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

1 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: 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: 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 Real world example of a single currency area Fiscal transfers:  Taxes:  Texas: boom Massachusetts: recession (1) Federal fiscal system Fiscal transfers:  Taxes:  (2) High labour mobility Asymmetric shock: oil prices . Affects Texas and Massachusetts differently. The challenge of asymmetric shocks Euro area less good at coping with shocks?

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 uncertainty → stimulates investment Euro leads to increased trade and investment flows “One market, one money”

13 Economic policy in EMU

14 Economic policy making - the euro area and the US Monetary policy Federal Reserve Chairman Ben S. Bernanke ECB President Jean-Claude Trichet Fiscal policy Treasury Secretary Henry M. Paulson Eurogroup Finance Ministers 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 15 th, 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) Make the single market work better (especially for Services)

19Conclusions 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?