Does The Maastricht Convergence Criteria Work?

During its 13 year history, the euro area experienced the most severe economic downturn in the late 2000s as a result of the 2007 financial-economic crisis stemming from the US banking sector. The crisis in the monetary union, besides posting a significant economic and social cost, revealed several weaknesses not just of the currency block as a whole, but also of its constituting members, which were masked by the prosperous economic environment characteristic for the 2000s. These conditions have put to the test the solidarity among the euro zone members, or in other words the existence of the currency block. One important problem of the currency block is the lack of harmony between the fiscal and economic policies of the member states, creating several and occasionally very divergent parts of the currency block. The aim of this research is to enhance the Maastricht convergence criteria'(tm)s and the Stability and Growth Pact'(tm)s role as a monitoring mechanism, allowing them to become more informative tools for the policy makers. For this, based on the relevant literature, we propose new potential explanatory variables which could enhance the role of the Maastricht convergence criteria and the Stability and Growth Pact. Some of the studied variables, like indebtedness of the private sector, capital flow compared to the size of the economy, government revenue compared to total public debt and current account balance help in enforcing the nominal convergence, while others (real labour productivity) contribute to the real convergence. The explanatory power of the proposed variables are investigated in the case of France, Germany, Greece, Ireland, Italy, Portugal and Spain for the period comprised between 2000Q1-2011Q4. Results of the research show that with the exception of government revenue compared to total public debt, all proposed variables have significant explanatory power regarding the evolution of the state of the economy in all seven countries analyzed. France and Germany, characterized by healthy fiscal and economic policies is also exposed to risks stemming from the evolution of the private debt. In case of Greece, Ireland and Spain the high current account deficit represented a significant explanatory variable, while the outstanding loans to the private sector proved to be significant in the case of Ireland, Italy and Portugal. The significance of real labour productivity for Greece and Italy proves that real convergence should also be obtained beside nominal convergence by economies in the currency block. All significant variables had explanatory power through their lagged value, hence counterbalancing policies can be elaborated in a timely manner in order to stabilize the economy if signs indicate a potentially unsustainable economic path.