DOWNLOAD PDF MONETARY UNION AND FISCAL STABILITY

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1 Chapter 1 : Economic and Monetary Union: past and present The Economic and Monetary Union (EMU) is not an end in itself. It is a means to provide stability and for stronger, more sustainable and inclusive growth across the euro area and the EU as a whole for the sake of improving the lives of EU citizens. The operations and management of the economic and. Otherwise the Commission will declare a breach of the debt-criterion by the publication of a 3 report, and provided no special "breach exemptions" can be found to exist by this report i. The concept of the Fiscal Compact, however, is that national legislation instead shall ensure an automatic correction will be implemented immediately when such a potential 6 situation is detected, so that the state can manage automatically to correct it in advance, and hereby avoid the Council will ever decide to open up a 6 debt-breached EDP against the state. For transitional reasons, the regulation granted all 23 EU Member States with an ongoing EDP in November, a 3-year exemption period to comply with the rule, which will start in the year when the member state have its EDP abrogated. This special transitional "satisfactory pace" is calculated by the Commission individually for each of the concerned states, and is published to them in form of a figure for: The annually required Minimum Linear Structural Adjustment MLSA of the deficit in each of the 3 years in the transition period â ensuring the compliance with the new debt brake rule by the end of the transition period. If it becomes clear that the fiscal reality does not comply with the "balanced budget rule", which is the case when a "significant deviation" is observed from the MTO or the adjustment path towards it, then an automatic correction mechanism should be triggered. The exact implementation of this mechanism will be defined individually by each Member State, but it has to comply with the basic principles outlined in a directive published by the European Commission. This directive was published in June, and outlined common principles for the role and independence of institutions such as a Fiscal Advisory Council responsible at the national level for monitoring the observance of the rules, which is one of the key elements to ensure that the "automatic correction mechanism" will actually work. The directive also outlined the nature, size and time-frame of the corrective action to be undertaken under normal circumstances, and how to undertake corrections for states subject to "exceptional circumstances". If a significant deviation more than 0. The assessment starts by comparing the headline deficit target and the recommended improvement in the structural balance, as notified by the latest Council recommendation to the state, with the headline deficit and the apparent fiscal effort measured by the change in structural budget balance. If not achieved, the Commission will carry out a "careful analysis" based on 1 a top-down assessment of the adjusted change of the structural balance adjusting for: The adjustment path towards reaching a MTO shall at minimum entail annual structural deficit improvements of 0. Member States having an Excessive Deficit Procedure EDP opened up after the treaty enters into force, shall submit to the Commission and the Council an Economic Partnership Programme EPP for endorsement, detailing the necessary structural reforms to ensure an effective and durable correction of their excessive deficit. This shall be done a few weeks after the EDP has been notified by a 6 report. If the granted EDP-deadline for correction subsequently gets extended, the state will at the same time be required to submit a new updated programme. The main instrument utilized for monitoring whether the state comply with its programme, is the National Reform Programme report, being submitted to the Commission each year in April. If a state under EDP at the same time benefit from a sovereign bailout programme, it shall not submit an EPP, as their content already will be covered by the conditional Economic Adjustment Programme report. The EAP report is updated at regular intervals, and payment of the next bailout tranches will only be conducted if it conclude the state is still in ongoing compliance with its conditional programme. For the purpose to better coordinating the planning of national debt issuance between Member States, each state shall submit its public debt issuance plans in advance to the European Commission and Council of the EU. Commitment always to support EDP recommendations: This provision only apply for eurozone states, which shall be committed when meeting in the Council format, always to support approval of the EDP related proposals or recommendations submitted by the European Commission. However, this obligation shall not apply if a qualified majority of the eurozone states are opposed to the proposed or recommended decision. Embedding the "Balanced budget rule" Page 1

2 and "Automatic correction mechanism" into domestic law: The Balanced budget rule and Automatic correction mechanism shall be embedded in the national legal system of each state at the statutory level or higher, no later than 12 months after the treaty entered into force for the state. The European Commission is responsible for monitoring this, and shall submit an evaluation report â which has been scheduled to happen for the first time in September If the non-compliance continues after expiry of the new extended deadline ruled by the Court of Justice, then it can impose a penalty of up to 0. The fine goes to the ESM if a eurozone state is fined, or to the general EU budget if a non-eurozone state is fined. Title IV â Economic policy co-ordination and convergence[ edit ] Coordination of policies improving competitiveness, employment, public fiscal sustainability and financial stability: All states bound by this provision shall "work jointly towards an economic policy that fosters the proper functioning of the economic and monetary union and economic growth through enhanced convergence and competitiveness". To this end, each state is required to "take the necessary actions and measures in all the areas which are essential to the proper functioning of the euro area in pursuit of the objectives of fostering competitiveness, promoting employment, contributing further to the sustainability of public finances and reinforcing financial stability". The state shall report through its annual National Reform Programme, how its economic policies comply with this provision, while the Commission and Council subsequently publish their non-legally-binding opinion if the actions taken are considered to be sufficient or insufficient. For the purpose of working towards a more closely coordinated economic policy, all major economic policy reforms a member state plans, shall be discussed ex-ante and â where appropriate â coordinated among all states bound by Title IV. Any such coordination shall involve the institutions of the European Union. To this end, a pilot project was conducted in July, which recommended the design of the yet to be developed Ex Ante Coordination EAC framework, should be complementary to the instruments already in use as part of the European Semester, and should be based on the principle of "voluntary participation and non-binding outcome" with the output being more of an early politically approved non-binding "advisory note" put forward to the national parliament which then can be taken into notice, as part of their process to complete and improve the design of their major economic reform in the making. Contracting parties are committed "to make active use whenever appropriate and necessary" of two additional instruments: Title V â Governance of the Eurozone[ edit ] Meetings for policy governance: Title V of the treaty provides for Euro summits to take place at least twice a year, chaired by the President of the Euro summit to be appointed by Eurozone countries for a term that runs concurrent to the term of the President of the European Council. The meeting members include all heads of state from the Eurozone and the President of the European Commission, while the President of the European Central Bank is also invited. Agendas for the summits are limited to "questions relating to the specific responsibilities which the Contracting Parties whose currency is the euro share with regard to the single currency, other issues concerning the governance of the euro area and the rules that apply to it, and strategic orientations for the conduct of economic policies to increase convergence in the euro area. The Eurogroup has been tasked with preparing and conducting the follow up work between Euro summit meetings, and for that purpose the President of the Eurogroup may also be invited to attend the summits. Finally a tie exists to the European Stability Mechanism, which requires its Member States to have ratified and implemented the Fiscal Compact into national law as a pre-condition for receiving financial support. Stability and Growth Pact regulation[ edit ] Main article: Stability and Growth Pact The fiscal provisions introduced by the Fiscal Compact treaty for those states legally bound by these measures function as an extension to the Stability and Growth Pact SGP regulation. Compliance is monitored by the European Commission and by the Council. The counter measures will only be outlined in general, identifying the size and the time-frame of the needed corrective action to be undertaken, while taking into consideration country-specific risks for fiscal sustainability. EU member states outside the eurozone cannot be fined for breaches of the fiscal rules. Ratification and implementation[ edit ] In December, Finland became the twelfth eurozone state to ratify the treaty, thus triggering its entry into force on 1 January For subsequent ratifiers, entry into force is on the first day of the month following their deposit of the instrument of ratification. Slovakia became a party to the treaty on 1 February, as did Hungary, Luxembourg and Sweden on 1 June, Malta on 1 July, Poland on 1 September, the Netherlands on 1 Page 2

3 November, Bulgaria on 1 February and the last signatory Belgium on 1 April The ratification processes is summarised in the table below. In Cyprus, ratification was performed by a governmental decree without involving the parliament. In Ireland, a referendum was held to approve a constitutional amendment that empowered the government to ratify the treaty. Page 3

4 Chapter 2 : â Economic and Monetary Union: Prospects for Reform By using a dynamic multi-country simulation model, it is possible to pinpoint a monetary union, and repercussions produced by fiscal retrenchment policies. Interest and exchange rate effects could only be captured once a new approach including innovations in the solution methodology had been developed. Under the null hypothesis of no cointegration, the residuals,, are. The alternative does not presume a common value for. The first group mean test uses semi-parametric corrections, while the second is a parametric ADF test. The results, reported in Table 2, indicate that both tests reject the null hypothesis of no cointegration at the 5 percent level. We confirm that there are two cointegrating relations in the trivariate model using the system panel cointegration test proposed by Larsson, Lyhagen and Lothgren The null hypothesis is that all of the countries in the panel have at most cointegrating relationships among the 3 variables, cointegrating relations for all and the alternative is that all the countries have 3, cointegrating relations for all This is a sequential procedure where first is tested. If this hypothesis is rejected, is tested. The sequential procedure continues until the null is not rejected or the hypothesis is rejected. The test is computed using one-lag difference terms and it includes individual specific fixed effects. In Table 3 we verify that there are two cointegrating relations in the model. The panel test statistic indicates that in the model with three variables, and. This implies that there is a single stochastic trend in the data, implying that there are cointegrating relations between and and consistent with previous results. It is a semi-parametric approach that adjusts for the effects of endogenous regressors and short-run dynamics of the errors. The results, in Table 4, indicate that the group mean panel estimate for the real interest rate is 4. It is important to recognize that the error term in equation 9 could be autocorrelated in the data. If so, then the error could be correlated with the right-hand-side variables, biasing estimates of the coefficients on the error-correction terms. For some countries, the test chooses a single lag in levels, implying that equation 9 is appropriately specified. However, for others, two lags are chosen. Therefore, to be sure that we are not omitting relevant lags and thereby biasing estimates of coefficients, we estimate the model with an additional lag, such that the error-correction specification becomes A perisistent, but negative surplus shock, perhaps created by a war, would imply a negative error in the first cointegrating relation and rising past government debt, implying a negative correlation between the two terms. Therefore, failure to include the lagged change in debt could bias the estimate on the coefficient on the error in the cointegrating residual. First, we use the estimated cointegrating parameters of the interest rate and target surplus to construct the error correction terms for each country. Then we estimate the coefficients of the error correction model, augmented with lagged changes in variables, providing estimates for and. We use the group mean procedure recommended by Pesaran and Smith Asymptotically, the fact that we use the estimated error correction terms rather than the true error correction terms in 14 does not affect the standard properties of our estimates due to the super-consistency properties of the estimator of the cointegrating relationships. Therefore, since all are not statistically significant different from the, and since the estimate is significantly larger than one, our best inference is that all, implying the fiscal policy in the EMU is sufficiently responsive to debt for the system to be globally stable. Using our terminology, we cannot reject the null that fiscal policy in each country is strongly passive, allowing monetary policy to determine the price without fiscal influence. We note also, that our tests imply fiscal sustainability and passive fiscal policy since the criteria for both is a positive value for We have not allowed estimates of the parameters of the error correction model to change as the monetary union has evolved over time. However, if the coefficients in the cointegrating relationships had changed and no account were taken for the change, then we should not have rejected the null of no cointegration. The values for the coefficients on the error correction terms could have changed. To test for a change in, we break the sample into two sub-periods, the pre-maastricht era and the post-masstricht era. Table 6 shows that in both sub-samples is larger than one and similar in size, although variances are too high to yield significance. The split sample evidence is consistent with the hypothesis that the surplus is sufficiently responsive to debt to give the monetary authority control of the price level in both sub-samples. Conclusion A country entering the EMU surrenders its monetary policy and its debt becomes denominated in terms of a Page 4

5 currency over which it has no direct control. However, many countries have violated these limits. This leaves an open question regarding the role of fiscal policy in determining the price level in the EMU. We assume that there is an upper bound on the present value of the primary surplus, motivated by an upper bound on distortionary taxes which a government can raise to service the debt. This implies an upper bound on debt. Fiscal policy is assumed to follow a fiscal rule with time-invariant parameters. For the ECB to have power to control the price level in the EMU, the fiscal rule must imply that debt is not expected to explode relative to its upper bound. We show that this requires that the primary surplus responds to an increase in real debt by at least enough to pay interest on the debt. We call such a policy "strongly passive" since the criteria are stronger than those requiring the expected present-value of debt to vanish in the limit, as with passive policy. We show that a strongly passive fiscal policy yields a model which is globally stable, such that initial deviations of the primary surplus from its target and from debt service are expected to vanish in the long run for any initial values. This gives the monetary authority the freedom to determine price in equilibrium. This paper estimates a rule for the primary surplus to determine whether fiscal policy in EMU countries is strongly passive. Using panel cointegration and panel data techniques that allow for heterogeneity and for cross-sectional dependence across countries, we estimate the coefficients of the error correction model for the primary surplus in a panel of ten EMU countries over the period The group mean estimate for the coefficient on lagged debt is consistent with the hypothesis that fiscal policy in EMU countries is strongly passive, allowing the monetary authority control over the price level. Inflation," in Ben Bernanke and Julio Rotemberg, eds. MIT Press Fuller, "Distribution of the estimators for autoregressive time series with a unit root," Journal of the American Statistical Association, 74, Granger, "Co-integration and Error Correction: Representation Estimation, and Testing," Econometrica, 55, Cambridge University press, Ostry, "International Evidence on Fiscal Solvency: Is Fiscal Policy "Responsible? Phillips, "Vector Autoregressive and Causality," Econometrica, 61, Walsh, "Testing Intertemporal Budget Constraints: Theory and Applications to U. A Requirement for Price Stability? For Luxembourg and Portugal there was not data available for a lot of years. For Germany we use the data for West Germany before unification and Germany after unification. The real values of the variables for each country are obtained by dividing the nominal values by the GDP deflator. Panel Cointegration Statistics Pedroni 1. Page 5

6 Chapter 3 : Monetary Union IMF Blog Economic and monetary union represents a major step in the integration of EU economies. Launched in, the union involves the coordination of economic and fiscal policies, a common monetary policy, and a common currency, the euro. Whilst all 28 EU Member States take part in the economic union. The framework of rules for entry into the Eurozone was laid down in the Maastricht Treaty in This treaty also created the rules for membership of the European Union EU in general. The euro-system The euro-system has two elements - the European Central Bank ECB, which is responsible for all monetary policy in the eurozone euro area, and the National Central Banks CBs of the 19 member countries. Other European countries are free to join the euro area if they meet the criteria laid down in various treaties. The two most important criteria for entry are that the applicant country has demonstrated price stability, and that its public finances are well managed. Co-ordination of macro-economic policies Co-ordination of policy was designed to enable the original 12 economies of the euro-area to converge. A key feature of this was the Stability Pact, which involved members agreeing to keep their economies stable, and keeping their budget deficits under control. This restriction was designed to prevent any unnecessary fiscal stimulus which might de-stabilise the economy, even in the face of high unemployment. However, several countries, including Germany, France, and most notably, Greece, have broken this rule, and this has cast serious doubts about the ability of the euro area to maintain this rule. The European Financial Stability Facility The EFSF was formed to help stabilise the European economies after the financial crisis, recession and sovereign debt crisis, and now forms a key element of the reformulated euro-system. The fiscal compact In attempt to prevent EU countries from running up further debts, the majority of the EU states signed a fiscal compact which opened up their domestic budgets to collective scrutiny. It remains to be see how successful this measure will be, and whether its leads to a full fiscal union. The advantages of the Euro There are several significant benefits of having a single currency area. These are primarily derived from the benefits of fixed exchange rates, and include the following: Transparency Producers and tourists can more easily compare the prices of international goods, services and resources. Lower transaction costs Transaction costs are reduced because there are no commission payments to financial intermediaries. Certainty and investment The Euro creates certainty because firms can predict the cost of imported raw materials and can set the price of their exports, which means they can plan, and are more likely to invest. Trade creation Trade between members of a single currency area is likely to increase because of the benefits of sharing a currency. Job creation Increased trade is likely to generate jobs in those industries that experience increased exports. Discipline against inflation Members cannot take the easy option devaluation to get out of economic difficulty. The disadvantages of the Euro Loss of economic sovereignty Once a country become a member of the euro area, National Central Banks, including the Bank of England, lose their ability to use interest rate policy to achieve independent macro-economic objectives. Following the financial crisis and global recession, recession-hit countries like Greece were not able to reduce interest rates unilaterally. Difficulty of conversion Many European countries, including the UK, may never be able to converge fully with the euro area. In addition, the UK labour market is highly flexible in comparison with France, Germany, and Spain and this also makes convergence difficult. One cap does not fit all Having only one interest rate is not sensible when dealing with a diverse range of economies and economic circumstances. Even within a single currency area, great diversity can exist, suggesting that a common economic policy might be unproductive. Dealing with asymmetric shocks Asymmetric shocks are external shocks that have an unequal impact on an economy or, in this case, the EU area. The following recent shocks did not have an equal effect across Europe: The growing imbalance between the more affluent northern euro members, including Germany, and the increasingly indebted southern ones, including Greece, Italy and Portugal, has also raised the issue of the inadequaces of having a single monetary policy. In these types of circumstance it is argued that a single interest rate will not be appropriate. A member experiencing a negative perhaps domestically originating shock would require lower interest rates and looser monetary policy in comparison with those members less affected. The weakness of an asymmetrical monetary target Having an asymmetrical inflation Page 6

7 target means that the ECB must only intervene if the rate is exceeded, and not if inflation falls below the target rate. Critics argue that, as a result, there is a built-in deflationary bias. The euro area has certainly experienced deflationary pressures in recent years. Membership tests In the UK government laid down five conditions for the UK to join the euro area. Economic convergence The trade cycles of the UK and euro area should be in alignment. Flexibility Joining should not harm the highly flexible product and labour markets of the UK. Investment Joining should not discourage domestic investment and FDI. Financial services The City the financial centre should not suffer as a result of membership of the euro area. Growth and jobs Membership should be good for growth and job creation. Given the strength of the case against joining the euro area, even before Brexit, it was increasingly doubtful whether the UK would every scrap the pound. Indeed, the financial crisis re-opened a wider debate about the benefits of enlarging the euro-area. Brexit impact This debate has, clearly, been overshadowed Brexit. With the future of the EU itself now uncertain, there is the increased risk that some members of the euro-area, notably Greece and italy, might wish to revert back to their previous currencies. The single currency does not appear to have led to any great reduction in price differences across Europe. It was thought that price transparency would have brought prices much closer together, but, without perfectly free trade and tax harmonisation, price differences are still likely. For example, considerable price differences in many basic products, such as cigarettes, chocolate, and water, still persist, as indicated below: Chapter 4 : Stability and Prosperity in Monetary Union The Economic and Monetary Union (EMU) is an umbrella term for the group of policies aimed at converging the economies of member states of the European Union at three stages.. The policies cover the 19 eurozone states, as well as non-euro European Union stat. Chapter 5 : Economic and Monetary Union of the European Union - Wikipedia We examine prospects for a monetary union in the East African Community (EAC) by developing a stylised model of policymakers' decision problem that allows for uncertain benefits derived from monetary, financial and fiscal stability and then calibrating the model for the EAC for the period Chapter 6 : FRB: Fiscal Policy in the European Monetary Union This book addresses the macroeconomic implications of a country's transition to a monetary union. By using a dynamic multi-country simulation model, it is possible to pinpoint a monetary union, and repercussions produced by fiscal retrenchment policies. Interest and exchange rate effects could only. Chapter 7 : European Fiscal Compact - Wikipedia This book addresses the macroeconomic implications of a country's transition to a monetary union. By using a dynamic multi-country simulation model, it is possible to pinpoint a monetary union, and re. Page 7