Marcro micro econmiy david begg chapter 035

Chapter 35
European integration

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith


Some key issues
■

The European Single Market
–

■

Economic and Monetary Union (EMU)
–
–

■

what difference did it make?
why did it happen?
What difference will it make?

Reform in Eastern Europe
–

how are these countries faring in their
transition from central planning to market

economies?
35.2


The Single Market

with December 1992
as the target date for
completion
–

which was met

6000

400
350

5000

300

4000

250

3000

200
150

2000

millions

■

Established under the
Single European Act
of 1987

billions of ECUs

■

100

1000

50

0

0

EU

USA Japan

GDP (LH scale)

Population (RH scale)

35.3


Objectives of the Single Market
■

Abolition of remaining foreign exchange
controls on capital flows

■

removal of non-tariff barriers within the EU

■

elimination of bias in public sector
provisioning

■

removal of frontier controls
–

■

with some provisos

progress towards harmonization of tax rates

35.4


Benefits of the Single Market
■

Improved resource allocation
–

■

Scale economies
–

■

larger potential market increases the scope for economies of
scale

Intensified competition
–

■

removal of non-tariff barriers allows more exploitation of
comparative advantage

may stimulate greater cost efficiency

Factor mobility

–

enables greater efficiency through mobility of labour and capital

35.5


Gains from the Single Market

% of initial GDP

25
20
15
10
5
0

F, D, I,
UK

Den

Low

2

2

3

High

3

5

4

NL, Sp B,Lux

Ire

Gr

Port

4

4

5

19

5

10

16

20

Source: Allen, Gasiorek and Smith (1998)

35.6


From EMS to EMU
■

■

A monetary union has
–

permanently fixed exchange rates within the union

–

an integrated financial market

–

a single central bank setting the single interest rate
for the union.

The Maastricht Treaty set criteria for EMU entry
–

■

to define ‘convergence’

The single currency area began in January 1999 with
11 member countries.

35.7


The Maastricht criteria
■

Inflation rate
–

■

Long-term interest rate
–

■

in the narrow band of ERM for 2 years

Budget deficit
–

■

no more than 2% above the average of the lowest 3 EMS
countries

Exchange rate
–

■

no more than 1.5% above the average of the inflation rate of the
lowest 3 countries in the EMS

no larger than 3% of GDP

National debt
–

no greater than 60% of GDP

35.8


Sterling and Europe
UK membership of ERM/EMU? UK trade patterns
North Sea oil made the UK different
The UK is less integrated
with the rest of Europe
– but this is changing ...

% of UK
trade

60
50
40
30
20
10
0

The UK has a greater tradition of
macroeconomic sovereignty.
Black Wednesday and the ERM crisis
The UK’s business cycle was out
of phase with the rest of Europe.

1972

1998

35.9


The economics of EMU
■

Optimal currency area
–

■

a group of countries better off with a
common currency than keeping separate
national currencies

3 key attributes (Mundell)
–
–
–

countries that trade a lot with each other
countries with similar economic and
industrial structures
flexibility in labour markets
35.10


So is Europe an optimal currency area?
■

Europe is ‘quite’ but not very closely
integrated

■

Some countries are more closely
integrated than others

■

but the act of joining may itself feed

the process of integration

35.11


Macroeconomic policy
for a small member of Euroland
A small Euroland member
faces a horizontal LM curve,
given that interest rates are
fixed by the ECB.
Suppose an external shock
moves the IS curve to IS1
If the country is too small
to influence the ECB to alter
interest rates, either the
country must wait for wage &
prices to shift IS back via
improved competitiveness,

IS1

IS0
LM

r0

or fiscal policy will be required to
enable more rapid adjustment.

Y1

Y0
35.12


Central and Eastern Europe
GDP per capita in 1988/89

0

5000

10000

15000

20000

US$

35.13


Eastern Europe:
some key issues
■

■

On the eve of transition
–

low per capita income

–

high international debt

Supply-side reforms
–

■

■

crucial for prices to reflect true scarcity

Trade and foreign investment
–

markets needed for products

–

and physical capital/management skills

Macroeconomic conditions
–

firm and credible macro policy needed

–

especially to avoid excessive inflation.

35.14


10
5
1998

1997

1996

1995

1994

1993

1992

-5

1991

0

1990

700
600
500
400
300
200
100
0

Growth of real GDP

Inflation

% p.a.

% p.a.

A progress report on the transition

-10
-15

Hungary
Romania

Poland
Bulgaria

Hungary
Romania

Poland
Bulgaria

35.15