Introduction to the European Union - Economic, Monetary and Fiscal Policy (Video)

Learning Aims

• Understand the central role of economic integration in the development of the EU project
• Reflect on historical developments significant for economic and monetary integration in the EU
• Theorise integration in this space – think about how integration is driven
• Provide a brief history of EC/EU economic, monetary and fiscal policy – including key terms, concepts and institutions
• Consider different perspectives on economic and monetary union (EMU)
• Explore key questions about whether the EU is primarily a political or an economic project

Brief history of EC/EU economic, monetary and fiscal policy

• Original purposes of the EC
  • Political: Peace among member states
  • Economic: Establish a Customs Union (abolition of tariffs and import quotas)
• Economic dimension developed over time:
  • 1980s: Single market programme (Single European Act 1986 aimed to establish a single market by Dec 1992)
  • 1990s: Single currency (fully introduced by 2002)
• Why the customs union was not enough
  • Proliferation of non-tariff barriers to trade
  • Need for a single market to remove non-tariff barriers via EC legislation
• Examples of non-tariff barriers to trade:
  • Subsidies to firms/sectors (state aids) from member state governments
  • Differences in indirect taxation (e.g., VAT and excise duties)
  • Different standards on goods or services across member states

Introduction to the Single Market

• The Internal Market vs The Common Market vs The Single European Market
• The single most important and wide-reaching element of the EU?
  • Not a large share of EU expenditure; it is primarily regulatory in nature
• Focus: completion of a single market across all EU territory

European economic integration: visuals and framing

• Visual slogan on page emphasizes engagement with local and continental politics (contextual framing of integration debates)

Stages of economic integration around the World

• The slides present a color-coded map of where different forms of integration exist worldwide, highlighting the most advanced form each country participates in:
  • Economic and monetary union (CSME/EC$, EU/€)
  • Economic union (CSME, EU)
  • Customs and Monetary Union (CEMAC/franc, UEMOA/franc)
  • Common market (EEA, EFTA, CES)
  • Customs union (CAN, CUBKR, EAC, EUCU, MERCOSUR, SACU)
  • Multilateral Free Trade Area (AFTA, CEFTA, CISFTA, COMESA, GAFTA, GCC, NAFTA, SAFTA, SICA, TPP)

Degrees of Economic Integration

• Free trade area
• Customs Union
• Single Market
• Currency Union
• Complete integration

Features by integration level (summary interpretation)

• Free trade area (e.g., EFTA, NAFTA):
  • Abolition of internal customs duties for goods produced within the area
  • Reduction of tariff trade barriers within the area
  • Reduction of non-tariff barriers within the area (to some extent)
• Customs union (e.g., Mercosur):
  • Abolition of internal tariffs and adoption of a common external tariff
  • Common customs policy vis-à-vis third countries
• Single market (e.g., EU, AEC):
  • All above plus reduction of non-tariff barriers and mobility/establishment barriers
• Currency union (Eurozone):
  • Introduction of a common currency

The Single Market therefore…

• Abolishes non-tariff barriers for free movement of goods and services
• What is a non-tariff barrier? Any measure other than a customs tariff that acts as a barrier to international trade
• Non-tariff barriers include:
  • Regulations: rules on how a product can be manufactured, handled, or advertised
  • Rules of origin: proofs of which country goods were produced in
  • Quotas: limits on amounts of a product that can be sold in a market

The EU single market established "four freedoms"

• Goods: Free movement of goods
• Persons: Free movement of people (workers, residents, etc.)
• Services: Freedom to provide and receive services
• Capital: Free movement of capital
• Other related freedoms mentioned:
  • Free movement of imports/exports
  • Free movement of workers
  • Free movement of payments
  • Freedom of establishment
• To join the single market, countries must adhere to the four freedoms of goods, persons, services and capital

The Single Market in practice

• TIMELINE and practical development of the European Single Market (historical progression and milestones)

Theorising the single market

• Intergovernmentalists?
• Neofunctionalists?

Key theories driven by the single market project (Intergovernmentalists vs Neo-functionalists)

• Intergovernmentalists:
  • Institutional dynamics of the SEM project arise from convergence of policy preferences in the early 1980s among national governments
  • National interests drive economic integration: state resources, power, bargaining
• Neo-functionalists:
  • Supranational actors shape the Single Market; Commission acts as a “policy entrepreneur” shaping European agenda
  • Supported by business interests seeking benefits from an enlarged, integrated market

Aston University – Economic and Monetary Union overview

• Reiteration of the degrees of economic integration: Free trade area, Customs Union, Single Market, Currency Union, Complete integration

Intro to the single currency: advantages and disadvantages of a single currency for the EU

• Key questions the slide raises about a single currency

Benefits and costs of the euro

• Benefits:
  • Monetary stability
  • Greater price transparency
  • Greater convenience for travelers; fewer bureaucratic barriers for investors and businesses
  • Global and political influence (the euro as a world-class currency)
• Costs:
  • Loss of policy independence: Eurozone states cannot independently devalue their currencies or set separate interest rates in response to shocks
  • Underlying long-term weaknesses in some EU economies can undermine the eurozone as a whole
  • Some convergence criteria were fudged to allow more countries to join; issues surfaced during the 2007-08 financial crisis

Monetary and currency visuals (currency notes and ECB references)

• The visuals depict various currencies and ECB references (illustrative of monetary integration and the euro’s governance)

A process by which Eurozone countries share a single currency (the Euro)

• Maastricht Treaty was the first step
• The Euro was created on January 1, 1999
• Coins and notes began circulating in 2002
• The euro countries share the same monetary policy – The ECB – with: a single interest rate and controls the money supply
• What is Economic and Monetary Union (EMU)?

Monetary policy

• Definition: about the supply of money and credit conditions
• Tools include setting reserve requirements for banks and central bank manipulating interest rates to control money supply and manage inflation
• Difference between monetary policy and fiscal policy

Fiscal policy

• Definition: about government spending and taxation
• Governments can influence the economy through fiscal means (e.g., tax cuts to increase disposable income)
• Can you have common monetary policy without fiscal policy?
• Difference between monetary and fiscal policy (summarised):
  • Monetary policy: changes in interest rates/money supply; set by central bank; targets inflation; usually independent from political process
  • Fiscal policy: changes in government spending and taxes; set by government; affects deficits/borrowing; has a strong political dimension

A few explanations of key terms and concepts

• How can central banks influence exchange rates?
  • Most stable economies use floating exchange rates (e.g., GBP, EUR, USD); fixed rates are an alternative (pegged to another currency)
  • Central banks can set key interest rates that influence the exchange rate by attracting or deterring investors
  • High rates attract investment but reduce borrowing/spending, balancing inflation and growth
• What are macroeconomic policies?
  • Broadly includes monetary policy and fiscal policy

A major step towards EMU (historical timeline)

• In 1969, six leaders declared an intention to establish an economic and monetary union by 1989
• Pierre Werner was asked to write a feasibility study (a 10-year transition plan)

Benefits and drawbacks of a single currency (historical rationale)

• Perceived long-term benefits for producers and consumers:
  • Eliminate exchange rate fluctuations
  • Security of purchasing power
  • Removal of transaction costs
  • Price transparency
• These benefits were thought to stimulate economic activity across the single market

The Maastricht Treaty and euro adoption

• Maastricht Treaty set a firm political commitment to EMU and a fixed timeline to introduce the euro
• The UK negotiated an opt-out; Denmark joined later with an opt-out/arrangement
• The treaty required that all EU members adopt the euro once they satisfied the membership conditions

Building a strong European economy in the context of global power shifts

• Context: counterweight to US global economic dominance
• Rationales included: monetary policy credibility and stability, greater investment confidence, and a credible European economic policy framework

Reasons for a single currency and the benefits for exporters

• Export-driven economy would benefit from a single currency
• The euro could stop “competitive currency devaluations” (e.g., feared from Italy)
• A common currency would prevent new eastern members from adopting similar devaluation strategies

Joining the euro – the convergence criteria

1) Price stability:

• The country must have a sustainable price performance; inflation rate no more than 1.5 percentage points above the rate of the best-performing member states, measured over a year
  • Expressed as: ext{Inflation}{i} \le ext{Inflation}{ ext{best 3}} + 1.5 ext{ ext{%}}
    2) Sound and sustainable public finances:
• Government deficit not exceeding 3 ext{ \% of GDP}
• Government debt not higher than 60 ext{ \% of GDP}
  3) Exchange-rate stability:
• Participation in ERM II for at least two years without significant deviations from the central rate
  4) Long-term interest rates:
• Convergence of long-term interest rates to sustainable levels (durability of convergence)
  5) Legal convergence:
• Alignment of national legislation (especially governing the national central bank) with EU law

Convergence criteria (continued) and the Stability and Growth Pact

• Stability and Growth Pact (since 1997): rules to ensure sound public finances and coordinated fiscal policies
• Fiscal metrics defined as percent of GDP:
  • Deficit: ext{deficit} / ext{GDP}, debt: ext{debt} / ext{GDP}

Who joined the euro and institutional framework

• Of the 15 original member states, 11 joined initially; today 20 of the 27 EU states are part of the euro area
• ECOFIN Council: finance ministers of 27 EU countries
• Eurogroup: finance ministers of 20 euro-area countries

The Eurogroup: role and evolution

• Initially informal gatherings of eurozone ECOFIN ministers
• Lisbon Treaty gave the Eurogroup formal status
• Seen as a counterweight to the ECB by some (France) and as a way for Germany to influence the ECB by signaling commitment to integration
• Primary role: oversee fiscal aspects of EMU
• Meets just before ECOFIN
• Lacks final decision-making power as an institution, but has gained political significance, especially after the eurozone crisis

Analytical perspectives on EMU (economics)

• Two schools of thought (economics): 1) Optimum Currency Area (OCA): Countries should adopt a single currency only if they are sufficiently economically integrated and can handle asymmetric shocks
  • There are differing views on how close the eurozone is to an OCA
    2) Central bank credibility: A single currency should be adopted if the central bank is strong and financial markets trust its policies
  • ECB credibility was facilitated from the outset by:
    a) a clear treaty-based monetary policy framework (Maastricht Treaty, 1992) establishing the ECB
    b) individual central banks following the policies of the leading Bundesbank-like authority

Analytical perspectives on EMU (political science)

• Neofunctionalist approach:
  • EMU best explained as spillover and incremental policymaking; success of the exchange rate mechanism and single market completion necessitated further monetary integration
• Intergovernmentalist approach:
  • EMU best understood by examining the interests and bargaining behavior of the largest member states (e.g., France to counter German influence; Germany to reinforce its commitment and secure a near-domestic-like monetary regime)

Closing note

• Thank you for engaging with the material on EU economic, monetary and fiscal policy and the various theoretical perspectives on EMU