Directorate-General for Research WORKING PAPER Background to the €uro Economic Affairs Series ECON 130 EN Directorate-General for Research WORKING PAPER Background to the €uro BEN PATTERSON WITH ANTON JEVCAK AND MARIE -CLAUDE GROTTI Economic Affairs Series ECON 130 EN 10-2002 This study was requested by the European Parliament's committee on Economic and Monetary Affairs within the annual research programme This study is published in the following languages: DE, EN (original), FR. Authors: Ben Patterson with Anton Jevcak and Marie-Claude Grotti Responsible Official: Ben Patterson Division for Economic, Monetary and Budgetary Affairs Tel.: (352) 43 00-24114 Fax: (352) 43 00-27721 Email [email protected] Manuscript completed on 14 October 2002. Copies can be obtained through: Publications Office Tel.: (352) 43 00-24053/20347 Fax: (352) 43 00-27722 Email: [email protected] Further information on DG4 publications can be accessed through: www.europarl.eu.int/studies Luxembourg, European Parliament, 2002 ISBN 92-823-1690-4 The opinions expressed in this document are the sole responsability of the author and do not necessarily represent the official position of the European Parliament. Reproduction and translation for non-commercial purposes are authorised, provided the source is acknowledged and the publisher is given prior notice and sent a copy. © European Communities, 2002 Printed in Luxembourg BACKGROUND TO THE € CONTENTS A SHORT GLOSSARY...........................................................................................................................................6 I. THE THEORY OF CURRENCIES...................................................................................................................7 THE FUNCTIONS OF MONEY ...................................................................................................................................7 EXCHANGE RATES .................................................................................................................................................8 Alternative systems...........................................................................................................................................8 Volatility ...........................................................................................................................................................9 OPTIMUM CURRENCY AREAS ..............................................................................................................................10 Specialisation, Asymmetry and Interest Rates...............................................................................................10 THE LUCAS CRITIQUE ..........................................................................................................................................12 FISCAL POLICY .....................................................................................................................................................12 The aggregate fiscal stance............................................................................................................................14 Redistribution .................................................................................................................................................14 II. A BRIEF HISTORY OF EMU........................................................................................................................17 THE WERNER PLAN , THE SNAKE AND THE EMS .................................................................................................17 THE DELORS REPORT ...........................................................................................................................................18 THE MAASTRICHT PROCESS ................................................................................................................................20 Nominal convergence.....................................................................................................................................20 Real convergence ...........................................................................................................................................21 THE EVENTS OF 1992 AND 1993...........................................................................................................................22 THE ACHIEVEMENT OF EMU ...............................................................................................................................22 THE FIRST THREE YEARS ......................................................................................................................................24 THE INTRODUCTION OF € NOTES AND COINS ........................................................................................................27 Implementation of the changeover.................................................................................................................28 Evaluation of the changeover.........................................................................................................................30 THE PRICES ISSUE .................................................................................................................................................30 Prices: the outcome........................................................................................................................................33 III. FISCAL AND ECONOMIC POLICY: THE STABILITY AND GROWTH PACT .............................37 THE "EXCESSIVE DEFICITS " PROCEDURE ..............................................................................................................37 THE STABILITY PACT ...........................................................................................................................................38 THE PACT IN PRACTICE ........................................................................................................................................39 CRITICISMS AND INTERPRETATIONS ....................................................................................................................40 Automatic Fiscal Stabilisers ..........................................................................................................................41 Nominal or cyclically-adjusted deficits .........................................................................................................41 The effect on public investment......................................................................................................................43 Debt sustainability..........................................................................................................................................44 The Commission and ECOFIN response.......................................................................................................46 ECONOMIC POLICY CO -ORDINATION ....................................................................................................................47 IV. SOME FURTHER ISSUES............................................................................................................................51 INSTITUTIONAL ISSUES ........................................................................................................................................51 THE CONDUCT OF MONETARY POLICY ................................................................................................................52 Monetary or Inflation targets?.......................................................................................................................52 Accountability.................................................................................................................................................53 Transparency..................................................................................................................................................54 CROSS -BORDER PAYMENTS ..................................................................................................................................55 ASSET PRICES , CREDIT AND INVESTMENT ...........................................................................................................56 V. ENLARGEMENT OF THE EURO AREA ...................................................................................................59 DENMARK ............................................................................................................................................................59 SWEDEN ...............................................................................................................................................................60 THE UNITED KINGDOM ........................................................................................................................................61 THE APPLICANT COUNTRIES ................................................................................................................................62 THE CRITERIA FOR EU MEMBERSHIP ...................................................................................................................63 THE STATUS OF NEW MEMBER STATES IN RELATION TO EMU ..........................................................................63 3 PE 323.094 BACKGROUND TO THE € CRITERIA FOR PARTICIPATION IN EMU ...............................................................................................................64 The inflation