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Analysis of Convergence in the Economic and Monetary Union

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Analysis of Convergence in the Economic and Monetary Union Sofia University „St. Kliment Ohridski“ Faculty of Economics and Business Administration Department: „Industrial Economics and Management“ ANALYSIS OF CONVERGENCE IN THE ECONOMIC AND MONETARY UNION Seventh Annual Academic Contest "Dr. Ivanka Petkova" Prepared by: Magdalena Vlahova-Veleva SOFIA 2018 Contents List of figures ______________________________________________________________ 2 List of tables _______________________________________________________________ 2 Abbreviations ______________________________________________________________ 2 1. Introduction ___________________________________________________________ 3 2. Relevance of the subject _________________________________________________ 3 3. Research question ______________________________________________________ 3 4. Research methodology ___________________________________________________ 3 5. Economic and Monetary Union ___________________________________________ 4 6. Maastricht criteria ______________________________________________________ 4 7. Advantages and disadvantages of adopting the euro __________________________ 6 8. Overview of the criteria __________________________________________________ 6 9. Bulgaria ______________________________________________________________ 12 10. VAR model ___________________________________________________________ 15 11. Conclusion ____________________________________________________________ 18 References ________________________________________________________________ 19 1 List of figures Figure 1 Maastricht Criteria - European Union ......................................................................... 7 Figure 2 Balance and Debt- EU-28, 2017 .................................................................................. 9 Figure 3 EMU criterion and debt ............................................................................................... 9 Figure 4 Debt and deficit clusters, 2016 .................................................................................. 10 Figure 5 HICP .......................................................................................................................... 11 Figure 6 Corrplot ...................................................................................................................... 12 Figure 7 EU, EA, Bulgaria ....................................................................................................... 14 Figure 8 Bulgaria, Lithuania and Greece ................................................................................. 15 Figure 9 Impulse response function ......................................................................................... 17 List of tables Table 1 Maastricht Criteria ........................................................................................................ 5 Table 2 Criteria – EU overview ................................................................................................. 7 Table 3 Criteria overview and member states ............................................................................ 8 Table 4 ERM II and introducing the euro ................................................................................ 10 Table 5 Correlation ................................................................................................................... 12 Abbreviations BDIF Bulgarian Deposit Insurance Fund EA Euro area EC European Commission ECB European Central Bank EMU Economic and Monetary Union ERM II Exchange Rate Mechanism II ESCB European System of Central Banks ESM European Stability Mechanism EU European Union GDP Gross Domestic Product HICP Harmonised Indices of Consumer Prices VAR Vector AutoRegression model 2 1. Introduction The analysis examines the interaction between the macroeconomic indicators of the European Union member states and the dynamics of the government securities as well as the other convergence criteria. The report begins with an introduction of the concept of Economic and Monetary Union in Europe. Followed by a presentation of the Maastricht convergence criteria, which each Member State of the European Union should meet in order to join the Eurozone. An overview of the values of these criteria is made: price stability, sound and sustainable public finances, exchange rate stability, long-term interest rates for the period 2006-2017. Data on Bulgaria and their compliance with the benchmarks are considered. 2. Relevance of the subject The relevance of the subject of the report is determined by the diverse concepts of deepening the economic and monetary union (EMU). The reinforcement of EMU remains one of the European Commission's key priorities for restoring a strong and stable European financial system since the start of the global financial crisis in 2008. Currently, there is an ongoing work on strengthening the structure of EMU, allowing a faster and more resolute response to future challenges. Various initiatives on this subject were presented on 6 December 2017. In 2018, they are expected to be considered and tangible steps in this direction are expected to be taken. The overall objective is to improve the unity, efficiency and democratic accountability of the Economic and Monetary Union in Europe by 2025. The Eurogroup meeting held on 12 July 2018 presented a roadmap for the accession of Bulgaria and any future candidate country to the Eurozone. Furthermore, the concept of convergence is of particular importance in the context of the European Union and the euro area. A key idea of the project are the so-called Maastricht criteria and whether the Member States cover them. Applying the relevant reference values for Bulgaria also strengthens the importance of the chosen topic, due to the fact that the country is targeting a recent adoption of the single European currency - the euro. Full membership in the European Union also implies joining the Eurozone when the country meets the relevant criteria. The need for sound economic policies, however, does not end with the adoption of the euro. The dynamic events in Europe over the past few decades have put the issue of completing EMU, creating new institutions and rules on the agenda. 3. Research question The analysis studies the degree of meeting the Maastricht criteria, if members states or groups of countries are compliant or not, and to which appertains Bulgaria. Moreover, the study analyses the relationshiops between the four convergence criteria. 4. Research methodology The research methodology in the report is based on generally accepted research methods, which are characteristic of the realization of reasoned results. In addition, the research question was explored by applying econometric methods. Statistical information is processed through software products: Microsoft Excel and R Studio. The interrelations between the indicators are analyzed. A VAR model is used to investigate the linear dynamic interdependencies of the variables. The empirical model 3 examines whether inflation, budget deficit and government debt have any explanatory effects on long-term interest rates (yield on government securities) in member states. 5. Economic and Monetary Union Currently, 28 countries are part of the European Union (EU), with some consolidating their integration by adopting a single European currency - the euro. This latter is called the Eurozone, consisting of 19 Member States1. As members of the EU, the other nine countries have committed to introducing the euro (with the exception of Denmark and the UK, the EU Treaties foresee "opt-out" clauses for them2) and are called "member states with a derogation". The Economic and Monetary Union (EMU) draws in a common monetary policy, the coordination of economic and fiscal policies and the euro – the common currency. Initially, the euro was introduced as an accounting currency for cash payments in 1999 and in 2002 as real banknotes and coins. According to Eun and Resnick (2012), the euro must be seen as a product of historical development towards the ever-deepening integration of Europe, beginning with the creation of the European Economic Community in 1958. The euro was founded with the aim of reviving European countries and to achieve closer economic integration leading to faster economic growth and guaranteeing a peaceful Europe (Stiglitz, 2016). The first ten years of EMU creation are characterized by low inflation and moderate economic growth (Papademos, 2008). Participation in EMU is considered a common insurance condition for all its members (European Commission, 2008). All countries must meet the same criteria and be assessed in the same way - "the principle of equal treatment" (Stark, 2008). 6. Maastricht criteria To join the euro area, EU Member States need to comply with the convergence criteria laid down in the Maastricht Treaty3 of 1992. These economic and legal conditions ensure that the individual member state is ready to join the euro area, without creating risks for the economy of the country itself, but also for the euro area as a whole. In order to monitor the process of convergence of economic dynamics in the member states related to the European Monetary System (EMS), the European Commission and the European Central Bank monitor the Maastricht criteria (Gerunov, 2016). These convergence criteria have the following economic purposes: price stability, sound and sustainable public finances, exchange rate stability and long-term interest rates. There is also a legal convergence whereby the candidate country must ensure that its national laws regulate
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