EMU 1.What is EMU? Acronym for Economic and Monetary Union 2. How Does it Work? All national currencies of member states convert into the EURO at an irrevocably fixed rate. The EURO will float freely against other main currencies (yen, $). National banknotes will cease to be legal on 1 July 2002. 3. What is the role of the ECB? The Governing Council of the European Central Bank (ECB) consists of six executive board members responsible for current business and the 11 ministers of the National Central banks. The ECB is responsible for the money supply in Euroland.
4. Does the EMU lead to a loss of sovereignty of its member states? A nation’s currency symbolizes national autonomy. Monetary policy is a powerful economic instrument, that has an impact on inflation, interest rates, governmental debt, short term unemployment, and economic cycle 5. What happens if the economic cycles in different EMU member states are out of synch? The exchange rate weapon is ruled out. There is no redistribution effect of federal taxes (For example: If one part of the U.S. moves into recession, its tax payments (linked to income and sales) will fall and federal benefit payments will rise). Adjustments in the EMU will have to take place through: - Relocation of workers - Relocation of businesses - Change of wages - Transfer payments between EMU member states
Greek Crisis 1. Timeline of the Crisis Greece joins currency union in 2001 No currency devaluation to counteract increasing ULC Domestic businesses are increasingly loosing competitiveness Low interest rates, low inflation, access to capoital markets Economic boom financed with cheap money Hay fire of cheap money is burnt out. Economy is not competitive
Increasing Loss of Competitiveness 2012 numbers: http://www.ecb.int/stats/exchange/hci/html/hci_ulct_2012-10.en.html
1. Timeline of the Crisis cont. Hay fire of cheap money is burnt out. Economy is not competitive Governmental spending to counteract increasing unemployment, low consumption, and failing companies Public debt explodes Investors slowly start to react and buy less Greek bonds and increasingly take out Credit Default Swaps to get insurance against default Price of bonds falls and interest rate increases. “Bad” speculators refuse to buy bonds despite skyrocketing interest rates. Price of Credit Default Swaps goes through the roof and markets start to freeze EU and IMF commit € 750 billion to bail Greece out. EZB buys bonds
2. Potential Solutions • Quasi Permanent Transfer Payments (Model East Germany) Greek economy does not become competitive. Long-term transfer payments (€ 60 billion per year?) are necessary to keep up the standard of living. • Structural Reforms This is the favorite model by European politicians. Debt relief coupled with severe structural reforms to make the Greek economy more competitive. This would lead to a drastic decrease of the standard of living for years to come.
2. Potential Solutions cont. • Exit the Currency Union Investors of Greek bonds get a haircut. New currency will be heavily devaluated. Access to international capital markets is obstructed. High interest rates. Drastic increase of import prices. Temporary decrease of standard of living. Danger of inflation. Economy becomes competitive. Exports, tourism, and production for domestic consumption increase. 4. ?