Lecture 8

EUROPEAN MONETARY UNIFICATION AND THE EURO

-Robert Mundell, check. 

EMU, European monetary union

-12 original members, now 19. 

-Euro controlled by European Central Bank.

European snake- exchange rate tunnel, not completely fixed or free float-> this policy was followed by EU in  73.

 

Maastricht Treaty- Formation of more wide ERM--> Finland joined. 

-UK and Denmark dropped. 

Need for Convergence

-countries with same currencies should become similar -> Example inflation rate. 

-if countries have different rates of inflation the high inflation countries will lose markets to low inflation countries. 

-if countries have different interest rates capital will flow to high-interest rate countries seeking a higher return.

--> Countries with common currency inflation and interest rates, budget and government deficits.

 

Maastricht  Convergence Criteria

1. National currency in ERM for 2 yeras

2. Budget deficit <3% of GDP

3. Government debt < 60% of GDP

4. Inflation <1.5% above the average of lowest 3. !Estonia when entering EU!

5. Long-term interest rates <2% above average of lowest 3

Without adjustment

-when one country is hit with  a shock that others are not

WInners and losers of EMU

Winners: Multinational companies, costs of operating in multiple countries were reduced. Europe's biggest banks were expected to gain through consolidation across borders. Consumers, able to comparison-shop across borders. 

Losers: Small firms (e.g. shops, restaurants), for whom changeover was costly with little benefit.

The EUro zone crisis

-In process of negotiating a mechanism to 1. provide loans to troubled countries 2. put pressure on them for austerity--> cut spending and raise taxes. 3. FOrm banking union to safely manage bank failures. 

Greek debt

-tradeoff between

Bailout money from others to pay it off--> favoured by weaker countries (France)

Bonds cut for private investors. --> supported by the stronger countries (Germany)

-structural deficit in EU budget, a nominal deficit in bookkeeping, revenue vs expenses. Structural adjusted to by business cycles. Potential annual growth...what is nest years forecast. GDP gap!! Hard to say exact GDP gap... many ways to calculate. 

NB! Japan high loan to GDP ratio. Japanese gov loans bought by Japanese individuals. 

Headline and underlying inflation

-one includes the energy prices. 

1. GDP- growth, is the country  economy stuck or evolving

2. High Government debt--> loan interest, credit rating

3. Inflation/deflation --> purchasing power

4. interest rate on loans-->  availability of loans, consumer ability to pay 

5. Credit quality of loans