All ten countries that joined the European Union in May 2004
will eventually have to adopt the euro, although there is no
fixed timetable for them to do so. While three of the 15 older
member states the UK, Denmark and Sweden have
declined to join the single currency, the new member states were
not given that choice in their negotiations for EU membership.
As a consequence, the current 12-nation euro zone should
expand to at least 22 members in the years ahead. The UK and
Denmark, which long ago sought and won the right to opt out of
the single currency, are for now showing no sign of changing
their minds. That is also true of Sweden, which rejected the
euro in a referendum.
The lack of choice does not, however, seem to be a problem for
the new member countries, who tend to be enthusiastic about euro
membership. Politically, joining the euro would solidify their
status as committed EU members; economically, it would aid their
economic growth by significantly lowering interest rates.
All this will mean a great deal of work for the European Central
Bank (ECB), which, together with the European Commission, has
to assess the readiness of the new member states for euro membership.
Entrants into the
euro area must fulfill the so-called convergence criteria also
known as the Maastricht criteria that set targets
for fiscal deficits, government debt, inflation, and interest
rates.
Specifically, the criteria stipulate that annual government budget
deficits must not exceed three percent of GDP; that total outstanding
government debt must not exceed 60 percent of GDP; that inflation
must not be more than 1.5 percentage points above the three best
performing euro area countries; and that average nominal long
term interest rates must not be more than two percentage points
higher than the average rate in the three countries with the
lowest inflation rates.
Even if they meet these criteria, however, the new member countries
could not join the single currency immediately. Aspirants to
euro membership have to establish their stability credentials
by spending at least two years in an exchange rate mechanism
(known as ERM2) that limits how far their currencies can fluctuate
against the euro. Some people call this a “waiting room”;
we say it is more of a “workout room”, where a little
muscle can be developed before moving on to the more demanding
obligations of the euro area.
Although they all entered the
European Union at the same time, in what was known as the “Big
Bang”, the ten new member states are unlikely to repeat
the experience in joining the euro. Their accession to the euro
area is more likely to come in several waves. Some countries,
particularly the smaller ones, are more prepared to take the
step and have shown a lot of discipline in their fiscal policies.
Cyprus, Estonia, Latvia, Lithuania, Malta and Slovenia have
already pegged their currencies to the euro by joining ERM2,
and their
performance under the arrangement has so far been very good.
Other new member states are still discussing their target dates
for adopting the euro, and their timetable for joining ERM2,
which requires participants to keep their exchange rates within
a band of plus or minus 15 percent against the euro. These discussions
have tended to drift a little. At first, there was a great
desire to adopt the euro as soon as possible. But this subsequently
changed with the realization that some of the adjustments needed
might take more time. Some of the larger new member states have
now set target dates for euro entry toward the end of the decade,
after the requisite minimum two-year preparatory period in ERM2.
There are no formal criteria for joining the exchange rate mechanism a
country can simply declare its intentions to the relevant authorities
in Brussels and Frankfurt. But successful participation requires
that major policy adjustments be undertaken before joining. The
ECB and the Commission, as well as the IMF, have been encouraging
aspirant countries to make these changes before moving to the
ERM2 phase. If they fail to do so, they will have a tougher time
in the exchange rate mechanism.
“Some of the larger
new member states
have set target dates
for euro entry
toward the end
of the decade”
The recommendation is first to
adjust fiscal policy, to bring it much closer to the Maastricht
criteria, and to lower inflation if it is too high. Countries
still, of course, have a minimum of
two years to continue working on these policy objectives while
they are members of ERM2. But it is better to be in good shape
before joining the exchange rate mechanism. Unfit people who
go to the gym and immediately get on a high-speed treadmill are
not going to do very well.
It is important to stress that each country will be assessed
on its own
merits and be given equal treatment. There is no single trajectory
toward euro adoption, and not every country will feel ready at
the same time. Each country’s progress will be continually
monitored by the Commission and the ECB, but without any preset
timetable for euro membership.
There are a number of reasons why the entry of the new member
states will not change the ECB’s monetary policy. First
of all, the principles of “non-inflationary growth” and “price
stability” are defined as key objectives in the European
Union Treaty. The central banks of the new member states will
also have to adopt central banking laws which ensure that price
stability is the primary objective of monetary policy, and that
decision-making is independent from political authorities.
“The entry of the new member states will not change the ECB’s
monetary policy”
In any case, the entry of the new member states will not add
much to the economic weight of the euro area. All ten countries
together represent about six percent of euro area GDP, although
we certainly hope and expect that this will soon rise, as they
are growing much faster than the old member states.
Furthermore, the need to fulfill the convergence criteria implies
that the main macroeconomic parameters of the new member states
are likely to be similar to those of the euro area. In other
words, at the time of entry we expect that their fiscal deficits
will be in line with the criteria, and their inflation rates
not far above the euro area average, as provided for in the rules.
When the new member states adopt the euro, they will be represented
on the governing council of the ECB, and we expect the new governors
to be committed to guaranteeing price stability in the euro area
as a whole. Eventually, there will be a change in the way the
European Central Bank council functions in
order to prevent the number of voting members from growing too
large and unwieldy as more and more countries join the euro.
A rotation system will be introduced, under which not every council
member will always be allowed to vote not that there
is actual voting today, but in principle there could be on monetary
policy issues. Under the future system, voting rights will vary
according to
a country’s economic weight. Thus
Germany, for instance, will have a voting seat more often than
Malta, which is not surprising. Even Germany, however, will not
always be entitled to vote.
Critics, of course, may argue that the expansion of the euro
area will make “one size fits all” monetary policies
even less appropriate than they are today. And it is true that
ECB monetary policy will continue to be geared toward price
stability in the euro area as a whole. But governments can still
respond to specific shocks to their economies through
national policy measures. Flexibility in labor and product markets
will be
particularly important in helping economies adjust, and governments
should heed the constant calls that are being made for structural
economic
reform in Europe. Some of the new member states, in fact, have
considerably more flexible markets than some of the older members
and should be able to set useful examples of needed changes.
Finally, it must be stressed that the single monetary policy
cannot and should not try to address national or
regional differences in inflation and output growth. And here
we can look to
another major currency area the United States to
provide the example. Suppose, say, the Texas oil industry runs
into difficulties, as has happened in the past. The monetary
policy of the Federal Reserve cannot react to that problem alone.
It has to take into account of what is happening throughout the
United States. That will also be the approach of the ECB.
J. Onno de Beaufort Wijnholds is the Permanent Representative
of the European Central Bank in Washington. He previously served
as Executive Director at the International Monetary Fund, representing
the Netherlands and eleven other countries, mainly in Eastern
Europe. Before that, he was Deputy Executive Director at De Nederlandsche
Bank, responsible for monetary policy and
financial markets, and Alternate Executive Director at the IMF.
He has been Professor of Money and Banking at the University
of Groningen, the Netherlands.
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