Background Information On The Euro And Euro Area

Background information on the euro and euro area

THE EURO AREA

Which Member States form part of the euro area?

The euro area was established on 1 January 1999, when 11 of the then 15 European Union Member States adopted the euro by irrevocably locking their bilateral exchange rates. The 11 were: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. Greece adopted the euro in 2001.

The euro banknotes and coins were introduced on 1 January 2002, after a transitional period of three years (one year in the case of Greece) during which the euro could be used as book money, while national banknotes and coins were still used in cash payments.

Slovenia was the first of the 10 European countries that joined the EU in 2004 to adopt the euro, on 1 January 2007. Cyprus and Malta will follow on 1 January 2008, bringing the number of euro-area Member States to 15. The euro area will then include 318 million out of the EU's total 493 million population (see IP/07/1982).

How big are Cyprus and Malta?

Cyprus had a population of 778,684 at the beginning of 2007 and Malta 407,810. They are the two smallest economies of the euro area, contributing 0.17% and 0.06% respectively to the area's GDP, and 0.24% and 0.13% to its population.

In 2006 Cyprus's GDP per capita was 92% of the EU average. Malta's was 77% (see Eurostat release STAT/07/179 of 17 December 2007)

What about the other 12 EU countries?

As of January 2008, of the 12 EU countries that have not yet adopted the euro, 10 have what is known as a derogation, which means that they do not presently fulfil the necessary conditions to fully participate in the final stage of Economic and Monetary Union (= adoption of the euro). They are the Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland and Slovakia (of the group that joined the EU in 2004), Bulgaria and Romania, which became EU members in 2007, and Sweden.

Denmark and the United Kingdom have opted to stay out for the time being, and negotiated two Protocols to that end which are annexed to the Maastricht EU Treaty. However, the new Danish government announced in its programme on 22 November 2007 that it wished to give the Danish electorate the possibility of a fresh vote on the opt-outs concerning the euro and three other EU policies.

Which EU countries are likely to adopt the euro next?

The Treaty expects all EU Member States to adopt the single currency. However, as euro adoption is dependent on the Member State's compliance with the economic and legal criteria laid down in the EU Treaty, this question cannot be answered in advance of those criteria being met.

Being open economies, the Member States concerned will benefit from euro adoption provided the conditions of entry are right and the economies are sufficiently flexible to operate under the single monetary policy. Thus, they should strive to pursue sound macroeconomic and budgetary policies to prepare their economy and meet the required criteria in a sustainable way.

The country with the closest target date for adoption of the euro is Slovakia, which aims to do so on 1 January 2009. The Commission and the ECB will assess the fulfillment of the degree of convergence reached by all the Member States with a derogation - including Slovakia - in their next regular convergence reports in spring 2008. Romania has set its target date at 2014. The other EU countries with a derogation have no specific target date but have expressed the intention to switch to the euro at some point between 2010 and 2014.

THE QUALIFYING CRITERIA AND TECHNICAL PREPARATIONS

What are the Maastricht criteria?

According to Article 121 of the EU Treaty, the Commission and the ECB must examine whether a country satisfies the following conditions in a sustainable way:

* the achievement of a high degree of price stability;

* sustainability of public finances;

* observance of the normal exchange rate fluctuation margins provided for by the Exchange Rate Mechanism ERM for at least two years,

* durability of the convergence achieved by the Member State and of its participation in the ERM, as reflected in long-term interest-rate levels.

These four criteria are further elaborated on in a Protocol annexed to the Treaty which states that:

* The criterion on price stability means that a Member State must have a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1.5 percentage points that of, at most, the three best performing Member States in terms of price stability.

* The criterion on the government budgetary position means that at the time of the examination the Member State is not the subject of a Council decision under Article 104(6) of this Treaty that an excessive deficit exists. The Commission last assessed the convergence progress of all countries concerned in December 2006[1]. In May 2007 it concluded that Malta and Cyprus, which had asked for Convergence Reports, were ready to adopt the euro.[2] The next regular report will be published in the spring 2008.

What is the procedure for the adoption of the euro by a Member State?

The procedure for the adoption of the euro is set out in Articles 122 and 123 of the Treaty and specifies that every two years, or at the individual request of an EU country, the European Commission and the European Central Bank will report on the progress made in fulfilling the "Maastricht" convergence criteria.

On the basis of a proposal from the Commission, and after consultation of the European Parliament and discussion by the Heads of State or Government, the Council decides whether or not a country can adopt the euro.

It is also the Council, on a proposal from the Commission and after consulting the ECB, which adopts the conversion rate at which the national currency will be irrevocably fixed to the euro.

What practical preparations are necessary in a country preparing for the adoption of the euro?

National authorities are responsible for preparing and co-ordinating the preparatory work for the introduction of the euro: the framework document they prepare is called a national changeover plan.

This includes setting a target date for the introduction of the euro and appointing a committee to deal with the changeover details, which range from the duration of the period during which the euro will circulate alongside the legacy currency and when banks and shops start receiving euro cash to arrangements for extended bank opening hours around €-day and, of course, a comprehensive information campaign of all those involved, including the population itself. Unlike the original launch of the euro, when countries waited three years after the launch of the currency before introducing euro cash, most countries that have made changeover plans intend to make the transition in a 'Big Bang' scenario. This is what Slovenia did and what Cyprus and Malta will do as well.

The Commission issues regular reports on the state of practical preparations for the enlargement of the euro area. The last one was published on 27 November 2007.[3] Past experience demonstrates that comprehensive preparations, begun well in advance, are crucial for a smooth changeover

What is ERM II?

ERM II is an exchange rate mechanism in which participating currencies fluctuate within a specified margin (+/-15%) around a stable but adjustable central rate defined against the euro. It is a 'training ground' for the euro. ERM II replaced the European Monetary System and the original ERM in January 1999, when the euro was launched. A minimum of two years of participation without severe tensions in this mechanism is expected before euro adoption can be considered.

An agreement between the ECB and the national central banks of the Member States outside the euro area lays down the operating procedures for ERM II.

The present members of ERM II are Estonia and Lithuania, which joined on 28 June 2004, Cyprus, Malta and Latvia (2 May 2005), Slovakia (28 November 2005) and Denmark (1January 1999). Cyprus and Malta will leave the mechanism once they are in the euro area.

THE EURO AND THE EVOLUTION OF PRICES

The evolution of prices has been exceptionally good since the launch of the euro, with most Member States registering their lowest inflation rates for five decades[4]. This is despite a series of adverse shocks including an increase in oil prices, which have more than trebled in dollar terms since 2003.

In the 1970s, when oil prices also increased significantly, although not as much as in the last four years, average inflation rates reached more than 9%. When the Maastricht Treaty was approved by the Heads of State or Government at the European Council in Maastricht in 1991, the average inflation rate in the Member States which now form the euro area was around 4%. By comparison, since the launch of the euro annual inflation in the euro area has averaged 2.1%.

The euro changeover in the first group of countries in 2002, and more recently in Slovenia, is estimated to have caused a one-off increase in prices of 0.1-0.3 percentage points. This means that if the average price rise in the year of the changeover was € 2.30 for a € 100 basket of purchases, no more than thirty cents of this increase can be attributed to the euro.

For more information on the euro see the leaflet How the euro benefits us all and DG ECFIN's website:

http://ec.europa.eu/economy_finance/the_euro/

[1] See 2006 Convergence Report on:

http://ec.europa.eu/economy_finance/publications/specpub_list9259.htm

[2] See 2007 Convergence Reports on Cyprus and Malta on:

http://ec.europa.eu/economy_finance/publications/specpub_list9259.htm

[3] Available at:

http://ec.europa.eu/economy_finance/publications/publication_summary10508_en.htm

[4] See the decline of inflation volatility in the euro area in the last Quarterly Report on the Euro Area, Volume 6, N°4 (2007) available at:

http://ec.europa.eu/economy_finance/publications/quarterly_report_on_the_euro_area_en.htm

ENDS

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