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 consCOSTS of a common currency BENEFITS 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 circulation3)Change short-term interest rates

1) Elimination of transactions costs2) Price transparency3) Elimination of exchange rate

uncertainty4) 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 best-performing 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

PREAMBLEStrengthening and convergence of economies to establish an Economic and Monetary Union and the euro as a single and stable currency

Title I:Common ProvisionsArticle 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 InstitutionsArticle 13

The European Central Bank becomes formally an institution of the Union

Title VIII:Economic and Monetary PolicyArticle 119

Adoption of an economic policy based on:•close economic coordination of Member States’ economic policies• the introduction of the euroWith the following guiding principles:• Stable prices, sound public finances, and balanced balance of PYMT

Chapter 1Monetary PolicyArticle 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

Article 121

1. Economic policy a matter of common concern2. The Council on recommendation from the Commission formulate a draft

with broad lines of the economic policies of the MS3. The Council monitors the economies and reports to the Commission4. NEW: if guidelines are breached a MS risk jeopardizing the proper

functioning of economic and monetary union…1. The commission adopts warning2. 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 ContributionArticle 126

The Most Important Article

1. MS shall avoid excessive government deficits2. The Commission to monitors budgetary discipline

1. No more than 3% government deficit except:1. Substantial decline2. Exceptional decline

2. No more than 60% government debt1. Unless the ratio is diminishing sufficiently

3. Limits are set in Protocol No. 124. Commission reports about risk of excessive deficit5. The Economic and Financial Committee gives opinion on report6. NEW The Council based on the report ask MS and the Council

decides7. If the Council decides there is an excessive deficit adopt

without delay the recommendation of the Commission that shall not be public

8. If the MS does not take the actions recommended, the Council will ask the MS to submit a report with a time table

9. If the MS still does not comply, the Council may take second set of sanctions

10. The President of the Council shall inform the European Parliament of the decisions taken

11. When the Council adopt a decision:1. The vote of the MS is not taken into account 2. 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, vice-president, 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

C ountry Entry Date Actual A ustria January 1, 1999B elgium January 1, 1999N etherlandsJanuary 1, 1999Fi nland January 1, 1999Fra nce January 1, 1999G ermanyJanuary 1, 19991 999Ireland January 1, 1999Italy January 1, 1999L uxembourgJanuary 1, P ortugalJanuary 1, 1999S painJanuary 1, 1999G reeceJanuary 1, 2001D enmarkNever joinedS wedenNever joinedU nited KingdomNever joined

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 EMU entry date ExpectedCyprus January 1, 2008C.Republic 2013Estonia Has met the accession criteria 2011Hungary 2012Latvia 2013Lithuania 2010Malta January 1, 2008Poland 2012Slovenia January 1, 2007Slovakia January 1, 2009

Bulgaria 2012 Romania 2014

Non-EU countries and the euro

Country Pegged to Adopted Euro Agreement signed Seeking

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

Spanish peseta

January 1, 1999 December 31, 1998 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 UnionThe 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 UnionName 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 2010-2015

Southern African Development Community Unknown 2020

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

SUCRE (Sistema Unificado de

Compensación Regional)

4th quarter of 2009 (Oct/Nov/Dec)

The Eurozone and the euro

The Current Economic Crisisand

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 ProblemPortugal Spain Greece Eurozone

BudgetDeficit

8.7% 10.4% 8.7% 6.8%

GovernmentDebt

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