EMU and the euro . . .

(for dummies?)

Presentation by Nigel Nagarajan

Student Orientation – 2009 Euro Challenge
Miami-Florida European Union Center of Excellence
January 22nd, 2009
 What are we going to cover today?

• What is EMU?
• What are the costs and benefits of
having a single currency?
• What economic benefits derive from the
single market?
• How is economic policy made in a
monetary union?
• Will EMU break up?
2
 What EMU isn’t

Sorry to disappoint you, but . . .

HELLO, MY NAME IS

Dromaius
Novaehollandiae

. . . EMU is not a bird!

3
 What does EMU stand for?

Does EMU stand for:

European Monetary Union?

Or:

Economic and Monetary Union?

4
EMU vs. the euro area

• EMU is a Treaty
objective shared by all
27 EU Member States
• The euro is a reality
for 16 Member States
(“the euro area”)
• What about the “E” in
EMU?
5
 What are the three parts of EMU?

1) The euro – countries give up their own

currency when they join the euro area. The
ECB sets interest rates for the euro area (16)

2) The single market – all countries

participate in the single market, with free
movement of goods, services, capital and
people (27)

3) Enhanced policy coordination –

countries retain sovereignty over other
economic policies but commit to coordinate
more closely at the European level (27/16) 6
Which countries are in the euro area?

Euro area: Austria, Belgium,

Cyprus, Finland, France,
Germany, Greece, Ireland,
Italy, Luxembourg, Malta,
Netherlands, Portugal,
Slovakia, Slovenia, Spain.
EU Member States obliged
to adopt the euro
eventually: Bulgaria,
Czech Republic, Estonia,
Hungary, Latvia, Lithuania,
Poland, Romania, Sweden.
EU Member States with an
opt out from adopting the
euro: Denmark, United
Kingdom.

7
 How does a country join the euro?

A Member State must fulfill the “convergence

criteria” laid down by the Maastricht Treaty:

• Low inflation
• Low interest rates
• Low government deficit
• Low government debt
• Stable exchange rate (ERM II)

8
 What are the benefits of the euro? And the costs?

CITIZENS benefit from greater price

transparency, which should stimulate
competition and reduce prices and from the
elimination of currency exchange costs

For BUSINESSES it is easier to make

investment decisions (no exchange rate risk)

The ECONOMY benefits from price stability,

and lack of exchange rate risk

Countries that adopt the euro can no

longer change their INTEREST RATE
or their EXCHANGE RATE. In a
monetary union, you cannot have an
INDEPENDENT MONETARY POLICY.

9
 The challenge of asymmetric shocks

Massachusetts: recession
(1) Federal fiscal system
(2) High labour mobility
Fiscal
transfe
Real world example of a
rs: 
Taxes:

Fis
l tsingle currency area
ca
Ta ra
xe ns
s: fer
 s:


Asymmetric shock: oil Euro area less

prices . Affects Texas and good at coping
Massachusetts differently. with shocks?
Texas: boom 10
The benefits of EU membership – the single market

• Larger market → more

competition
• More competition →
more choice, lower
prices for consumers
• More competition →
promotes efficiency
• Larger market → firms
can exploit economies
of scale 11
The single market – economies of scale

• Larger firms enjoy cost

advantages over smaller firms
(e.g. purchasing, marketing)
• EU firms can produce for a
market of 500m consumers
• And pass on lower costs to
consumers
• This should encourage
economic efficiency and
stimulate economic growth 12
 The euro and the single market

• The euro eliminates

currency transactions costs
• Leads to greater price
transparency → price
convergence
• Eliminates exchange rate
“One market, one money” uncertainty → stimulates
investment
• Euro leads to increased
trade and investment flows 13
Economic policy in EMU

14
 Economic policy making - the euro area and the US

Monetary policy

Federal Reserve Chairman ECB President

Ben S. Bernanke Jean-Claude Trichet

Fiscal policy
Treasury Secretary
Eurogroup Finance Ministers
Henry M. Paulson

Economic policy co-ordination more difficult? 15

 EMU and the financial crisis

“this is an equal-opportunities economic crisis, and the euro

area is in it just as deep as America, Britain and the rest.” –
The Economist, January 15th, 2009
• US and euro area economies connected by
strong trade, investment links
• European banks invested heavily in US sub-
prime mortgages
• Euro area has less flexible economy than US,
with lower productivity growth – less resilient?
• Some euro area economies had housing
bubbles
• European consumers less indebted than US
16
EMU and the financial crisis

• Crisis exposes persistent

divergences in EMU
• “One size fits all monetary
policy” problematic?
• Countries need to use fiscal
stimulus, just as in US
• But difficult to coordinate
fiscal response of 16 Member
States
• Break-up of EMU? 17
 The financial crisis – how should Europe respond?

ECB cuts interest rates to 2%

European Economic Recovery

Plan – governments enact
fiscal stimulus packages

18
 The financial crisis – how should Europe respond?

Speed up economic reforms

(Lisbon Strategy)
http://ec.europa.eu/growthandjobs/index_en.htm

Make the single market work

better (especially for Services)

19
 Conclusions

• The launch of the euro was a tremendous

achievement for the EU
• But EMU is still a work in progress
(especially for the “E” part)
• How will EMU cope with its first recession?
• Will the crisis lead to the break up of EMU
or will it encourage countries to speed up
reforms?
• Can you have a monetary union without a
complete economic union? Political union?
20