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What kind of convergence does the euro area need?
  • The Economic and Monetary Union has failed to generate convergence for its member states in the area of economic performance. It is true that the Single Market Act of 1986 was followed by rapid convergence write Anna Brinke, Henrik Enderlein, and Joachim Fritz-Vannahme. 
    . However, since the introduction of the euro there has been slow and steady divergence. Why did this happen?
  • It was clear from the beginning that the euro area would need far more convergence than other currency unions. As early as 1989 the Delors Report, which paved the way for the adoption of the euro, emphasized the need for greater convergence in economic performance. The Maastricht Treaty and the Stability and Growth Pact both focused on convergence. However, they were inad- equate. The Maastricht criteria applied only to the period before a state entered the euro area, and the Stability and Growth focused on deficit and debt rules.
  • By 2008 it had become evident that the rules had failed to prevent the growth of imbalances within the euro area. This led to the introduction of the Macroeconomic Imbalance Procedure (MIP), which was designed to pro- vide a more nuanced view of the overall macroeconomic picture. Since its introduction in 2011 the MIP score- board has shown in detail how member states started to diverge in the 2000s.

The study shows that three important lessons can be learned from all this. First, we need a better under- standing of convergence. And we need to prioritize and ask how much convergence is strictly necessary for the survival of the euro area. Second, we need a more balanced approach to convergence in the euro area. It should include prices, public spending, competitiveness and the external balance. Third, we need clear-cut rules based on the best available indicator which can provide guidance for policy-making and help to detect prob- lems before member states begin to embark on diver- gent trends.

• In this study, we argue that the euro area is a special case because it lacks adjustment mechanisms that are needed to correct imbalances, and has a single market that is far from being complete. In addition, monetary policy by the European Central Bank can only be effec- tive if the member states have very similar inflation rates. For these reasons the euro area needs more nomi- nal convergence than other monetary unions.

• We argue that we need simpler convergence goals and indicators. In order to be stable, the euro area needs (i) price stability in the form of small inflation differen- tials, (ii) competitive member states that can maintain a balance between wage growth and productivity rates, and (iii) a balanced external position. There may well be short-term differences as economies adjust. However, over the course of a business cycle these should be no more than minor deviations.

The study pays close attention to the feasibility of the reform proposals. How to get the right kind of con- vergence in the euro area ought to be a priority in the current policy debate. Thus the next steps should focus on the integration of binding compliance criteria into the existing economic governance framework. The new targets should be combined with an improved compli- ance mechanism. Convergence cannot resolve all of the stability design flaws of the euro area, but it is both necessary and a pre-condition for future reforms.

This study was commissioned by The Bertelsmann Stiftung and the Jacques Delors Institut Berlin. A full version can be found at :- http://www.strengthentheeuro.eu/fileadmin/files/BSt/Publikationen/GrauePublikationen/Studie_EZ_What_kind_of_convergence_does_the_euro_area_need_2015.pdf
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