International Economic Outlook: The Maastricht Fiscal Drag Will Slow Down the Pace of Expansion in Western Europe

THE MAASTRICHT FISCAL DRAG WILL SLOW DOWN THE PACE OF EXPANSION IN WESTERN EUROPE I. Economic and Monetary Union (EMU) in The process of economic integration in Western began in 1988 with the creation of the Delors committee for the study and development of a plan to implement an Economic and Monetary Union (EMU) for the members of the European Community. In December 1991, the leaders of the member signed in Maastricht the treaty on European Union (EU), which formalized their intentions to create the EMU by the end of this century in three stages: stage one, which begun in 1990 was characterized by the completion of the Single Market or the socalled Europe 1992 and the participation of currencies in the Exchange Rate Mechanism (ERM). Based on the Maastricht Treaty, stage two began in 1994 with the creation of the European Monetary Institute (EMI), the forerunner of the European Central Bank (ECB). The Monetary Committee, which consists of senior civil servants from central banks and ministries of finance, and the EMI have been charged with the design and implementation of the European currency. In stage three EMU will become reality. The exchange rates of the participating members will be pegged to each other irrevocably at the time of the conversion. Individual currencies will be replaced with a single and its value against the US dollar will be the same as the ECU at the time of the transition. Monetary policy decisions will be made by the supranational ECB. This final stage of European economic integration will start on January 1, 1999. Prior to the establishment of the EMU, in accordance to the Maastricht Treaty, the member countries have to meet a set of designated convergence criteria for the creation of monetary union. The decision on which member country meets the criteria will be made at the latest by July 1, 1998. The progress that each country has made in meeting the criteria, therefore, will be based on information regarding economic performance statistics on 1997 and early 1998. The member countries that do not meet the entry conditions will be excluded from EMU and referred to as states with derogation until they fulfill the convergence criteria. The convergence criteria for entry into the EMU have and will continue to dramatically influence the design of economic policy in the member of the European Union. In accordance with the Maastricht Treaty, these convergence criteria are: 1. Inflation to be no more than 1.5% points above the average of the three lowest inflation rates in the EU member 2. Long-term interest rates to be no more than 2% points higher than the average of the three lowest inflation rates in the EU member 3. Exchange rates must have remained within the normal bands of the Exchange Rate Mechanism (ERM) for at least two years without realignment. 4. Budget deficits should not be more than 3% of the member country's GDP. 5. Government debt should not be more than 60% of the member country's GDP. Looking at Table 4, only Germany and Luxembourg pass all five criteria for monetary union as of now. Both the inflation and the interest rate criteria are now met by about 11 countries (including Sweden which is very close to the interest rate criterion). The exchange rate criterion is currently met only by six countries because five countries Finland, Greece, Italy, Sweden and the United Kingdom - do not participate in the ERM for two years, and the currencies of the other countries have been realigned in the recent currency turmoils. The EU has witnessed considerable currency fluctuations since the summer of 1992. Five currencies - those of the UK, Italy, Spain, Portugal and Sweden depreciated by 20% or more against the stable European Monetary System's currencies in the last three years, while the Irish pound was devalued by 10% in February 1993. The most important obstacles to entry in the EMU are, therefore, the two fiscal policy criteria. …