4. The Euro Area Enlargement

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The Euro Area EnlargementThe new Member States• are large in population• but are small in economic terms

2003Population

(millions)

GDP

(billion euros)New Member States 75 413

EMU12 305 (24%) 6828 (6%)

EU15 381 (19%) 8843 (5%)

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The Euro Area Enlargement

• Basic Statistics

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The Euro Area Enlargement

• EU10 Country Profiles

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The Euro Area Enlargement

• EU10 Country Profiles

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The Euro Area Enlargement

• EU10 Country Profiles

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The Euro Area Enlargement

Nominal versus real convergence• High divergence of real GDP per capita and of price

levels

Economic catch up leads to (Balassa – Samuelson effect)– high inflation OR– nominal appreciation of the currency

Real GDP Gap: Economic Convergence Theory by Robert Solow

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The Euro Area Enlargement

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The Euro Area Enlargement

• Unemployment Rates

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The Euro Area Enlargement

Inflation rates: Because of catch up growth, inflation rates in EU10 countries higher than in EU15

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The Euro Area EnlargementInflation rates

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The Euro Area EnlargementLong-Term Interest Rates

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The Euro Area EnlargementLong-Term Interest Rates

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The Euro Area Enlargement

Nominal versus fiscal convergence

• Central bank independence and convergence of inflation are prerequisites for joining EMU

• These increase the burden for government budgets.• Budget deficits in many new Member States have increased a lot.

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The Euro Area EnlargementGovernment Deficit to GDP Ratio

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The Euro Area EnlargementGovernment Deficit to GDP Ratio

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The Euro Area EnlargementGovernment Debt to GDP Ratio

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The Euro Area EnlargementGovernment Debt to GDP Ratio

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The Euro Area EnlargementGovernment Deficit and Government Debt to GDP Ratio

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The Euro Area EnlargementExchange Rate Stability

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The Euro Area EnlargementExchange Rate Stability: ERM II

Denmark: the Danish kroner joined the Exchange Rate Mechanism II (ERM II)on 1 January 1999 andobserves a central rate of 746.038 andnarrow fluctuation margins (±2.25%) vis-à-vis the euro.

Estonia: the Estonian kroon joined the Exchange Rate Mechanism II (ERM II)on 28 June 2004 andobserves a central rate of 15.6466 andstandard fluctuation margins (±15%) vis-à-vis the euro.Estonia unilaterally maintains a euro-based currency board.

Cyprus: the Cyprus pound joined the Exchange Rate Mechanism II (ERM II)on 2 May 2005 andobserves a central rate of 0.585274 andstandard fluctuation margins (±15%) vis-à-vis the euro.

Latvia: the Latvian lats joined the Exchange Rate Mechanism II (ERM II)on 2 May 2005 andobserves a central rate of 0.702804 andstandard fluctuation margins (±15%) vis-à-vis the euro.

Latvia unilaterally maintains the exchange rate of the lats within a 1% fluctuation band around its central rate vis-à-vis the euro.

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The Euro Area EnlargementExchange Rate Stability: ERM II

Lithuania: the Lithuanian litas joined the Exchange Rate Mechanism II (ERM II)on 28 June 2004 andobserves a central rate of 3.45280 andstandard fluctuation margins (±15%) vis-à-vis the euro.

Lithuania unilaterally maintains a euro-based currency board.Malta: the Maltese lira joined the Exchange Rate Mechanism II (ERM II)

on 2 May 2005 andobserves a central rate of 0.429300 lira andstandard fluctuation margins (±15%) vis-à-vis the euro.

Malta unilaterally maintains the exchange rate of the lira at the central rate vis-à-vis the euro.Slovenia: the Slovenian tolar joined the Exchange Rate Mechanism II (ERM II)

on 28 June 2004 andobserves a central rate of 239.640 andstandard fluctuation margins (±15%) vis-à-vis the euro.

The tolar will leave ERM II when Slovenia adopts the euro on 1 January 2007.Slovakia: the Slovak koruna joined the Exchange Rate Mechanism II (ERM II)

on 28 November 2005 andobserves a central rate of 38.4550 andstandard fluctuation margins (±15%) vis-à-vis the euro.

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The Euro Area EnlargementBalassa – Samuelson Effect

Traded goods sector (manufactured goods)• Economic catch up implies higher productivity growth in traded

goods sector• Higher productivity leads to higher wages for worker in this sector

Non-traded goods sector (services)• As labour is mobile between the traded and non-traded goods

sectors, wages in the services sector rise as well• But productivity does not increase in the services sector.

Consequently, prices of services rise. Inflation is higher than in the EU15

• Real convergence (higher productivity growth) conflicts with nominal convergence (to a common inflation level)

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5. The EU Unemployment

• Basic Facts

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5. The EU Unemployment

• Basic Facts

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5. The EU Unemployment

• Basic Facts: Duration of Unemployment

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5. The EU Unemployment

• Basic Facts: Young Unemployment Rate