by George Dorgan
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In this post we examine the reasons for the euro crisis. The following slide set from Thomas Mayer, from Frankfurt University, former Deutsche Bank chief economist gives a very good summary of the reasons for the European debt crisis.
(if the file does not show up in the PDF viewer, here the direct link)
He shows divergences in Taylor rate and labor costs among the members. On the last pages he speaks of a harder “Northern Euro” that could remain a virtual currency, but helps the “Latin”, Southern member states to gain relative competitiveness.
The creation of the euro was based on the Maastricht treaty. In the following we will present the convergence criteria of this treaty and how they look today.
The Maastricht Treaty and its Convergence criteria
The Pact for Growth and Stability, the so-called “Maastricht Agreement” foresaw several so-called convergence criteria (source Wikipedia).
1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing member states of the EU.
2. Government finance:
Annual government deficit:
The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.
Government debt:
The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.
3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devalued its currency during the period.
4. Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states.
The government debt rule was quickly excluded from the decision about which countries could obtain the euro.
The Maastricht treaty was more and more weakened between 2003 and 2007. During a phase of slow German growth, chancellor Schröder urged European leaders, to provide more flexibility and to temporarily weaken the 3% rule for the deficit.
2012 Maastricht criteria are ad absurbum
The Maastricht criteria are completely at odds.
Especially criteria 4 (no divergence of long-term interest rates) has been violated:
Only during the period between the euro introduction and 2009 it could hold.
The picture changes again in 2013
Austerity helped to reduce deficits, while the European austerity and tighter U.S. monetary policy helped to stop the strong expansion. Global dis- and deflation reduced government bond yields in the periphery.
