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7/28/2019 The European Monetary Union and the Current Debt Crisis
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The European monetary unionthe current debt crisis: developments, trends, policy responses
and future prospects1/23/2012
Prof. P. Aganidis
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The European monetary union and the current debt crisis: developments, trends, policy responses and
future prospects.
The idea of the European Monetary Union (EMU) did not start just a couple of years before the
introduction of the Euro. On the contrary, it existed as a vision since the 1960ies. In 1970 a committee
was set up, headed by Luxemburgs Prime Minister Pierre Werner, in order to figure out how the EMU
could be formed by 1980. Finally, the European Monetary System (EMS) was created in 1979 together
with the European Currency Unit (ECU) which was nothing more than the weighted average of all the
countries participating in the EMS. This was one of the step stones into looking further into how a
monetary union could also be achieved. In December 1991 the Maastricht convergence criteria were
agreed upon, namely: a) inflation rate no higher than 1.5%, b) maximum percentages on government
deficit (3%) and debt (60%), c) members of the EMS and the exchange rate mechanism for at least two
years and d) interest rates no higher than 2%. In 1998 the European Central Bank is created and on
January 1999 the Euro is introduced into the Central Bank system (in a non-physical form). This is when
the European Union further established itself as a new global player. The new Euro coins and notes were
introduced on January 1st 2002 .1
The creation of a common currency signified the beginning of a unified monetary policy for the
participating countries. By joining the Euro a country is privy to many advantages but also
disadvantages. The elimination of currency exchange rate costs is greatly advantageous to businesses
since they do no longer face the risk of exchange rate fluctuation, thus making investments much easier
for them. With price transparency businesses can become more competitive and consumers can
compare prices of products across the countries of the euro-zone. The common currency also provided a
1ECFIN
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boost to tourism since crossing the border does no longer mean incurring the cost of exchanging
currency. Combining all of the above, it is apparent that the Euro is a currency strong enough to
compete against the US dollar and the Japanese Yen. Currently, the Euro-zone, with population of 331.9
million2 people, is the area with the largest population that has a common currency, closely followed by
the US and the dollar with a population of 312.8 million3 and Japan with 127.08 million4. The Euro is a
new hard currency with high bargaining power.
However, the main disadvantage of the common currency is that the countries participating had to
give up control of their monetary policy. Adjusting ones interest rate in order to attract investments, for
instance, is no longer an option since interest rates are set by the European Central Bank. Needless to
say, devaluating ones currency in order to adjust the exchange rate is out of the question. Apart from
the common monetary policy, the control of over the individual countries fiscal po licy imposed by the
Stability and Growth Pact5
makes it more difficult for governments to be flexible with their budgets
when they need to spend money in order to overcome economic difficulties (feed their economy with
money through government spending in order to encourage spending). Governments have no longer in
their policy toolkit any stabilization tools resulting in weak economic governanance.
But did we, with the creation of the European Monetary Union, forget the goal of political
integration? A year before the creation of the European Central Bank, in 1997, Giscard d Estaing and
Helmut Schmidt were quoted saying in the International Herald Tribune: One must never forget that
monetary union, which the two of us were the first to propose more than a decade ago is ultimately a
political project. It aims to give a new impulse to the historic movement towards union of the European
states. Monetary union is a federative project that needs to be accompanied and followed by other
2TGM
3US & World Population Clock
4Japan
5ECFIN
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steps.6Europes Monetary Union is something that aims to bring the members of the EU a step closer
to their political union. A future common fiscal policy (which seems to be becoming more and more
likely) will bring the countries even closer to this goal. A common currency means giving up part of the
member-countries national sovereignty. In order to achieve political convergence the EU nations will
need to give up an even bigger part of their national sovereignty. In a matter of speaking, the monetary
union is preparing the EU countries for giving up a greater part of their sovereignty in the future.
The last couple of years though, things do not seem that optimistic. The European Monetary Union
has been lately facing maybe its biggest crisis of all times. It is not only the biggest but a unique crisis,
since it is sort of a triple crisis because it is financial (banks), economic (affects GDP and
unemployment) and debt (inability to refinance a countrys debt). There have been hints of a debt crisis
since 2009, maybe as early as September 2008 when the Irish government announced its first recession
since the 80ies.7
Then followed Greece in 2009 with its inability to be consistent with its debt
obligations, because of increased government spending. And things followed from there like a domino
effect. Next up was Portugal with its own sovereign debt crisis. Things are bound to go south in other
European countries as well. Italy, a member of G8 and G30 has been facing problems since the mid of
2011. There is a problem and it seems to be quickly spreading and affecting not only the smaller
countries of the European Union, but also countries such as France. (Figures 2, 3, 4) Was Henry Kissinger
right in saying in The Sun in 1998 that It is difficult to see how monetary union can succeed?8 Is the
contagious effect of the current debt crisis going to bring the European Monetary Union to its knees?
It might not have a devastating effect on the EMU but it will certainly bring many changes to the
countries individually and the European Union itself. We have been observing that in Greece and Italy
there has a been a new type of governance with interim presidents and prime ministers in order for
6Excerpt
7CSO
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measures against the current debt crisis to be enforced. Appointing a prime minister without election in
democratic states was unheard of before the current situation. Another change is that through loans
and other types of financial aid from third parties, such as the International Monetary Fund, countries
are bound by contracts to form their policies according to guidelines named in said contracts. In
essence, there is a direct involvement of third parties (whether they are countries or international
organizations) in the governance of sovereign nations. Apart from the changes that have taken place
affecting individual countries the current debt crisis is bound to have a profound effect on the structure
of the European Union itself as well as the laws and policies governing it. There have been talks and
rumors about the creation of a multi-speed Europe or two-speed Europe, namely the northern and
the southern members of the EU, based on the strength of their economies.
Apart from the political part of the EU, the structure of the Europes monetary union will most likely
change. Having a common monetary policy (which as mentioned before severely limits state members
reactions to crises such as the current one) which is has proven to be highly rigid and unable to react to
the debt crisis, accentuates the need of a common fiscal policy too. Since such a change cannot happen
overnight though, the first crucial step would be to strictly enforce the Stability and Growth Pact
according to which budget deficits need to be less than 3% and debt should not exceed 60% of GDP.
Even though the Pact exists a big number of countries (Figure 2) does not abide by it and there have
been no consequences. Strict enforcement of the Stability Growth Pact, together with some
complimentary rules and regulations, could eventually bring the European Union closer to a common
fiscal policy. As it was previously mentioned the convergence of the EU member states on both financial
and monetary policies will eventually bring political integration.
The current debt crisis is now said to be of equal magnitude with that of 1932. Still, nobody was
prepared for such a shock of such magnitude in the European economy and consequently there was an
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absence of any defense mechanism to prevent such an occurrence or of support system in order to aid
countries of the European Union found in such a situation. The first signs of structuring such systems
were seen when the debt crisis in Greece took place. Even though it took some experimentation, it
seems that there is currently a clearer picture on what needs to be done in the future in cases like the
one we are currently facing. It is certain that in the near future safeguards will be put into place in order
to avoid future occurrences of the same issue, through regulatory reforms.
Unfortunately, it seems that such a debt crisis was needed in order to undermine the architecture of
European Monetary Union and bring forward both short- and long-term changes in the European Union
and European Monetary Union. It is certain that Europe will come out stronger out of this situation. In
the same manner that diamonds are formed in areas of immense temperature and pressure, will the
member states of Europe and the European Union itself come out unified and become an even more
formidable player in the worldwide economic and political scene.
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Appendix
Figure 1
Which countries have adopted the euro and when?
1999Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the
Netherlands, Austria, Portugal and Finland
2001 Greece
2002 Introduction of euro banknotes and coins
2007 Slovenia
2008 Cyprus, Malta
2009 Slovakia
2011 Estonia
Source:http://ec.europa.eu/economy_finance/euro/index_en.htm9
9
ECFIN
http://ec.europa.eu/economy_finance/euro/index_en.htmhttp://ec.europa.eu/economy_finance/euro/index_en.htmhttp://ec.europa.eu/economy_finance/euro/index_en.htmhttp://ec.europa.eu/economy_finance/euro/index_en.htm7/28/2019 The European Monetary Union and the Current Debt Crisis
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Figure 2
General Government Deficit (-) / Surplus (+), % General Government Gross Debt, %
2004 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 201
Belgium -0.3 -2.7 0.1 -0.3 -1.3 -5.8 -4.1 94.0 92.0 88.0 84.1 89.3 95.9 96.
Germany -3.8 -3.3 -1.6 0.2 -0.1 -3.2 -4.3 66.3 68.6 68.1 65.2 66.7 74.4 83.
Ireland 1.4 1.7 2.9 0.1 -7.3 -14.2 -31.3 29.4 27.2 24.7 24.8 44.2 65.2 92.
Spain -0.1 1.3 2.4 1.9 -4.5 -11.2 -9.3 46.3 43.1 39.6 36.2 40.1 53.8 61.
France -3.6 -2.9 -2.3 -2.7 -3.3 -7.5 -7.1 64.9 66.4 63.7 64.2 68.2 79.0 82.
Italy -3.5 -4.4 -3.4 -1.6 -2.7 -5.4 -4.6 103.4 105.4 106.1 103.1 105.8 115.5 118
Luxemburg -1.1 0.0 1.4 3.7 3.0 -0.9 -1.1 6.3 6.1 6.7 6.7 13.7 14.8 19.
Netherlands -1.7 -0.3 0.5 0.2 0.5 -5.6 -5.1 52.4 51.8 47.4 45.3 58.5 60.8 62.
Austria -4.4 -1.7 -1.5 -0.9 -0.9 -4.1 -4.4 64.7 64.2 62.3 60.2 63.8 69.5 71.
Portugal -3.4 -5.9 -4.1 -3.1 -3.6 -10.1 -9.8 57.6 62.8 63.9 68.3 71.6 83.0 93.
Finland 2.5 2.8 4.1 5.3 4.3 -2.5 -2.5 44.4 41.7 39.6 35.2 33.9 43.3 48.Greece -7.5 -5.2 -5.7 -6.5 -9.8 -15.8 -10.6 98.6 100.0 106.1 107.4 113.0 129.3 144
Cyprus -4.1 -2.4 -1.2 3.5 0.9 -6.1 -5.3 70.9 69.4 64.7 58.8 48.9 58.5 61.
Malta -4.7 -2.9 -2.8 -2.4 -4.6 -3.7 -3.6 71.7 69.7 64.1 62.1 62.2 67.8 69.
Slovakia -2.4 -2.8 -3.2 -1.8 -2.1 -8.0 -7.7 41.5 34.2 30.5 29.6 27.8 35.5 41.
Estonia 1.6 1.6 2.5 2.4 -2.9 -2.0 0.2 5.0 4.6 4.4 3.7 4.5 7.2 6.7
Source : Eurostat Statistical- 2012 Edition Eurostat European Commission
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Figure 3
-35 -30 -25 -20 -15 -10 -5 0 5 10
2004
2005
2006
2007
2008
2009
2010
General Government Deficit (-) / Surplus (+), %
Estonia Slovakia Malta Cyprus Greece Finland Portugal Austria
Netherlands Luxemburg Italy France Spain Ireland Germany Belgium
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Figure 4
0 20 40 60 80 100 120 140 160
2004
2005
2006
2007
2008
2009
2010
General Government Gross Debt, %
Estonia Slovakia Malta Cyprus Greece Finland Portugal Austria
Netherlands Luxemburg Italy France Spain Ireland Germany Belgium
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