THE EURO:
PAST, PRESENT & FUTURE
Dr. Maria Lorca-Susino
European Union Center of Excellence
the University of Miami
Fort Lauderdale, May 20, 2010
The facts
• The Theory of Optimum Currency Areas by
Robert Mundell (Nobel Price)
• Adopting the euro: Costs and benefits
• The History
• To adopt the euro: The Maastricht Treaty
– Convergence requirements to adopt
• With the euro:
– Monetary policy: The European Central
Bank
– Fiscal policy: The Stability and Growth
pact
• The euro and the Eurozone today
The History
•
•
•
The path to the EMU and the euro has not been an easy.
The 19th century witnessed three major attempts:
– Austro-German monetary union (1857-1866).
– The Latin Monetary Union (1865-1878) between France, Belgium, Italy, and
Switzerland.
– The Scandinavian monetary union (1875-1917) between Denmark, Norway,
and Sweden.
The 20th century witness three major attempts:
– The 1969 Den Haag summit, during which the Werner Report was
introduced.
• This report represented the first commonly agreed upon plan of action
to create an economic and monetary union in October 1970
– In 1979, the European Monetary System (EMS) and the introduction of the
European Currency Unit (ECU) as common currency
• set up a zone of monetary stability and to increase efforts to achieve
closer economic convergence between Member States
– In April 1989, Jacques Delors introduced the Delors Report:
• A thorough, three-stage plan—to introduce the EMU and the euro
• Delors Report was approved at the informal ECOFIN meeting on May
19-20, 1989, at the Hotel La Gavina in S’Agaro on the Costa Brava
(Spain).
• During the Madrid European Council that took place in June 1989, the
Delors Report was adopted as the roadmap for work on the creation of
the EMU
The Theory of Optimum Currency
Areas by Robert Mundell
•
•
•
•
Mundell  “the most dramatic change in the international monetary
system since President Nixon took the dollar off gold in 1971.”
In 1961: paper entitled “A Theory of Optimal Currency Areas.”
In 1970 in Madrid, during a conference on optimum currency areas,
he presented two major papers:
– “Uncommon Arguments for Common Currencies,”
– and “A Plan for a European Currency” in which he proposed to
name the new currency ¨Europa.¨
– After the conference he received a phone call in his home in
Siena from Lorenzo Bini-Smaghi, a senior staff member of the
European Monetary Institute (EMI):
• Three questions (1) the first to name the currency
¨europa¨?, (2) would be still a good name now? and (3)
how long would it take to be operative?
• “it is more difficult than you think. Even if there were no
political impediments, it would take at least three weeks¨.
Finally, in 2003 claimed the benefits of a world currency—an idea
that he had already promoted in a paper published in 1968—the
“INTOR”.
EUROPA
•
•
•
•
According to Greek mythology: Europa was a Phoenician
woman of high lineage and the namesake of continental
Europe.
Europa was the youngest daughter of the king of Phoenicia.
The story goes that, one day, she was playing with her elder
sisters, Asia and Africa, by the sea when Zeus spotted her.
He fell in love with her and transformed himself into a
beautiful white bull.
He transported her on his back to Crete and the myth of the
¨The Rape of Europa¨, ¨The Abduction of Europa¨ or “The
Seduction of Europa¨ began.
Adopting the euro: pros and cons
COSTS of a common currency
A country that relinquishes its national
currency:
* A) Loss of identity and national
sovereignty
* B) relinquishes an instrument of
economic policy  loses the ability to
conduct monetary policy:
1)No longer can change the price of its
currency (devaluation or revaluation)
2)Determine the amount of national
currency in circulation
3)Change short-term interest rates
BENEFITS of a common currency
1) Elimination of transactions costs
2) Price transparency
3) Elimination of exchange rate
uncertainty
4) A common currency will become
international currency  boosts
productivity, international exposure,
and opens the country.
The Delors Report
• Stage one: The preparatory phase  from July 1990
to December 1993
– the Member States of the EU needed, to
implement the first of the “four freedoms”: the
liberalization of capital movements
– The Maastricht criteria
• Stage two: The transitional phase  from January
1994 to December 1998.
– a exchange rate mechanism was set up in order to
provide currency stability between the euro and
the national currencies of those countries that
were not yet part of the Eurozone.
• Stage three: On January 1, 1999: Enforcement of the
conversion rate triggered the start of the final stage
of the Delors Report, which continues to this day.
The Maastricht Treaty
• It sets standards to ADOPT the euro
• Protocol: ¨On the Convergence criteria”
Target
Requirement
Inflation Rate
No more than 1.5 percentage points higher than the 3 bestperforming Member States of the EU.
Public finances
The ratio of the annual government deficit to gross domestic
product must not exceed 3% at the end of the preceding fiscal
year.
Interest rates
The nominal long-term interest rate must not be more than 2
percentage points higher than the 3 best-performing Member
States.
Exchange rate
stability
Applicant countries should have joined the exchange rate
mechanism under the European Monetary System for 2
consecutive years and should not have devaluated its currency
during the period.
To maintain the euro
• Once the euro has been adopted  countries must
comply with the economic and monetary requirements
established in Title VI of the Maastricht Treaty.
• Title VI: Economic and Monetary Policy
- Chapter 1: Economic policy –Article 104
- Art. 104C – Excessive government deficits
- Art 104C-2b: government deficit to GDP
- Art 104C-2c: government debt to GDP
- Art 104.14: Protocol on excessive Deficit
Procedures
- Art 103: No bail-out rule  to avoid members
states from becoming responsible for financial
liabilities of other members
- Chapter 2: Monetary policy – Article 105
- Art 105.1: objective: price stability by European
System of Central Banks (ESCB) = INDEPENDENT
- Art 105.2: explains tasks of ESCB
- Chapter 3: Institutional provisions
• On the Excessive Deficit Procedure --- The
Stability and Growth Pact (SGP)
– Article 1: The reference values referred to
in Article 104c.2 of this treaty are:
• 3% for the ratio of the planned or
actual government deficit to GDP
• 60% for the ratio of government debt
to GDP at market prices
WHERE
Contribution
PREAMBLE
Strengthening and convergence of economies to establish an Economic
and Monetary Union and the euro as a single and stable currency
Title I:
Common Provisions
Article 3
The Union should work for: balance economy and growth and price
stability  to establish an economic and monetary union whose
currency is the euro
Title III:
Provisions on the Institutions
Article 13
The European Central Bank becomes formally an institution of the
Union
Title VIII:
Economic and Monetary
Policy
Article 119
Adoption of an economic policy based on:
•close economic coordination of Member States’ economic policies
• the introduction of the euro
With the following guiding principles:
• Stable prices, sound public finances, and balanced balance of PYMT
Chapter 1
Monetary Policy
Article 120
MS shall conduct their economic policies with a view to contributing to
the achievement of the objective of the Union
WHERE
TREATY OF LISBON
1.
2.
3.
4.
Article 121
Economic policy  a matter of common concern
The Council on recommendation from the Commission  formulate a
draft with broad lines of the economic policies of the MS
The Council monitors the economies and reports to the Commission
NEW: if guidelines are breached  a MS risk jeopardizing the proper
functioning of economic and monetary union…
1. The commission adopts warning
2. A QM in the Council can
1. Make recommendations (public or not public)
3. The MS concerned has no vote
Article 122
Measures in case of severe difficulties  Measures can be taken and financial
assistant can be granted
Article 125
No bail-out rule  The Union shall no be liable for or assume the commitments
of central governments, regional, local or other public authorities
WHERE
Article 126
The Most Important
Article
Contribution
1.
2.
MS shall avoid excessive government deficits
The Commission to monitors budgetary discipline
1.
No more than 3% government deficit except:
1.
2.
2.
No more than 60% government debt
1.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Substantial decline
Exceptional decline
Unless the ratio is diminishing sufficiently
Limits are set in Protocol No. 12
Commission reports about risk of excessive deficit
The Economic and Financial Committee gives opinion on report
NEW The Council based on the report ask MS and the Council
decides
If the Council decides there is an excessive deficit  adopt
without delay the recommendation of the Commission that shall
not be public
If the MS does not take the actions recommended, the Council
will ask the MS to submit a report with a time table
If the MS still does not comply, the Council may take second set
of sanctions
The President of the Council shall inform the European
Parliament of the decisions taken
When the Council adopt a decision:
1.
2.
The vote of the MS is not taken into account
A QM of the other MS is: 55% of the MS of the Council comprising
65% of the population
IMPORTANT CONTRIBUTION
• Article 50 of the Treaty of Lisbon includes the “exit clause”:
“Any Member State may decide to withdraw from the Union
in accordance with its own constitutional requirements.”
• Possibility to rejoin the union following the procedures in
Article 49.
“Any European State which respects the values referred to in
Article 2 and is committed to promoting them may apply to
become a member of the Union.”
• Article 2:
“The Union is founded on the values of respect for human
dignity, freedom, democracy, equality, the rule of law and
respect for human rights, including the rights of persons
belonging to minorities.”
THE EUROZONE
AND
THE EURO
Eurozone Member States: EMU
Economic and Monetary Union
(EMU)
1. Monetary Policy:
-European Central Bank
- Price stability
- 2% inflation rate
2. Economic Policy:
•Fiscal Policy: Stability and Growth Pact
• Gov. Deficit to GDP: 3%
• Gov. Debt to GDP: 60%
1. Monetary Policy
• European Central Bank (ECB)
– Founded: June 1, 1998
– Operative: January 1, 1999
– Main objectives: Maintain price stability to
maintain inflation under control (< 2%)
• Sets interest rates in the Eurozone:
EURIBOR
• EURIBOR (Euro Interbank Offered Rate): is
the rate at which euro interbank term
deposits within the euro zone are offered
by one prime bank to another prime
bank.
– This sets interest rates for households
and business
Organization
The Governing Council is the most
important decision making body in
the ECB. It is responsible for
establishing monetary policy and
interest rates.
The Executive Board is in charge of
implementing the monetary
decisions made by the Board and
informing the various EU member
states’ NCBs of these decisions
The General Council is composed
of the ECB’s president, vicepresident, and the governors of
the NCBs of all EU member states.
Governors of those EU countries
that have not yet adopted the euro
cannot participate in decisions
related to the euro, although they
are invited to participate in
discussions involving monetary
policy issues.
Structure of the ECB Governing Council
President
Jean-Claude Trichet
Vice – President
Lucas Papademos
Governors of the
National Central
Banks
Guy Quaden (Belgium),
Axel A. Weber (Germany),
John Hurley (Ireland),
Georgios Provopoulos
(Greece),
Miguel Fernández Ordoñez
(Spain),
Christian Nayer (France),
Mario Draghi (Italy),
Athanasios Orphanides
(Cyprus),
Yves Mersch (Luxemburg),
Michael C. Bonello (Malta),
Nout Wellink (Netherlands),
Ewald Nowotny (Austria),
Victor M. Ribeiro Constancia
(Portugal),
Marko Kranjec (Slovakia),
Ivan Sramko (Slovenia),
Erkki Liikanen (Finland)
Harmonized Index of Consumer Price
and the Euribor
2. Economic Policy: Fiscal Policy
• The Stability and Growth Pact (SGP): A set of
requirements to maintain fiscal discipline in the
EMU.
• The SGP was initially proposed in the mid 1990’s
by Theo Waigel (German finance minister)
– Germany obsession: maintain low inflation
• an important part of the German strong
economy's performance since the 1950’s.
• After adopting the euro, the SGP ensures that
Eurozone Member States continue to observe
them.
• The requirements:
– an annual budget deficit no higher than 3%
of GDP
– a national debt lower than 60% of GDP or
approaching that value.
Stability and Growth Pact
Deficit/Surplus (3%)
Government Debt (60% of GDP)
The Euro and…
The EU 27 and the Eurozone
Denmark, Sweden, and the U.K.
•
•
•
Denmark's national currency, the KROEN linked to the euro
through
– The government has met the economic convergence criteria
for participating in the third phase of the (EMU), but
Denmark, in a September 2000 referendum rejected joining
the EMU
• New Referendum: ?
Sweden: rejected the euro in a popular vote maintains its own
currency, the Swedish Krona
– The Swedish Riksbank founded in 1668 is the oldest central
bank in the world
– Convergence problems – Working on inflation
The U.K. The currency is the pound sterling.
– The Bank of England is the Central Bank
– The UK chose not to join the euro at the currency's launch.
– British Prime Minister, Gordon Brown MP, has ruled out
membership for the foreseeable future.
– Former Prime Minister Tony Blair promised to hold a public
referendum based on a number (five) points.
– In 2005, more than half (55%) of the UK were against
adopting the currency, while 30% were in favour.
Enlargements: 2004 & 2007
Country
Cyprus
C.Republic
Estonia
Hungary
Latvia
Lithuania
Malta
Poland
Slovenia
Slovakia
Bulgaria
Romania
EMU entry date
January 1, 2008
Has met the accession criteria
Expected
2013
2011
2012
2013
2010
January 1, 2008
2012
January 1, 2007
January 1, 2009
2012
2014
Non-EU countries and the euro
Country
Pegged to
Adopted Euro
Agreement signed
Monaco
French franc
January 1, 1999
December 31, 1998
San Marino
Italian lira
January 1, 1999
December 31, 1998
Vatican City
Italian lira
January 1, 1999
December 31, 1998
Andorra
French franc
January 1, 1999
December 31, 1998
Spanish peseta
Seeking
Agreement but not
membership to EU
Montenegro
German mark
January 1, 2002
Never
Membership to EU
Kosovo
German mark
January 1, 2002
Never
Membership to EU
Existing Monetary Union
The East Caribbean dollar: in Anguilla,
Antigua and Barbuda, Dominica, Grenada,
Montserrat, Saint Kitts and Nevis, Saint
Lucia, Saint Vincent, and the Grenadines.
The Central and West CFA franc used by
currency used in 12 formerly French ruled
African countries plus Guinea-Bissau
(Portuguese) and Equatorial Guinea
(Spanish)
The East African Shilling used in the East
African Community (EAC) between the
Republics of Kenya, Uganda, the United
Republic of Tanzania, Republic of Burundi,
and Republic of Rwanda
The Facto Monetary Union
The euro
is legal tender in Andorra, Kosovo, and Montenegro.
The Hong Kong Dollar
is used in Macau
The Russian rubble
is used in Russia and the Georgian Autonomous republics
of Abkhazia and South.
The Swiss franc
in Liechtenstein
The U.S. dollar
is used in Palau, Micronesia, the Marshall Islands, Panama,
Ecuador, El Salvador, Timor-Lester, the British Virgin
Islands, and the Turks and Caicos Islands.
Planned Monetary Union
Name
Currency
Date
West African Monetary Zone – as part of the
Economic Community of West African States
(ECOWAS)
Eco
December 2009
Gulf Cooperation Council (GCC)
Khaleeji
2015
Caribbean Single Market and Economy (CSME) as
part of the CARICOM
Unknown
Due between 20102015
Southern African Development Community
Unknown
2020
SUCRE
(Sistema Unificado de
Compensación Regional)
4th quarter of 2009
(Oct/Nov/Dec)
Alternativa Bolivarianas para los Pueblos de
América (ALBA) - Bolivarian Alternative for the
Americas  Bolivia, Nicaragua, Honduras, Cuba,
Venezuela, Dominica, and San Vicente-Granadinas
(which have the East Caribbean Dollar) and Ecuador
is not sure bc it has the US dollar
The Eurozone and the euro
The Current Economic Crisis
and
Financial Uproar
The economic crisis….
• Has increased the need of government intervention
in the economy
– Bail-out plans
• Increased imbalances
– GDP = C + I + Gs + NE
– With the crisis:
• Reduction of the C + I
• Increase of Gs
– Deficits = Tax < Expenditures
– Government deficit: Borrow money to close the deficit
The Problem
Portugal
Spain
Greece
Eurozone
Budget
Deficit
8.7%
10.4%
8.7%
6.8%
Government
Debt
82%
60.1%
119.9%
84.8%
Amount of $
needed
$16bn
$71bn
$40bn
$600bn
Amount of $
Raised
$11bn
$38bn
$22bn
$395bn
Greece and Spain: Budget cuts of 1.5% for 2010 and 2% for 2011
Portugal: halts large-scale projects worth more than €60bn ($76bn) to reduce
deficit to 7.3% of GDP
60% of Germans wants to leave the euro and go back to the D-mark
SOCIAL REVOLTS
In the mean time
• MEPs  salary increased: $2,000
• Assistant Budget per Month: $20,000
• Monthly Meetings Strasburg:
– Economic Profligacy
– @700 MEPs
– @3,000 aids
– 280 m
– $250 mil
• 2010 budget: increased by $10m
• 2011 budget: increased by 6%
The Danger
Solutions to save the Eurozone
• 1). Bail-out plan for Greece:
– €110bn in bilateral loans at 5%
– Breaks the Treaty “no-bail-out” rule
• 2). Loan Package: €750bn ($962bn)
– Euroarea: €440bn
– EU’s budget: €60bn
– IMF: €250bn  controversial for US’s
involvement
• 3). The European Central Bank
– Buy debt from countries  a
controversial and “illegal” measure
The US and the European Rescue
• The IMF: €250,000 mill (US$310,000 mill)
• The US is the biggest contributor to the IMF
• The US is involved with $54,000 mill which represents the 17% stake that
the US holds in the IMF.\
• President Obama has contacted Spanish President  Spanish economy is
5 times bigger than Greece  too big to fail  would need an estimated
€474,000 mill while Greece needed €110,000 mill.
• Chicago Federal Reserve Bank President Charles Evans said on Friday May
14, 2010:
– “It will affect global demand which will influence our net export position, I am
hopeful that our exposure will be minimal to modest.”
• Geithner on May 15, 2010:
– “we have a bog stake in helping Europe manage through these things. We’re
going to do it in a way that’s sensible for the American economy, the American
taxpayer.”
THANK YOU