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EMU@10 and beyond: on the way to an enlarged euro area Massimo Suardi European Commission Head of Unit - Monetary and exchange rate affairs - Directorate General Economic and Financial Affairs - Conference – Common currency and its future – Lessons for the New Member States Warsaw, 15 October 2008 European Commission

EMU@10 and beyond: on the way to an enlarged euro area · Directorate General Economic and Financial Affairs - ... Looking ahead – on the way to an enlarged euro area. European

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1

EMU@10 and beyond: on the way to an enlarged euro area

Massimo SuardiEuropean Commission

Head of Unit - Monetary and exchange rate affairs -Directorate General Economic and Financial Affairs -

Conference – Common currency and its future –Lessons for the New Member States

Warsaw, 15 October 2008

European Commission

2

Outline

• EMU: The first ten years

• Achievements and challenges

• Lessons and policy agenda

• On the way to an enlarged euro area

• A sequenced process

• Many roads to the euro

• Progress with convergence

• Conclusions

3

EMU: The first ten years

4

The achievements of EMU

Price stability and low cost of borrowing

Elimination of intra-area exchange rate volatility

Increased trade and FDI ; financial integration

Strong job creation

Sounder fiscal positions

Greater resilience to external shocks

The euro is the 2nd global currency

5

Inflation performance has improved

Inf latio n perfo rm ance in the euro area

S ource : European Com m ission .

*Corresponds to the period s ince the sta rt o f Stage III o f E MU .

0

2

4

6

8

1 0

19 60s 19 70s 19 80s 199 0s 20 00s *

Av erage

Sta nda rddev ia tio n

6

Cost of borrowing fallen dramatically

Evolution of 10-year government bond yields (in percent, annual data)

2

4

6

8

10

12

14

16

18

20

22

24

2619

90

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Source: Eurostat

BE DE

IE GR

ES FR

IT NL

AT PT

FN LU

SI

7

EMU boosted FDI, trade and growth

The impact of the euro on:

0%5%

10%15%20%25%30%35%40%

FDI Trade Growth

min max

8

EMU promoted financial market integration

0%

20%

40%

60%

80%

100%

Home bias inequity markets

Cross borderholdings of euroarea long-termdebt securities

Share of domesticcredit institutionsin banks' assets

start of EMUMost recent data

9

More than 16 million jobs createdEmployment growth

ES

IE

NL

LU

US

AV

PTELEAITSE

FIDK

UK

FR

BEDE

AT

0

1

2

3

4

5

-1 0 1 2 3 41989-1998, % per annum

1999

-200

8, %

per

ann

um

Source: European Commission.

10

Fiscal positions improved

-6

-5

-4

-3

-2

-1

0

1995 1998 2007

% o

f GD

P

Cyclially-adjusted fiscalbalance

Fiscal balance

11

Increased resilience to shocks

Cumulated output loss due to recession

0

2

4

6

8

10

1980s 1990s 2000s

% o

f GD

P a

t ful

l cap

acity

utilis

atio

n

12

But not all expectations have been fulfilled

GDP growth is slow in some countries, due to unsatisfactory productivity performance

Rising divergences in competitiveness and large current account imbalances require correction

In general, structural reforms have been less ambitious and frequent than in the rest of the EU

Banking and financial markets are still predominately nationally organized and supervised

Not much progress in international representation

Weaknesses in public perception of the euro

13

Major external imbalances built up

Current account positions39

141 9 1310

-26 -43-9

-15 -97-25-12

-10-8-6-4-202468

NL DE FI AT BE IT FR IE PT ES EL

% o

f GD

P

Numbers indicate the absolute position, billions of euros

2007

Source: European Commission.

14

Driven by competitiveness developments

Cumulated change in relative unit labour cost

-15-10

-50

510

1520

IE PT EL ES IT NL FR BE FI AT DE

%

1999-2007

Source: European Commission.

15

The implementation of structural reform recommendations has disappointed in some

countries

1.0

1.5

2.0

Euro area Top 3 euro areaperformers

Denmark,Sweden, UK

Score on a scale from 0 to 3

16

Asymmetric impact of common external shocks

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

0 1 2 3 4 5 6 7 8 9 10

DEITIE

Euro/dollar exchange rate shock

(risk premium shock leading to 10% appreciation)

-0.3

-0.2

-0.1

0.0

0.1

0 1 2 3 4 5 6 7 8 9 10

DE

IT

IE

US slowdown (1% fall in private consumption and

investment by )

US slowdown (1% of GDP fall in private consumption

and investment)

(Source: QUEST III model simulations)

17

Lessons from EMU@10 for current and future euro area members (1 - challenges)

Price stability: equilibrium real appreciation complicates inflation control ; shorter history of anti-inflation policy and lower credibility ; conflict between fiscal and monetary authorities ; wage catching up

Effective adjustment capacity (incl. stabilisation):To deal with shocks without exchange rate instrument (but nominal exchange rate flexibility acts also as shock propagator, hence less ‘cost’ of giving up the XR instrument);

Relatively more frequent and persistent common shocks with asymmetric impact (exchange rates, terms of trade, shifting comparative advantages…); asymmetric shocks still possible (see Spain, Ireland, …)

Correction of large current account imbalances may require long and painful disinflation processes if coupled with stagnating productivity

EMU and financial integration help efficient resource allocation and allow for longer adjustment periods, but managing credit booms can be a challenge (already well before euro adoption)

Long-term challenges: sustain high potential growth (catching-up), in a context of ageing, globalisation (with more rapid shifts in comparative advantages)

18

Lessons from EMU@10 for current and future euro area members (2 – policy needs)

Improved budgetary control to reduce the risk of fiscal policy pro-cyclicality; budgetary frameworks in NMS are less developed and assessing cyclical component even more challenging

Flexible and integrated goods and factor marketsEffective supervision and regulation of financial markets ; NMS experience accelerated financial developmentSustainability of public finances Quality of public finances ; bias towards current expenditure in NMS

Growth-enhancing use of capital inflows ; NMS are receiving huge inflows, included EU funds; utilisation has differed a lot across NMS

More efficient use of labour resources (participation rates, structural unemployment, skill mismatches)

Business environment and investment climate (innovation, FDI, education, favour entry /exit of firms)

19

The three policy pillars of EMU@10Domestic agenda

Deepening fiscal surveillance Broadening policy coordinationIntegrating structural reforms in policy coordination

External agendaConsidering benefits, responsibilities and risks of a global currency Enhancing the international role of the euro area

Effective governanceExploiting existing tools better A stronger role for the Eurogroup, but ECOFIN remains the ultimate decision makerStronger dialogue with other institutions and partners

1919

20

Looking ahead – on the way to an enlarged euro area

21European Commission

All EU Member States (except UK, DK) committed to join the euro under the Treaty

Need to achieve a high degree of sustainable convergence, based on fulfilment of criteria

Sequenced process – Member States have room for manoeuvre in managing their path towards the euro

Thorough preparation essential

Euro adoption an opportunity for reforms

Road to the euro – the starting position

22European Commission

Impressive real convergence

Uneven progress with nominal convergence

NMS are overall well placed to benefit from euro adoption from OCA (stabilisation) point of view

High and growing level of integration (trade, FDI, financial)Correlation of business cycles; similarity of structureRelatively flexible markets

Road to the euro – progress with convergence

23

Many roads to the euro

European Commission

• No one-size-fits-all strategy• Exchange-rate policy is a matter of common interest (Art. 124) butsovereign choice of exchange rate regime:

Fixed exchange rate regimes (Estonia, Latvia, Lithuania, Bulgaria)

More flexible regimes (Czech Rep., Poland, Hungary, Romania)

Slovakia: ERM II, flexible regime

• In ERM II: Estonia, Lithuania, Latvia, Slovakia

24

Catching-up is advancing, but remains long-term challenge GDP per capita in 2007 (in PPS, EU=100) and average change over the period 2004-2007

European Commission

2.5

7.9

6.1

0.4

5.8

8.2

2.3

5.7

3.9

0 10 20 30 40 50 60 70 80 90

CZ

EE

SK

HU

LT

LV

PL

RO

BG

25

NMS are well-integrated with EU/euro area economy…Share of intra-EU trade (exports plus imports)

European Commission

0

10

20

30

40

50

60

70

80

90

CZ SK LV PL EE HU RO LT BG

2002

2007

26

Structural convergence has advanced, but divergences remain

Economic size and labour distribution by sector of activity, 2005

0%

20%

40%

60%

80%

100%

avg 9 NMS EA-13 avg 8 NMS EA-13agriculture industry and construction services

GVA, % of GDP Employment, % of total

note: NMS are BG CZ EE LV LT HU PL SK (RO)

27

GDP growth rates(in %, y-o-y)

European Commission

-2

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006 2007 H1-08

BulgariaEstoniaLatviaLithuania

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006 2007 H1-08

Czech RepublicHungaryPolandRomaniaSlovakia

28

State of convergence - HICP inflationRising inflation pressures due to supply and demand factors

12-month average inflation (in %, y-o-y)

European Commission

-2

10

-2

0

2

4

6

8

10

12

14

16

18

2002 2003 2004 2005 2006 2007 2008

reference value BulgariaEstonia LatviaLithuania

0

2

4

6

8

2002 2003 2004 2005 2006 2007 2008

reference value Czech RepublicHungary PolandRomania Slovakia

29

Fiscal positionsExternal constraints seem to matter for fiscal performance

General government balance and government debt (in % of GDP; 2007)

European Commission

CZ

EE

LV

LT

HU

PLSK

BG

RO

-8

-6

-4

-2

0

2

4

6

0 10 20 30 40 50 60 70government debt (in % of GDP)

budg

et b

alan

ce (i

n %

of G

DP)

60%

-3%

30

Exchange rate developmentsvs. euro, monthly averages (index numbers, Jan 2007 = 100)

European Commission

70

80

90

100

110

120

1302002 2003 2004 2005 2006 2007 2008

BGNEEKLVLLTL

↓ depreciation

70

80

90

100

110

120

1302002 2003 2004 2005 2006 2007 2008

CZKHUFPLNRONSKK

↓ depreciation

31

Long-term interest rates12-month averages (in %, y-on-y)

European Commission

2

3

4

5

6

7

8

9

10

11

2002 2003 2004 2005 2006 2007 2008

reference valueBulgariaEstoniaLatviaLithuania

2

3

4

5

6

7

8

9

2002 2003 2004 2005 2006 2007 2008

10

11 reference valueCzech RepublicHungaryPolandRomaniaSlovakia

32

Financially-driven convergence – large capital inflows and extension of external balance sheets

European Commission

NMS - External debtin percentage of GDP

0

20

40

60

80

100

120

Average 9 NMS Baltics + BG CZ HU RO PL SK

2002

2007

Source: Eurostat and Commission services and ECB

Net capital inflows (surplus on the capital account and financial account of the BoP without reserves, % of GDP)

0

5

10

15

20

25

30

NMS-9 Fixers' Floaters'

2000 2007

33

Rapid financial deepening from a low base Domestic credit (in % of GDP)

European Commission

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 H1-08

BulgariaEstoniaLatviaLithuania

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2002 2003 2004 2005 2006 2007 H1-08

Czech RepublicHungaryPolandSlovakiaRomania

34

Current account developmentsBalance on current transactions with rest of world (in % of GDP)

European Commission

-25%

-20%

-15%

-10%

-5%

0%2002 2003 2004 2005 2006 2007

BulgariaEstoniaLatviaLithuania

-25%

-20%

-15%

-10%

-5%

0%2002 2003 2004 2005 2006 2007

Czech RepublicHungaryPolandRomaniaSlovakia

35

NMS and the euro - Conclusions

• EMU@10 and beyond – building on the successes and meeting

the challenges

• Specific challenges for NMS. Achieving catching-up, nominal

convergence while preserving macro-financial soundness

• Euro area enlargement is ongoing; NMS have made

considerable progress on the road to the euro

• Policies need to be attuned to country-specific circumstances;

ownership and thorough preparation are key

• EMU@10 policy agenda will help • Short-term challenges: deal with fall-out from the financial crisis

European Commission