle to cut salaries and withdraw its efforts from the current
European debt crisis. This could have been diverted, if decisions within the economy were chosen
correctly.
However, the efforts of the EMU stands as an appropriate fixture to Portugal’s economic well-being and to
provide an efficient method to creating stability, unification, and opportunity.
The creation of the EMU creates enormous opportunities that Portugal possibly couldn’t have reached in
its lifetime.
Essentially, the euro helped rebuild a tighter economic integration system that refaced the image of
Europe's future. Future economic slowdown depends on the combined efforts of each individual neighbor.
When they instituted the euro, many countries realized that they didn’t have money when the conversion
rate decreased the overall money supply in country. This was the case in Portugal when there original
currency, the Escudo, had diminishing returns with the euro, and as a result, overall money supply
decreased.
Bailing out is bad policy, however, a lot of social outburst had occurred because of cutting spending's, as it
did in Greece. Germany’s inflation rate is lower compared to Greece’s inflation rate of 13% and the two
economy’s use the same currency which has the same monetary value. The German economy is much
more stable and carries large amounts of money supply but yet they have to abide by equal inflationary
expectations. This is an ineffective procedure in monetary policy that members of the EMU must face/
Other side of the coin
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Monetary policy is ineffective in regards to all the members as a whole. Having the same optimum
currency with similar speeds of money creation can burden the bigger economic countries like Germany
and France. Modernization is different in Portugal as it is in Germany. Portugal’s economy rests on the
creation of small businesses and not laundering of large sums of money supply, whereas, in Germany,
purchasing of bonds is much higher and therefore due to the higher creation of businesses in Germany,
large amounts of money (the euro in particular) is being circulated.
Furthermore, in this case, monetary policy shouldn’t be equally distributed if more money supply is
carried in one country than another. Germany, in this case, faces the burden of financial crisis from other
countries, as it did in the recent debt crisis.
Due to the infrequent changes in prices, theoretically, Portugal should obtain a higher rate of inflation
then Germany. Essentially, we see that a loop hole in the monetary policy of the EMU. Countries who
circulate large sums of money supply, should yield a lower rate of inflation with respects to small changes
in price level. If you examine Portuguese prices, they are much lower with a low supply of money
circulating the economy after the hyper exchange of escudos to euros. Theoretically, Portugal's prices
should be higher to prove that the monetary policy of the EMU is effective.
Consequently, the European Central bank of the EMU controls monetary policy, and on the basis of
unification, and harmonization, the bank issues one standardized policy.
Germany being one of the leading founders of the EMU refuses to lower the inflation rate due to the
historical incidents that occurred in post world war one. Which resulted in one of the worst hyperinflation
in German history. To fix this problem, Germany had to increase inflation and increase Money supply
which comes into conflict with the members of the EMU. This is on the basis of empirical work.
Bibliography
Online Database:
• Jain, Arvind K. "European Monetary Union." Encyclopedia of Business In Today's World. 2009. SAGE
Publications. 1 Dec. 2011. <http://sage-ereference.com/view/businesstoday/n357.xml>.
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Weatherston, Jamie. "Portugal." Encyclopedia of Business In Today's World. 2009. SAGE
Publications. 1 Dec. 2011. <http://sage-ereference.com/view/businesstoday/n747.xml>.
•
Demirbas, Dilek. "Economic Union." Encyclopedia of Business In Today's World. 2009. SAGE
Publications. 1 Dec. 2011. <http://sage-ereference.com/view/businesstoday/n325.xml>.
Website source:
• http://www.bportugal.pt/en-US/PoliticaMonetaria/Pages/default.aspx
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http://www.ecb.int/pub/pdf/scpwps/ecbwp1336.pdf
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http://news.stanford.edu/news/2011/november/portugal-president-silva-111511.html