Economic Convergence and Monetary Union

Abstract

The Maastricht Treaty has acknowledged, and translated into precise criteria and indicators, the need for increased economic convergence to enter the final phase of Economic and Monetary Union (EMU). In this paper, we examine the improvement in the process of economic convergence since the creation of the EMS in 1979 and until mid-1992, as well as the expectations of market participants on the evolution of the process over the period 1992–96. We also try to assess the extent of the adjustment still to be made by comparing it to the adjustment already implemented during the 80s. We reach four main conclusions:

• (i) Economic convergence, expressed in terms of inflation, interest, and exchange rates, has improved considerably during the life of the EMS, but remains incomplete and differentiated amongst countries

• (ii) Market participants do not expect a significant improvement in the convergence process over the next five years

• (iii) The adjustment still to be made, which should basically affect the budget deficit and the rate of inflation, seems to be beyond the reach of Greece, extremely demanding, but not impossible, in the case of Italy, Spain and Portugal

• (iv) Successful adjustment policies and confidence of market participants on the results of such policies are thoroughly interlinked and cannot survive in isolation.

The opinions expressed are the authors’ and do not necessarily reflect those of Banca d’Italia. The help of G. Boccuzzi, G. Cellai, S. Leoni, F. Panfili and D. Porciani in preparing the statistical material is gratefully acknowledged. The paper has been written and presented before the crisis of August-September 1992 in the EMS which led to the devaluation, and then to the suspension of compulsory interventions for the lira, the abandonment of the ERM by the pound, the devaluation of the peseta, as well as to severe tensions for other currencies in the system. These events will have important consequences for the achievement of economic convergence and monetary union which are not taken into account in this paper. By accident, or because of policy mistakes, the smooth transition towards EMU illustrated in this paper will not be achieved. The analysis of the options available after the crisis to achieve convergence and EMU is for another paper.