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Köhler calls for new European Union members to strengthen policies before adopting euro

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
February 2004
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Enlargement of the European Union (EU) from 15 to 25 members on May 1 will bring significant benefits for old and new members alike, notably through an expansion of trade, IMF Managing Director Horst Köhler said at a conference on euro adoption in Prague on February 2-3. However, to seize these benefits, both current and new EU members will need to reinforce their foundations for long-term growth and prosperity.

While Europe continues to possess significant economic strengths—including good public infrastructure, a well-educated workforce, and high domestic saving rates—many of its economies have underperformed in recent years compared, for instance, with hubs in Asia, where growth has outpaced Europe by 5 percentage points a year over the past decade, Köhler said. Europe needs to accelerate implementation of structural reforms, especially in its labor and product markets, to ensure that it can take full advantage of its large internal market and compete in the global economy.

Unlike the United Kingdom and Denmark, which have permanent opt-out clauses, the 10 accession countries are all committed to eventually adopting the euro as their national currency. Joining the common currency will deliver a significant boost to economic development through increased trade and financial flows by lowering transaction costs and eliminating market risks, Köhler said. A forthcoming study by IMF staff suggests that, over the long term, euro adoption could raise GDP by as much as 20-25 percent in most Central European countries.

But these gains are not automatic, according to Köhler. The loss of the monetary policy instrument after euro adoption will shift the burden of adjustment to other channels, notably fiscal policy and wage and price flexibility. Western Europe’s own experience of the 1990s showed that while in some countries euro adoption served as an incentive for economic reform and adjustment, in others—espe-cially the larger countries—it did less so.

Early and ambitious fiscal adjustment will help accession countries protect themselves against destabilizing capital flows in the run-up to adopting the euro. In some cases, he said, this adjustment ought to go beyond the requirements of the Maastricht criteria for deficits (below 3 percent of GDP) and public debt (less than 60 percent of GDP). Moreover, financial market supervisory agencies need to be acutely aware of the risks to domestic financial stability stemming from the rapid credit growth that is likely to accompany euro adoption.

New members and the Maastricht criteria

Four conditions—described in the Maastricht Treaty, which sets out the legal principles for Europe’s Economic and Monetary Union—must be met before countries can adopt the euro. The conditions, which must be assessed at a single point in time are

• annual average inflation rate that does not exceed that of the three best performing member states by more than 1½ percentage points;

• annual average nominal interest rate on the 10-year benchmark government bond that is no more than 2 percentage points above the corresponding average in the same three countries;

• a fiscal deficit below 3 percent of GDP and public debt less than 60 percent of GDP; and

• trading of the country’s currency against the euro without severe tensions within “the normal fluctuation margins” of the Exchange Rate Mechanism (ERM2) for at least two years.

The full text of the Managing Director’s speech is available on the IMF’s website (http://www.imf.org).

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