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1.2.4.1. Why were countries expected to respect the convergence criteria or "Maastricht criteria" before adopting the euro?

Past monetary disorder in Europe has been the consequence of lax monetary and fiscal policies, which were also too divergent from one country to another.  According to current arrangements, the economic policies of EMU remains the responsibility of member states, but they arise from a "common interest".

For the sake of the long-term future of EMU and the stability of the single currency, the countries that wish to join should avoid divergent economic policies.  Respecting the convergence criteria reflects the will of each country to adopt a long-lasting economic culture, which, is does not depend on monetary policy to correct weaknesses.

The convergence criteria, by Chris Huhne.  
Visual aid

To maintain a common reference interest rate in a monetary union of countries pursuing independent economic policies, it is necessary for these countries to have similar rates of inflation* and coherent budgetary policies.

Two additional considerations: Firstly, it is necessary to avoid leaving countries which followsound budgetary policies paying for those which follow lax policies.  Secondly, it is not necessarily in the interest of a country to accept the rigour of EMU monetary management standard, if its own economy has not been prepared.  The result would be a loss of competitiveness and jobs, which would quickly become socially unacceptable.

After their entry into the EMU, countries maintain their budgetary and fiscal autonomy, given the lack of European harmonisation in these areas.  In return, they are expected to respect the terms of the Stability and Growth Pact (see the chapter dedicated to this subject) which reiterates the same norms for the management of public finance as those required by the convergence criteria.

1.2.4.2. What are the convergence criteria?

The Treaty of the European Union sets out four criteria.

Article. 109 J.1 : « The reports [of the EC and the European Monetary Institute (EMI)] will examine (over and above the adaptation of the national legislation and the independence of the Central Bank* from political power) if an elevated degree of long-term convergence has been achieved, analysing to what extent each member state has satisfied the following criteria:

• the achievement of a high level of price stability - this arises from an inflation rate close to that of the three member states with the lowest inflation rates;
• public finance characterised by long-term sustainability: the budgetary deficit* and total gross national debt should not go beyond certain limits;
• the respect for the normal fluctuation margins* foreseen by the exchange mechanism of the European Monetary System (EMS), without devaluation of the currency with respect to another member state, for a period of at least two years;
• the durable character of the convergence achieved by the member state and its participation in the exchange mechanism of the EMS, reflected in the level of long-term interest rates.

Evolution in the convergence critera from  1995 to 1997.
© Promeuro - Illustration 1.2.4.a

1.2.4.3. What are the levels to be respected?

• Inflation should not exceed that of the average of the three best performing countries by more than 1.5%
• Regarding public finance, the financial requirements of central, regional and local administrations (including social security) should not exceed 3% of the Gross National Product (GNP*) and the gross debt should not be more than 60% of the GNP.  This double criterion concerning public finance led commentators to state, that there were five criteria.
• For long-term interest rates, the rates for state borrowing should not exceed that of the average of the three states with the lowest inflation by more than 2%.

For the launch of the euro in 1999, the levels measured will be those indicated in the official statistics for the year 1997.

Convergence of  inflation rates for the countries of the EU from 1990 to 1997.
© Promeuro - Illustration 1.2.4.b.

1.2.4.4. Could the convergence criteria be relaxed?

Any relaxation of the convergence criteria, for example to soften their impact on social conditions, would require a  unanimous decision of all those who signed the Treaty.  This is unlikely.  The Treaty makes allowances, in the criteria related to public debt, a certain tolerance available to the Council, without the necessary of resorting to a modification of the Treaty.  The choice of members of the EMU, is "founded" on these criteria, but does not require their strict application.  This is why Belgium and Italy (who have a public debt in excess of 100%) were considered as eligible countries, while Greece was required to take additional measures.  This is the evolution in which the levels of the criteria are taken into consideration, both for countries which are already members of the EMU, as well as for future candidates.


Evolution of the public deficit from 1993 to 1997.
© Promeuro - Illustration 1.2.4. c

Debts in euro per inhabitant and as a % of GDP in 1997.
© Promeuro - Illustration 1.2.4.d

Specifically, the exchange rate criterion* serves to verify that a country is capable of managing its economy without necessity resort to parity alterations*.  Thus it is a requirement that the currency of a country has participated in the exchange rate mechanism for at least two years, without overstepping the fluctuation margin* of 2.25% each side of the central rate.

In March 1998, ten currencies had adhered strictly to this criterion: the Belgian Franc (BEF), the Danish Crown (DKK), the German Mark (DEM), the Spanish Peseta (ESP), the French Franc (FRF), the Irish Pound (IEP), the Luxembourg Franc (LUF), the Dutch Guilder (NLG), the Austrian Schilling (ATS) and the Portugese Escudo (PTE).

The vast majority of currencies which took part remained grouped near their pivotal rates* during the reference period (March 1996 to February 1998), with the exception of the Irish Pound, which remained above its central rate over an extended period : in March 1998, a revaluation of 3% took place with respect to other currencies.

The Finish Mark and the Italian Lira joined the exchange rate mechanism in October 1996 and November 1996 respectively, i.e. less than two years after their acceptance.  These two currencies did not experience serious pressures during the two years of the reference period.

Three currencies did not participate in the exchange rate mechanism during the reference period, the Swedish Crown, the Pound Sterling (GBP) and the Greek Drachma (GRD).  The last mentioned joined the exchange rate mechanism in March 1998.

It should be noted, moreover, that, within the convergence process, less developed countries could have a more rapid economic growth rate and a higher inflation rate than the more advanced countries (Balassa-Samuelson Effect).  A certain degree of flexibility with respect to this criterion is, therefore, justified.

Finally, the maintenance of the currencies of candidate countries within the limits defined by the European Monetary System (EMS) over a period of two years, has the effect of hindering the monetary authorities in these countries from letting their currency adjust to a level which is economically correct, before fixing it definitively to the euro.  This is particularly the case for the United Kingdom which was shaken by the unfortunate episode of "Black Wednesday" in September 1997, when the GBP was rudely forced out of the EMS due to economic policies which were too divergent from those of the continent and massive speculation.

Historical evolution of relative exchange rates of several EC currencies (DEM, FRF, GBP, etc.)  with respect to the ECU.
© Promeuro – Illustration 1.2.4. e  

Historical evolution of relative exchange rates of several EC currencies (ITL, ESP, GRD, etc.)  with respect to the ECU. Illustration 1.2.4. f
© Promeuro - Illustration1.2.4.4. (d) 

1.2.4.5. Why were the convergence criteria subject to criticism?

The initial steps toward convergence in Europe took place during a period of profound economic recession and resulted in an high rate of unemployment.  Moreover, these steps required certain countries to undertake structural adjustments which result in social hardship.  Ordinary citizens gained the impression (and not unreasonably) that it was the most vulnerable members of society who suffered the most as a result of this type of social reform.  Similar effects were seen as a consequence of structural adjustments in underdeveloped countries.

Some of the points of criticism aimed at the convergence criteria:

• the levels expected to be achieved, given the gaps between these and the current situation in certain countries,
• their effect on economies which are weaker than others, and the price in terms of social hardship,
• the short time scale for achieving them, 
• their appropriateness at a time of profound economic crisis,
• the priority given to them once the EMS comes into existence.

The principle of a larger economic convergence within the EU has seldom been called into question. The principle of stability for the future single currency is a demand put forward by consumer associations.  The convergence criteria formed part of the Treaty ratified by all member states.  Past instability of exchange rates between European currencies necessitates that each future member of the EMU demonstrate a commitment to follow a rigorous monetary management policy before being allowed to enjoy the benefits of the euro.  That is why it is essential that the terms of the Stability & Growth Pact adopted by the Dublin European Council meeting in December 1996 be respected.


Hans Tietmeyer

 "The entry into the Monetary Union constitutes the foundation of a community of solidarity, and even a commonality of risks, which requires for its long-term survival, the links of a wider political integration."

Hans Tietmeyer*, President of the  Bundesbank, in the French newspaper  "Le Monde", 15 Febrary 1995.

1.2.4.6. Was there a risk that the EMU would either not take place or be postponed?

From 1997 onward most observers considered as minimal the risk of postponement of the date (January 1999) of the creation of the euro.  Nevertheless financial analysts noted the following events as possible causes of postponement:

• major movement in the money markets, which could put in jeopardy the increasing cohesion observed in previous years in the EU states along with the pursuit of a economic convergence;
• the countries acting as the driving force of the EMU becoming unable to satisfy the convergence criteria in 1998;
• serious and persistent social disorder in reaction to the austerity which could initially follow the stabilisation of public finances, during a period of economic recession, or as a result of profound changes in the European economy, even those independent of a single currency;
• delays in the adaptation to the euro by governments and private enterprise.  Ideally the euro should be used immediately, for example, in the payment of taxes, fixed prices or payment systems;
• refusal by citizens and a large part of the commercial sector to adapt progressively to the euro during the transition phase (1999 to 2002), which could complicate the complete abolition of national currencies in 2002.  Lack of participation by ordinary people constitutes a potential obstacle to the launch of the euro.  This has been identified as a significant risk, particularly by the European Investment Bank (EIB);

The decision taken on 12 September 1997, by the Council of Finance and Economic Ministers (Ecofin), to freeze, from May 1998 onward the cross rates of exchange (in ecu) for the currencies taking part in the EMU had the effect of reducing the risks of momentary perturbation during the sensitive period preceding their conversion into euros on 1 January 1999.

It is to be noted that, despite perturbations in the most significant money markets, which turned out to be more serious than expected (due to serious crises in Asia, Russia or Latin America) the successful measures of stabilisation of public finance and the prospect of participation of the euro had brought the promised stability in the financial markets of the member states.

Convergence of long-term nominal interest rates.
© Promeuro - Illustration 1.2.4.g 

1.2.4.7. What is the longer-term effect of the application of the convergence criteria by the member states before their adoption of the euro?

Respecting the convergence criteria ought to result in a long-term stabilisation of the public finances  in member countries seeking to adopt the euro.  To achieve this, the 11 member countries, which adopted the euro, ratified the Stability and Growth Pact, which confirms the thresholds set as a condition of entry and stipulates that the states will seek to balance their public accounts over the period of one economic cycle (see the chapter on the Stability and Growth Pact).  These were imposed by Germany, in particular, because of the fear that countries with a history of chronic public deficit - particularly France and several Mediterranean countries - would not succeed in maintaining the budgetary rigour adopted before entry into the Euro Zone, and that this would be a threat to the stability of the new currency.

It is admitted that:

• Certain member states, particularly Italy and Greece, presented statistics which did not correctly reflect the extent of their budgetary deficits and their public debt;
• The powers of the European Commission to ensure respect for the thresholds established had been greatly weakened by the European Council;  
• Germany and France organised a suspension in the application of the Pact in November 2003, as a result of their inability to respect the limit of 3% in annual public deficit over a period of several years;
• Mediocre economic conditions in the Euro Zone, with extensive and persistent unemployment, has led to a failure to respect the Pact on the part of several countries;

These factors, however, have not threatened the stability of the euro, at least not for the present, especially given the presence of a similar economic situation in the United States.  It is possible, therefore, to conclude that the application of the convergence criteria has not resulted in a lasting change in the economic culture of the member states, mainly among those who made the least effort toward reconstruction in order to join the Euro Zone.  Certain promoters of the euro have not hesitated to state publicly that the euro had possibly been launched too soon, because the stability afforded by the euro enables countries with chronic budgetary deficits to continue their economic policies without suffering a monetary correction on the international markets.

1.2.4.8. How reliable are the national statistics employed to measure the achievement of the convergence criteria ?

For the launch of the euro in 1999, the values of levels to be measured will be taken from the official statistics for the year 1997.

Doubts have been raised  regarding the reliability of the statistics for inflation and national debt originating from certain countries, including Italy, Portugal and Greece, a considerable time after their entry into the Euro Zone.

These EU economic statistics have been collected and analysed by EUROSTAT,  a branch of the European Commission.  Here is the response of Eurostat to the question raised:

« In order to assure the comparability of  figures employed for measuring the respect for the convergence criteria, Eurostat (the branch of the European Commission which collects and disseminates statistics within the EU) has developed legislation in the relevant domains, with the close cooperation  of the member states, as well as procedures to guarantee the respect for the convergence criteria.  Eurostat does not collect the figures directly from the declarations, but rather from the relevant statistical authorities.

In the specific case of fiscal statistics, the figures employed are those defined within the framework of national accounting, and (more precisely) within the economic system of the integrated accounts, SEC 95.  The fact that the indicators employed for measuring respect of the convergence criteria are defined from a statistical point of view has certainly assisted in assuring reliability.  The development within the member states of  three-monthly accounts for public administration has assisted greatly in improving quality.  Moreover, the reporting of  figures regarding national debt and balance of payments deficit on a statistical basis has obliged member states to maintain a very good level of  internal coordination amongst the groups responsable for various sets of  figures (in the majority of countries of the European Union: the finance ministry, the national central banks, and the national statistical institutions).

On the basis of the statistics supplied by the member states, Eurostat carries out a detailed analysis, including the involvement of delegations to the member states, in order to confirm that the figures supplied conform to accounting principles and are also consistent with the figures supplied by the respective public administration organisations as part of the SEC programme.  In the case of doubt or inconsistency, Eurostat has established a system of consultation with national statisticians."

Further details on the Eurostat website:

http://epp.eurostat.ec.europa.eu/

In the case of the specific countries mentioned,  Eurostat regards the differences to be too small to place in doubt the basis for the decisions taken regarding the integration of these countries into the Euro Zone.  For the most part, they arise from differences in the interpretation of the proposed norms and the timetable for their application.  Eurostat actively contributes to the improvement in consistency and reliability of European statistics.

In the particular case of Greece, which was unable to apply the SEC95 norms in 2004, see:

http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/GREECE/EN/GREECE-EN.PDF

1.2.4.9. Ought the convergence criteria serve as a basis for the entry of new candidate countries into the EMU ?

The member countries of the Union consider that following the creation of the EMU the convergence criteria require adaptation, because they believe that the initial criteria were conceived under circumstances completely different to those of  the present time.  Thus, for example, the requirement for a fixed rate of exchange for two years corresponded to a period in which the majority of currencies were either linked to the German Mark or else constrained to remain within the monetary snake*.  Today the rates of excahnge for possible candidate countries are either managed by "currency boards" and "close links", as is the case for Denmark and the Baltic countries, or else arise from economies aiming to maintain a fixed rate of inflation, with floating exchange rates (the United Kingdom, Sweden, the Czech Republic, Poland).

The problem arises for the latter group of countries, who manage their currencies in conformity to the rules followed by the European Central Bank, of respecting, in addition, the convergence criteria for the exchange rates, if the monetary policy is the same as for the euro, whilst external effects can lead to variations in the exchange rate which excede the limits imposed by the convergence criteria in the form that they were initially formulated.  (?? My reading of this sentence is that it is vague and ambiguous - I have gone for phrase-by-phrase translation.)

In November 2003 the limit of 3% of GDP on public budgetary deficit was dropped from the Stability and Growth Pact and replaced with much stricter rules relating to the management of public finances.  Following this step, what sense does this artificial limit continue to have, particularly in the case of a country whose economy cannot catch up to those of the existing members, except through considerable public expenditure on infrastructure, environmental protection, education, research etc. ?  Given that the members of the EU are supposed to respect the Pact, what interest is served by imposing an additional criterion?

With regard to inflation,  fixing the limit according to the three best-performing countries of the EU is a measure could have been sensible at the time.  Today it is more appropriate to fix it with reference to the average within the Euro Zone, or the limit established by the European Central Bank.  This restriction in particularly severe in countries where gowth is rapid, where an elevated rate of inflation is expected.

Thus it is possible to believe that the criteria employed to judge the capacity of member countries to launch the euro could be modified to take into account the experience gained since the launch of the Euro Zone.