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Chapter 17

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Chapter 17

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  1. Chapter 17

  2. Chapter 17 The European Monetary Union

  3. The Long Road to Maastricht and to the Euro On 13 July 2010 the Council of the European Union approved Estonia’s request to join the euro area on 1 January 2011. Estonia duly joined the euro area on that date and the euro replaced the kroon at a fixed conversion rate of €1 = EEK 15.6466. There will be a two-week period when both currencies are in circulation, with change normally provided in euro.

  4. The Maastricht Treaty • A firm commitment to launch the single currency by January 1999 at the latest. • A list of five criteria for admission to the monetary union. • A precise specification of central banking institutions. • Additional conditions mentioned (e.g. the excessive deficit procedure).

  5. The Maastricht Convergence Criteria • Inflation: • not to exceed by more than 1.5 per cent the average of the three lowest inflation rates among EU countries. • Long-term interest rate: • not to exceed by more than 2 per cent the average interest rate in the three lowest inflation countries. • ERM membership: • at least two years in ERM without being forced to devalue. • Budget deficit: • deficit less than 3 per cent of GDP. • Public debt: • debt less than 60 per cent of GDP: • Note: Observed on 1997 performance for decision in 1998.

  6. Convergence Criteria: Inflation convergence

  7. Convergence Criteria • Long-Term Interest Rate: easy to bring inflation down in 1997 and then let go again. • ERM Membership: need to convince the exchange markets. • Historically, all big inflation episodes born out of runaway public deficits and debts. • Hence requirement that house is put in order before admission. • Problem No. 1: • a few years of budgetary discipline do not guarantee long-term discipline • Problem No. 2: articifialceilings.

  8. Debt and Deficit in 1998

  9. Architecture of the monetary union

  10. A Tour of the Acronyms • N countries with N National Central Banks (NCBs) that continue operating but with no monetary policy function. • A new central bank at the centre: the European Central Bank (ECB). New Governor Mario Draghi (Super Mario in Italy) from November 2011 • The European System of Central Banks (ESCB): the ECB and all EU NCBs (N=27). • The Eurosystem: 11 countries made up the euro area when the euro was introduced in 1999. There are now 17 members, the newest being Estonia, Slovakia, Cyprus and Malta.

  11. How Does the Eurosystem Operate? • Objectives: • What is it trying to achieve? • Instruments: • What are the means available? • Strategy: • How is the system formulating its actions?

  12. Objectives • The Maastricht Treaty’s Art. 105.1: ‘The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community ‘ […].’ “In the pursuit of price stability, the ECB aims at maintaining inflation rates below, but close to, 2% over the medium term.” • Article 2. The objectives of European Union are a high level of employment and sustainable and non-inflationary growth.

  13. Scope ofmonetary policy ECB • Long-run neutrality of money • It is widely agreed that in the long run – after all adjustments in the economy have worked through – a change in the quantity of money in the economy will be reflected in a change in the general level of prices. But it will not induce permanent changes in real variables such as real output or unemployment. • This general principle, referred to as "the long-run neutrality of money", underlies all standard macroeconomic thinking. Real income or the level of employment are, in the long term, essentially determined by real factors, such as technology, population growth or the preferences of economic agents. • Inflation – a monetary phenomenon • In the long run a central bank can only contribute to raising the growth potential of the economy by maintaining an environment of stable prices. It cannot enhance economic growth by expanding the money supply or keeping short-term interest rates at a level inconsistent with price stability. It can only influence the general level of prices.

  14. Inflationrecord

  15. Instruments • The Euro OverNight Index Average (Eonia) is the overnight reference rate in the Euro zone

  16. Independence and Accountability • Arguments for central bank independence: • governments tend not to resist to the ‘printing press’ temptation • the Bundesbank has set an example. • But misbehaving governments are eventually punished by voters. • Independence removes central banks from such pressure. • A democratic deficit?

  17. Redressing the Democratic Deficit • In return for their independence, central banks must be held accountable: • to the public • to elected representatives. • Example: • the Bank of England is given an inflation target by the Chancellor. It is free to decide how to meet the target, but must explain its failures (the ‘letter’)

  18. Independence and Transparency