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European Monetary Union - ppr July 2006 2.qxp 15:39 Page...

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Perhaps the only clear lesson for the England football team from the World Cup is that a necessary though not sufficient condition for winning the FIFA trophy or even getting beyond the quarter finals is to join the euro. The key is not whether England has a Swedish or English or Brazilian football manager (note: Sweden is also a non member of the euro and also took an early bath in Germany) but rather whether Jean-Claude Trichet rather than Mervyn King manages the currency. The World Cup performances of Italy, France, Germany and Portugal – all bad boys of European monetary union (EMU) in recent years – have been among a number of indicators that things are getting better in the eurozone. Nonetheless, EMU faces three specific challenges over the next few years: first on the domestic policy mix; second on the implications of unwinding global economic imbalances; and third on how to manage the queue of potential new members in central Europe. The last has some implications for Britain should the essentially political blockages to EMU membership ever be removed. Most of this essay will concentrate on the domestic challenge, not least because the euro like the dollar floats against the rest of the world and because it is domestic policy that dominates all other considerations. The domestic policy challenges EMU is now some seven years old. The managers of the system at the European Central Bank (ECB), in Brussels and in national capitals, have gone through some torrid times, particularly as the exchange rate against the dollar first fell like a stone and then more slowly recovered. Inflation has been consistently above target at the eurozone level but this has hidden wide disparities across member states with some recording inflation above 5 per cent while others, notably Germany, had price growth fall below 1 per cent. Growth faltered in the core economies and above all in Germany after 2000 with consequent ballooning of budget deficits in France and Germany in particular. Since deficits did not fall when growth was more buoyant in 1999 and 2000, the increase started from a high base. The result was the failure of the Stability and Growth Pact (SGP), designed to maintain fiscal discipline within the eurozone. France and Germany, and latterly Italy, found it impossible to maintain budget deficits below 3 per cent of GDP or to bring them back in line on the timetable required by the EU Commission and their partners. They faced no sanctions for these failures as the system demanded. Instead the system was reformed in March 2005, to make it easier for them to comply; allowances that were not given to smaller countries when they were previously found to be in Excessive Deficit. This reduced the political credibility of the system among participants and in the eyes of the ECB. (This manifest weakening of the system seems, however, to have brought little if EMU Three challenges Professor Jim Rollo Sussex University research policy public © 2006 The Author. Journal compilation © 2006 ippr
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