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Why is this Communication and Report released now?
May 2008 marks ten years since Europe's leaders took the political decisions to move ahead with stage III of EMU, i.e. the creation of the euro, on 1 January 1999, in a first wave of eleven countries.
What is EMU?
EMU, or Economic and Monetary Union, is the official name for the process of monetary unification in Europe. It includes three stages: I – freedom of capital movement (achieved in 1990): II – Establishment of a European Monetary Institute (the predecessor of the European Central Bank), legal convergence and increased monetary policy cooperation (1994); III – irrevocable fixing of the conversion rates against the single currency (1999 for a first group of 11 countries). The Maastricht Treaty in 1992 established a number of nominal convergence ("Maastricht") criteria with regard to price stability, public finances, exchange rate stability and long-term interest rates that countries must comply with before they can adopt the euro. At present 15 EU countries participate in the euro area (Greece joined in 2001, Slovenia in 2007 and Cyprus and Malta in 2008). If approved by the Council of EU finance ministers, Slovakia will become the 16th member in 2009.
How does EMU work?
Under the EU Treaty, Member States are required to "regard their economic policies as a matter of common concern and shall coordinate them within the Council" (Articles 98 and 99). This coordination is ensured, through a variety of instruments, by the Commission and the Council of EU finance ministers (ECOFIN). Increasingly important is the Eurogroup that came into being in June 1998 and which will be given formal recognition in the upcoming Lisbon Treaty. The Eurogroup brings together the euro area finance ministers to discuss issues related to the single currency and policy coordination in the euro area. It has a stable president since 2005 (Jean-Claude Juncker, Prime-Minister and Finance Minister of Luxembourg). The Commission and the European Central Bank (ECB) take part in Eurogroup meetings.
The euro area has one currency with one monetary policy entrusted to an independent, centralised, decision making body. The ECB and the central banks of all EU Member States form the European System of Central Banks (ESCB). Decisions on monetary policy in the euro area are taken by the Governing Council of the ECB, which comprises the governors of the national central banks of those Member States that have adopted the euro and the members of the Executive Board of the ECB.
What was the rationale behind the creation of EMU?
The euro is a political project as much as an economic one. The main economic motivations were to provide macro-economic stability, putting an end to currency crisis, and to complete the single market launched in 1992. This, in turn, was expected to increase growth and jobs thanks to a reduction of transaction costs and risks that would boost intra-area trade and finance and this has indeed happened although the record can and must be improved with regard to growth.
How did EMU perform in its first decade?
EMU has succeeded in its core mission of securing macro-economic stability, by delivering low and stable inflation to euro area countries. It has led to lower interest rates, boosted trade, investment and financial market integration, fostered huge job creation and seen an increase in fiscal discipline as euro-area budget deficits have decreased. However, output and productivity growth have not been as strong as hoped. More progress on structural reforms is needed to further improve the euro area's economic performance and increase its capacity to respond to adverse economic developments.
Has economic growth really been weak in the euro area and, if so, why?
Economic growth has on average been around 2 per cent per year since the inception of the single currency, broadly the same rate as in the 10 preceding years. Extensive research yields overwhelming evidence that the single currency has strongly stimulated trade, investment (including foreign direct investment), better functioning financial markets, stability and growth. In fact, most of the smaller countries have fared remarkably well, also in comparison with their non-EMU neighbours. But at the same time growth has been weak in countries where structural reforms in product and labour markets have been lagging. Such slow pace of reform perhaps reflects the fact that the single currency has provided a shield against adverse shocks, which generally act as a stimulus to reform. This paradox can only be resolved by strengthening the co-ordination of structural reform in the euro area – one of the key recommendations in the EMU@10 Communication and Report.
What challenges is EMU likely to face in the next decade?
The euro area is set to expand further in the coming decade as more EU Member States adopt the euro. This heightens the need for further progress on structural reforms to ensure that all countries in a larger and more diverse euro area can adapt to economic developments and raise their growth and productivity performance. The report also highlights several major trends that EMU must face. Ongoing globalisation can stimulate efficiency in the production processes, reduce prices through greater competition and enhance consumer choice. However, less-efficient sectors of the euro-area economy need to continue to adapt to the external pressures. Population ageing will also kick in as the "baby boom" generation born after the Second World War moves into retirement. The relative size of the working age population will decrease markedly and, without policy changes, social welfare costs are likely to rise at the same time that potential output is falling. Finally, food and energy supply constraints and climate change issues are already causing price rises in the food and fuel sectors. Without an adequate policy response they could imply further inflationary pressures and thereby cause particular problems for the poorest in society who are disproportionately affected by increases in the price of essential goods.
What are the policy avenues proposed by the Communication and report ?
The proposed policy agenda is based on three pillars, which concern domestic, international and governance issues.
Other more general questions
What are the main benefits of the euro?
Many citizens believe the euro has increased prices, is this true?
We are aware of this perception but that's simply not borne out by the facts. Notwithstanding the recent spurt in inflation caused by soaring global food and energy prices, inflation had never been so low in so many countries and for such a long period of time! During the first decade of EMU it fell to around 2% from 8 to 10% in the 1970s and 1980s on average.
The changeover process in 2002 and more recently, when Slovenia, Malta and Cyprus became members of the euro area is estimated to have increased prices by an additional 0.1 to 0.3 percentage points, according to national statistics offices and Eurostat. To keeps things in perspective, this means an additional increase of thirty euro cents to the annual increase of about €2on a €100 basket of purchases!
If not true, how do you explain this negative perception?
Many economists and national central banks have tried to come up with an answer and, although there is no single or very clear response, a number of factors appear to have played a role:
How is inflation measured?
Typically every citizen consumes a number of articles partly daily and partly on a less frequent basis (weekly, monthly or even annually). This includes different goods such as food and beverages, clothing, furniture, electronic articles (like TV sets, telephones and computer), cars etc. It also includes services like hair-cutting, cafés, financial services, rent, holidays etc. It is the role of national statistical authorities to determine the consumption behaviour and pattern of citizens and establish so-called consumption baskets. Such baskets are updated regularly to reflect new products (e.g. flat screen TVs did not exist 20 years ago) or quality improvements (e.g. cars and computer today perform very much different from 3 or 5 years ago). The prices of these baskets are checked every month to calculate increases/decreases from one month to the other and from the year before. .
As a citizen should I worry about the strong euro?
Yes and no. First of all, from a trade point of view let's remember that although the euro-dollar is the most traded currency pair in the world's foreign exchange markets, more than half of the euro area trade is carried out within the euro area itself (in 2007, for example, more than 60% of French exports went to Germany). On top of this, the main external export market for the euro area is the United Kingdom and only afterwards the United States, followed by China and Switzerland. So although there is concern about the current exchange rate of the euro and sharp currency fluctuations it is better to compare against the basket of currencies of our main trading partners.
The euro's appreciation is also a sign of the relative strength of the euro-area economy compared to that of the other trading partners, in particular of the United States. The euro area has no external or internal imbalances – at 0.6% in 2007, its average public deficit was the lowest in decades; the current account position is also in balance.
For the consumer a strong euro provides a shield against the global surge in energy and food prices which are still largely denominated in dollars. It increases the terms of trade of both consumers and companies and allows containing imported inflation thereby permitting lower domestic interest rates which are beneficial for investment and growth. It also makes travel and holidays outside the euro area cheaper. On the other hand, industries that compete internationally see their competitiveness adversely affected, which requires continued efforts to improve it not only through cost containment, but also by focusing on increasing the quality of euro area products.
Which countries are likely to adopt the euro next?
Slovakia aims to introduce the euro as of 1 January 2009. The Commission assessed today that it fulfils all the criteria and proposed to the Council that Slovakia adopts the euro next January.
All EU countries have a right, and are welcome, to adopt the euro if they meet the convergence criteria in a sustainable way. Denmark and the United Kingdom have an opt-out. In order to plan ahead and focus the minds of the business community as well as the public they may set themselves a target date. The Commission, nevertheless, cannot and does not endorse national target dates or pronounce itself on their credibility.
In order to adopt the euro, national currencies are also expected to spend at least two years in the Exchange Rate Mechanism (ERM II) (see below) to test the stability of their exchange rate. The currencies of the Baltic countries do participate in the ERMII, but they do not presently meet the inflation criterion. Bulgaria, the Czech Republic, Hungary, Poland, Romania and Sweden do not participate yet in ERM II. Except Sweden, they also do not yet all fully respect the criteria for public finances, inflation and interest rates (see today's Convergence Report cited above).
What is the ERMII?
The ERM II is a mechanism for the currencies of EU countries which have not yet adopted the euro. It is based on stable but adjustable central rates to the euro, with standard fluctuation bands of +/-15% around the central rate. Exchange rate policy co-operation may be further strengthened, as is the case with Denmark, which has an agreed fluctuation band of +/- 2.25%.
 Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland
 See IP/08/715 and 2008 Convergence Report, published today, to see progress by other EU countries to meet the criteria