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Failure and success of single currency

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josh passantino

on 18 November 2012

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Transcript of Failure and success of single currency

FAILURES OF THE URO Critically discuss whether the Single Currency (Euro) can be regarded as a ‘success’ to date or not. Alli Sarfo
Iva Ilieva
Josh Passantino
Katariina Hedman
Tommy Grossi The First nine years Established by the provisions of the Maastricht treaty
Came into existence 1st January 1999
By 2002 notes and coins began to circulate

Several economic goals: Macroeconomic stability
Growth and Jobs
Cohesion and convergence Increasing stability and Growth Inflation rates came down substantially

(bulk of the disinflation in the Euro Area occurred in the 1990s as a result of the efforts to meet the Maastricht inflation criteria)

Average inflation has been broadly on a par with the ECB’s benchmark of price stability of close to but below 2%

No member country has enjoyed such a long period of low inflation since WW2 Integrating Financial markets Financial capital is easily transferred from countries

External surplus to those with a deficit and there are more opportunities for international risk sharing

Interest rates on inter-bank deposits and derivative contracts across the Euro Area converged fully on the benchmark Euribor and Eonia rates

Process of sustained convergence in yields on bonds issued by the Euro Area Member States Increased Intra-EU Trade & FDI Growth in job figures

creation of 16 million jobs

unemployment rate plummeting from 9 per cent in 1999 to 7 per cent in 2008

(unlikely that job gains would have been as impressive under the more volatile monetary conditions and fiscal instability that used to prevail under the previous system) First 9 years of the euro => little progress towards sound public finances “Almost as soon as the euro had been introduced, consolidation fatigue set in” (ECB, 2004)

Euro currency lacks the ability to manage shocks that hit different parts of the euro area economy differently Economic Stability and Growth Debt and deficit No effective checking system in place and as a result, sovereign debt crisis in the euro have centered around problems with spending and inaccurately reported government finances; Greece for example (Shambaugh, 2012)

Deficit -> Cyclical low of 1% of GDP in 2000 and 3% in 2003 (Schuknecht, et al 2011) THE FIGURES Price Convergence The bulk of price convergence took place in the early 1990s, little evidence that the introduction of the single currency has led to a further price convergence The introduction of the euro has not had a noticeable price convergence impact If anything, prices have diverged since then

The results raise doubts as to whether any significant aggregate effect can have occurred at all Only few instances in which the introduction of the euro can be associated with price level convergence, such as cars and alcohol

The lower/decreasing dispersion of prices for alcohol may be related to the harmonization efforts at the EU level (i.e. minimum taxation on alcoholic beverages or cigarettes) and the low price elasticity of these items Analysis of Price Convergence in the EU Reasons
Most product market integration took place in early 1990s, no second convergence wave was to be expected.

Other factors continue to hamper market integration and dominate the euro effects (sales taxes, price regulation, transportation costs)

Structural policies expected to induce price level convergence in the long run may even increase price dispersion in the short-medium run CASE STUDY: GREECE AND IRELAND Bet on bank loans Masked its debt problem What exacerbated the problems?

Inflexible economies were not able to become more competitive by currency devaluation

Not keeping up with the established Maastricht treaty regulations

Wrong assumptions: public debt risk believed to be equal Greece and Ireland:
Entering the Eurozone Greece: a downward spiral of
excess government spending
Booming economy before the crisis; heavy spending on the public sector
Low-interest rates; access to long-term borrowing
Economic growth of 4%

Government spending reached 50.4% of GDP Government revenue was less than 37% of GDP
The two existing problems exacerbated: Out of control government borrowing Long-term economic weakness

The first outlier in the EU: 115% public-debt to GDP ratio/ 14 % deficit
European Stabilisation Mechanism (ESM): €80bn were provided to Greece with €30bn additional aid from the IMF Outcome CRISIS PRE- 2008 Ireland: the burst
construction bubble One of the top economies in Europe

Irish banks pumped vast amounts of money into a property bubble PRE 2008 CRISIS OUTCOME End of 2010, the Irish government officially requested assistance from the ECB and the IMF

Up to €50bn in fiscal needs and up to €35bn in banking support measures Case Study: Two failures (why it went wrong) EARLY
Successes of the uro Jobs? THE FIRST NINE YEARS Established by the provisions of the Maastricht treaty

Came into existence 1st January 1999

By 2002 notes and coins began to circulate

Several Economic Goals : Macroeconomic Stability
Growth and Jobs
Cohesion and Convergence Sources (Buti & Van den Noord 2009) CONVERGENCE EU PRICES Removing trade barriers facilitates access to products across national borders
(physical introduction of the euro in 2002 that price differences became clearly visible, enhancing both competition and goods arbitrage)

Harmonization of regulation and taxation has gradually reduced the cost of doing business in other EU member countries

Eliminating exchange rate uncertainty

Firms outside the euro area may increasingly tend to set common prices for the entire euro area Substantial differences in the extent of the increase in Intra-EU trade

Three main Issues:
1) Rate of country engagement intrade and investment relations with the other countries is different in the individual states

2) The common currency caused trade or trade caused the common currency?

3) Need to control for differences between euro and non-euro countries that could cause different effects on trade that are unrelated to the euro Debate Over the Extent of the Increase in Intra-EU Trade & FDI A comparison (Cuaresma 2007) Debate Over the Extent of the Increase in Intra-EU Trade & FDI Several reasons to explain this lack of further convergence after Euro introduction: Ireland experienced the crisis much like the United States

Higher prices and low cost of borrowing increased the level of indebted homeowners THE FUTURE
Economist Robert Barro and Harvard professor Martin Feldstein declare that ‘the euro was a noble experiment, but it has failed.’

Philip Lane, an influential Irish economist, sees ‘a ray of hope’ in the euro's trials and says that ‘what does not kill you often makes you stronger’ (as quoted in the New York Times, 31 December 2009.) The Future of the Euro
Why it can’t succeed:

In the absence of a genuine political federation – which no one expects any time soon, if ever – the euro will remain a flawed, imperfectly governed construct

Why it can’t fail:

Europe's deep political commitment to the euro's survival may be underestimated. Government leaders know how dangerous a monetary breakup would be for their broader commitment to continent-wide integration, which continues to be seen as essential to peace in the region.


Cohen, B., 2012 The Future of the Euro A policy agenda to meet long term goals is built on three pillars:
Broader and deeper policy coordination and surveillance

A stronger international role for the Euro Area

More effective governance

-->Importance for new countries joining The Future of the Euro

The euro remains a hard currency; a hard core remains consisting of Germany, the Netherlands, Austria, Luxembourg and perhaps a few others

The euro becomes a soft currency, and Germany and others would abandon the common currency because the euro zone would develop into a transfer union, involving payments among members

“United States of Europe?” The economic and political problems are certainly solvable, with a huge step toward greater European integration

Austerity: Greece will not be released from its painful austerity measures, but terms will be relaxed enough to stave off possible secession

. The Future of the Euro: Different Scenarios "Member states would be economically better off if they had never joined. European monetary union was generally mis-sold to the population of Europe" UBS's Stephane Deo, Paul Donovan, and Larry Hatheway
Cohen, B., 2012.
Green European Foundation, 2012. Berger, H., Nitsch, V., 2005. Zooming out: the trade effect of the euro in historical perspective. CESifo Working Paper. no.1435. Munich.

Buti, M., Van den Noord, P., 2009. The Euro: Past successes and new challenges. National Institute Economic Review, [database] 208, p.68-96. Available through: University of Kent Library website <http://www.kent.ac.uk/library/> [Accessed 21/10/12]


Cohen, B., 2012. The Future of the Euro: Let’s Get Real. Review of International Political Economy, [database] 19 (4), p.689-700. Available through: University of Kent Library website <http://www.kent.ac.uk/library/> [Accessed 21/10/12]

Coy, P. 2012. The Failure of the Euro Experiment in Two Charts, [online] Available at: <http://www.businessweek.com/articles/2012-04-24/the-failure-of-the-euro-experiment-in-two-charts> [Accessed 5/11/2012]

Fischer, C. 2012. Price convergence in the EMU? Evidence from micro data. European Economic Review 56 pp. 757-776

Flam, H., 2009. The Impact of the Euro on International Trade and Investment: A Survey of Theoretical and Empirical Evidence. Swedish Institute for European Policy Studies, [database] 8, p.10-41. Available through: University of Kent Library website <https://moodle.kent.ac.uk/moodle/mod/resource/view.php?id=71928> [Accessed 31/10/12].

Green European Foundation. 2012. The future of the euro – can the common currency be salvaged? [online] Available at:<http://gef.eu/future/the-future-of-the-euro-can-the-common-currency-be-salvaged/> [Accessed 05/11/12].

Hallett, A.H., von Hagen, J. 2004. Study Finds Lack of Market Flexibility Has Undermined Stability and Growth Pact, [online] Available at: <http://www.cepr.org/press/p166.htm> [Accessed 6/11/12]

Schuknecht, L., Moutot, P., Rother, P., Stark, J. 2011. The stability and growth pact: crisis and reform. ECB paper series. Frankfurt, Germany.

Shambaugh, J. C. 2012. The Euro’s Three Crises Brookings Papers on Economic Activity. Georgetown, Washington.

Spiegel Online, 2011. A possible Scenario for the End of the Euro. [online] Available at: <http://www.spiegel.de/international/europe/uncommon-currency-a-possible-scenario-for-the-end-of-the-euro-a-790352.html> [Accessed 01/11/12].

Taylor, S. 2011. Financial Crisis in the European Union: The cases of Greece and Ireland, Bachelot Thesis, Virgina State University

Weisenthal, J. 2011. UBS Declares "The Euro Should Not Exist" In A Monster Report On The Odds Of An EU Breakup, [online] Available at: <http://articles.businessinsider.com/2011insider> [Accessed 6/11/2012] Effect of the euro in historical perspective. CESifo Working Paper. no.1435. Munich.

Buti, M., Van den Noord, P., 2009. The Euro: Past successes and new challenges. National Institute Economic Review, [database] 208, p.68-96. Available through: University of Kent Library website <http://www.kent.ac.uk/library/> [Accessed 21/10/12]


Cohen, B., 2012. The Future of the Euro: Let’s Get Real. Review of International Political Economy, [database] 19 (4), p.689-700. Available through: University of Kent Library website <http://www.kent.ac.uk/library/> [Accessed 21/10/12]

Coy, P. 2012. The Failure of the Euro Experiment in Two Charts, [online] Available at: <http://www.businessweek.com/articles/2012-04-24/the-failure-of-the-euro-experiment-in-two-charts> [Accessed 5/11/2012]

Cuaresma, J. 2007. "Price Level Convergence in Europe: Did the Introduction of the Euro Matter?" Available through: University of Kent Moodle site: https://moodle.kent.ac.uk/moodle/mod/resource/view.php?id=71976 (Accessed 5/11/2012)


The Economist (2011) Bailing out the bail-out. Available at http://www.economist.com/blogs/charlemagne/2011/05/greece_and_euro, Accessed on 6 November 2012

The Economist (2010) A Very European Crisis. Available at http://www.economist.com/node/15452594?story_id=15452594, Accessed on 7 November 2012

Fischer, C. 2012. Price convergence in the EMU? Evidence from micro data. European Economic Review 56 pp. 757-776 Flam, H., 2009. The Impact of the Euro on International Trade and Investment: A Survey of Theoretical and Empirical Evidence. Swedish Institute for European Policy Studies, [database] 8, p.10-41. Available through: University of Kent Library website <https://moodle.kent.ac.uk/moodle/mod/resource/view.php?id=71928> [Accessed 31/10/12].

Green European Foundation. 2012. The future of the euro – can the common currency be salvaged? [online] Available at:<http://gef.eu/future/the-future-of-the-euro-can-the-common-currency-be-salvaged/> [Accessed 05/11/12].

Hallett, A.H., von Hagen, J. 2004. Study Finds Lack of Market Flexibility Has Undermined Stability and Growth Pact, [online] Available at: <http://www.cepr.org/press/p166.htm> [Accessed 6/11/12]

Schuknecht, L., Moutot, P., Rother, P., Stark, J. 2011. The stability and growth pact: crisis and reform. ECB paper series. Frankfurt, Germany.

Shambaugh, J. C. 2012. The Euro’s Three Crises Brookings Papers on Economic Activity. Georgetown, Washington. Spiegel Online, 2011. A possible Scenario for the End of the Euro. [online] Available at: <http://www.spiegel.de/international/europe/uncommon-currency-a-possible-scenario-for-the-end-of-the-euro-a-790352.html> [Accessed 01/11/12].

Taylor, S. 2011. Financial Crisis in the European Union: The cases of Greece and Ireland, Bachelot Thesis, Virgina State University

Weisenthal, J. 2011. UBS Declares "The Euro Should Not Exist" In A Monster Report On The Odds Of An EU Breakup, [online] Available at: <http://articles.businessinsider.com/2011insider> [Accessed 6/11/2012] Spiegel Online, 2011 Cohen, B., 2012.
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