European intergration

Abbreviations:
- EMU: Economic monetary union -> once enter follow the rules (stability and growth pact, SGP)
- SGP: stability and growth pact
- EMS:
- ECB:
- OCA: optimal currency area
- CA: current account -> CA balance equals national income minus domestic absorption
- REER: The weighted average of a country's currency relative to an index or basket of other
currencies adjusted for the effects of inflation. (eurozone, single currency, many REERs)

Why:
Not: single currency, internal market, or economy
 try keep peace + prevent Europe becoming communist

Predecessors of EU:
- 1921 BLEU: Belgisch-limburgse Economische unie
- 1944 Benelux
- OEEC (predecessor OECD): support of the US to facilitate the Marshall Aid
- 1952 EGKS: European Coal and Steel Community
- 1957 The Rome treaty: Euratom (European Atomic Community) + EEC (European economic
community, free trade area) + Establishment counsel of ministers (as counterweight to the European
commission, and national level) + Creation European Parliament.

Founding members: Netherlands, Belgium, Luxembourg, France, Germany, and Italy

-> 1973: Ireland, UK, Denmark
-> 1982: Greece
-> 1986: Spain, Portugal
-> 1995: Austria, Sweden, Finland
-> more after

Economic corporation
- 1952 EGKS
- 1957 Common agricultural policy
- 1957 FTA: Free trade area (no internal tariffs, no common outside tariff)
- 1968 Custom Union: (FTA + common custom tariff)
- 1993 Single market: Free movement goods, some services, capital and people)
- 1999 EMU: Economic and monetary union (Eurozone, introduction common currency)

Data for monetary cooperation:

- 1970 Werner plan: first effort introduction common currency (plan dead after collapse of BW)
- 1979 EMS: European monetary system with exchange rate mechanism (ERM)
- 1991 Maastricht Treaty: introduction euro
- 1993: Start single market
- 1997 Stability and growth pact
- 1999 Start EMU
- 2002 Introduction of EMU coins and banknotes
- 2007 start of financial crisis in US
- 2008 Almost worldwide financial collapse (several countries needed European bail-out)
- 2010: Greece admits forging public debt figures, triggers a deep eurozone crises
- 2011: ECB saves euro (SMP, LTRO)
- 2012: ECB continues to save euro (LTRO, OMT)
- 2013: preparation banking union start
- 2014: asset quality review, EMU banking crises over
- 2015: ECB starts quantitative easing (also year of refugee crisis)
- 2016: British vote Brexit
- 2020: Corona, Europe closes internal borders, and starts support funds

Cooperation not about EMU,

Consolidation of internal market
 devaluations harmful for stability internal market
 A fragmented Europe is a declining power; combined one of the largest economic and political
power of the world.

Maastricht Treaty (1992):

- public deficit < 3% GDP
- public debt < 60% BBP or declining
- at least 2 years membership ERM
- inflation max 1.5% higher than best performing countries
- bond yields max 2% higher best performing countries on inflation
- politically independent central bank

Stability and growth pact

- basic rules: fiscal deficits < 3% of GDP
- public debt ratio < 60% of GDP or declining; no bail out clause ; many policies added ; no monetary
financing of public deficits allowed.
- reform 2005: take macro circumstances more into consideration; medium term sustainability of
public finances
- recent developments: realisation only focus on fiscal policy is not enough; European semester, two-
pack, six-pack; structural macroeconomic policies; ex-ante budget review; banking union (only two of
three pillars)

EMU is not optimal currency area

OCA: minimal costs of external shocks
relevant factors:
- mobility production factors (capital, labour) between and within sectors (labour market flexibility)
- diversity in production structure
- federal budget of sufficient size
- integrated financial markets
what is missing:
- no common fiscal policy
- no federal budget of any substance
- incomplete and altering integration on labour markets
- no mutualisation of public debt -> no common safe assets -> fragmented bond markets
- halfway house with the financial market integration

EMU: a bunch of countries that share a currency and a central bank? The reality is better: there are a
lot of policy rules that every member state more or less accepts

But it is hardly a full-fledged monetary union. Still work in progress.

Relevant questions are:

▪ What are economic costs and benefits of EMU participation?
▪ How is EMU affected by external shocks?
Relevant factors are:
▪ Mobility of production factors
▪ Central budget
▪ Diversity in production structure
Examples:
▪ How do individual countries react to a weaker US dollar?
▪ Are (fiscal and economic) policies sufficiently harmonized?

1999: Monetary Union is a fact, and the ECB starts its common monetary policy

1992: Maastricht treaty (criteria; max public deficit and debt, max inflation/bonds)

SGP criteria -> min fiscal deficits and min public debt ratio, in 2014 start banking union

EMU -> effected by external shocks

EMU relevant factors (mobility production factors; diversity production structure; federal budget of
sufficient size; integrated financial markets)
EMU missing: Common monetary policy; common fiscal policy; no federal budget; incomplete
integration of labour markets; no mutualisation of public debt; no common safe assets.
EMU weaknesses: (focused to much on public sector)(failed to finish:)
- economic and monetary union
- Schengen
- banking union
- capital market union

How to improve its functioning:

- economies or currency unions do net meet oca criteria without additional policy measures
- improve functioning pf a currency area until it de facto is an OCA
- EMU not political union and will not develop into one in years to come
- e improvement of the efficiency of markets.
- Labour market reform, including more labour mobility between sectors and between companies is
essential.
- fiscal discipline: most countries don’t play by the rule

Budgetary reforms
- mutualisation of public debt by use of Eurobonds or bill (however..)
- introduce common safe assets (otherwise capital market union will not function and euro will
remain incomplete currency and ECB remain junior partner of the Fed)
- more flexibility in the SGP
- larger income base of EC,, lower national contributions
- right instruments for ECB to fight inflation

SGP focusses almost completely on public finances (only savings balance public sector national
balance, not private sector) The current account of the balance of the balance of payments is the
national savings balance. Current account balances matter in an incomplete monetary union

Euro crisis three interconnected crisis: banking, growth and debt

Causes of CA imbalances
• Different stage of the business cycle
• Demographic factors
• Rich and ageing countries can be better off by investing in poorer developing countries

CA deficits must be financed. This can be done by:

1. Shrinking currency reserves and or selling foreign assets
2. Attracting foreign investments
3. Borrowing abroad (building up debts)

Most (if not all) financial crisis were preceded by prolonged periods of current account deficits. It is
an important stress-indicator

Since crises, measures taken to strengthen EMU:

• Sixpack (2011): 5 regulations and 1 directive with a.o. measures to strengthen the effectiveness of
the SGP, policies that aim to reduce the macroeconomic imbalances and an early warning system.
• European Stability Mechanism (ESM) 2012): A fund to provide support to member states in
financial distress.
• Twopack (2013): two regulations improving surveillance
• Banking Union (2014): Single Rulebook, Single Supervisory Mechanism, Single Resolution
Mechanism and EDIS (see lectue on supervision)
• Capital Market Union (2015): creating one EMU-wide capital market
‘

What can be done?

- improvement of the efficiency of markets
- labour market reform
- fiscal discipline