Ten years of monetary union in retrospect

1 January 1999 saw the start of the third and final phase of European Economic and Monetary Union (EMU). Ten years on, membership has expanded from the initial 11 members to reach 16 countries by January 2009. This article reviews the first decade of monetary union from a number of angles. Monetary policy under EMU managed to secure historically low inflation, thereby creating the conditions for sustainable economic growth. Despite large relative price movements stemming from globalisation, inflation expectations remained well-anchored at levels consistent with price stability. The high degree of price stability did not come at a cost in terms of less stable economic activity as both inflation and output volatility have declined markedly in the euro area over the past decade, as was the case in other industrialised countries too. The current financial turmoil nevertheless poses a serious challenge for monetary policy and it may well require swift and rapid action, as already illustrated by the Governing Council’s decisions to cut interest rates. Also, the Eurosystem’s operational framework has been used flexibly in order to accommodate euro area banks’ demand for liquidity. Before EMU, financial crises tended to hit countries with poor macroeconomic frameworks harder, so monetary union and its unified policy framework have clearly prevented financial turmoil putting even further pressure on individual Member States. Fiscal policy during the first ten years of monetary union cannot be described as an unqualified success as not all Member States reached their initial targets and their subsequent medium-term objectives set out in their respective Stability Programmes. Taking into account the consequences of population ageing, such fiscal policy shortcomings might endanger the sustainability of public finances in future. The introduction of the euro lowered trade costs within EMU, leading to higher international trade flows which in turn fostered price convergence. Financial market integration varies considerably across different market segments with markets closer to monetary policy displaying further integration. The standard of living in the euro area is well below that in the US and has not changed much during the first decade of monetary union. Further structural reforms and the deepening of the Single Market should strengthen Europe’s productive potential and the higher labour market participation rates should be sustained. Growth and inflation differentials in the euro area are relatively small in relation to historical trends and when compared with other monetary unions. Although these differences are not necessarily problematic, the good functioning of a monetary union depends crucially on the efficiency of adjustment mechanisms, such as the competitiveness channel that works through the real effective exchange rate, as illustrated by Germany and the Netherlands, for instance. The overall balance of Belgium’s participation in EMU is positive. However, the recent sharp surge in inflation raises questions about the functioning of product markets, in particular for energy, and also highlights the importance of wage moderation. Big challenges lie ahead for EMU. First and foremost, the financial turmoil poses a significant challenge for monetary policy and for safeguarding financial stability. Secondly, population ageing requires further consolidation of public finances. Structural reforms in product and labour markets can help make this budgetary challenge more manageable and further raise standards of living. Finally, the enlargement of monetary union to other EU Member States might entail more heterogeneity in the euro area, thus requiring efficient national adjustment mechanisms.