BRITISH MANAGEMENT DATA FOUNDATION

Introduction
The conditions for the start of EMU were introduced by the Maastricht Treaty and this Treaty was principally concerned with the development of the Single Currency and the criteria necessary for the start of the 'Third Stage' of Monetary Union. This stage marks the introduction of the Euro.

Since the Maastricht Treaty was signed in 1992, there have been further developments on the conditions that Member States which join the Single Currency must meet. These have been consolidated into the 'Stability Pact', which essentially requires the joining States to maintain their economies under the same conditions necessary to meet the criteria for entry into the Single Currency. The Stability Pact was discussed by the European Council of Amsterdam in June 1997 and despite reservations by some of the Member States, notably France, it was agreed that the two Regulations which make up the Pact should be formally adopted by the Council.

In addition to discussing the Stability Pact, the European Council adopted a Resolution on the fundamental principles and elements of the new Exchange-Rate Mechanism (ERM II), which would operate for those Member States which did not join the Euro on 1 January 1999. The national currencies would be allowed to fluctuate by 15% from the central rate.

The purpose of the Economic and Monetary Policy is to provide a legal framework for Economic and Monetary Union, leading to the establishment of a single currency, which was formed at the start of the Third Stage on 1 January 1999.

The structure of the policy was formed in 1989 following a report of the committee of European central bankers under the chairmanship of the Commission President Jacques Delors; the report is known as 'The Delors Report'.

The policy identifies three stages, of which the First, begun on 1 July 1990, was already under way before the Maastricht Treaty was ratified. This stage concerned the start of the Exchange Rate Mechanism. The Second Stage started on 1 January 1994, and related to the transfer of monetary and economic policy, including exchange rate policy, to the European institutions. The Treaty does not describe the detailed methodology of how the Single Currency and the irrevocable fixing of parities will take place.

The date for the start of the Third Stage was agreed at the Madrid Summit on 15 - 16 December 1995 where the European Council agreed that the date should be 1 January 1999 In addition, it was agreed that the Single Currency would be called the Euro.

Criteria for the Single Currency
The criteria for entry to the Third Stage forms the central part of the provisions of the Treaty and caused concern among the Member States on whether they would be able to meet these strict terms.

Member States had to fulfil the four necessary conditions for the adoption of the Single Currency. These conditions are:
(1): The average rate of inflation is no more than 1½% greater than the three best performing Member States for one year before the agreement for the start of the Third Stage.
(2): There is no excessive budget deficit. The two criteria used to assess budgetary discipline are:
(a): the ratio of the planned or actual government budget deficit to GDP at market prices does not exceed 3%;
(b): the ratio of government debt to GDP at market prices does not exceed 60%. These two criteria must either be strictly adhered to or the deficit must be shown to be exceptional and temporary, or it is sufficiently diminishing and approaching the reference values (Article 104.2).
(3): The currency has stayed within the normal fluctuation margins of the Exchange Rate Mechanism over a period of two years before the agreement for the start of the Third Stage, without devaluing against the currency of any other Member State.
(4): The average nominal long-term interest rate does not exceed, by more than 2%, the rates of the three best performing Member States, over a one year period before the agreement for the Start of the Third Stage.

These criteria are shown in two Protocols attached to the Maastricht Treaty. The Protocols modify the strict terms of the Treaty by stating that inflation and interest rates would be measured taking into account any differences in national definitions. In addition, the Council, acting unanimously, would be able to adopt appropriate criteria which would then replace the terms of the Protocols.

In the event, the strict application and interpretation of the criteria were substantially modified by some of the Member States. All the Member States intending to join the Single Currency concentrated their efforts on meeting the criterion of a 3% Government deficit.

Selection of Member States for the Single Currency
Until the start of the Third Stage (the formation of the Single Currency), all fifteen Member States, including those which have not initially joined the Single Currency, were involved in the Council's decision-making and in the committees concerned with the formation of the Single Currency.

The committees were the Monetary Committee in the Second Stage and the Economic and Financial Committee in the Third Stage (although the Council, acting by a qualified majority may define the composition of this Committee and therefore could exclude those Member States which do not join the Third Stage) and the European Monetary Institute (Articles 114, 117, 121 and 122).

Now that the Third Stage has started, the Council, acting by qualified majority and on the advice of the Commission, will decide whether a particular Member State fulfils the criteria for the adoption of a single currency and can therefore join the Single Currency.

The Council's recommendations will be passed to the European Council. The European Parliament will be consulted and its opinion passed to the European Council.

The European Council, acting by qualified majority, on the basis of the reports from the Council of Ministers, the Commission, the European Parliament and the EMI will decide whether it is appropriate for the Member State to enter the Third Stage.

Formation of the Single Currency
The Council, acting with the unanimity of the Member States fulfilling the criteria for acceptance to the Third Stage, adopted the conversion rates at which the currencies are irrevocably fixed and the Euro has been substituted for these currencies. The Euro is now a currency in its own right (the ECU remains the title of the 'basket of currencies').

Where a Member State wishes to join the Single Currency after it has been formed, the Council, acting unanimously, shall agree the rate at which the Euro will be substituted for the national currency of the joining country (Article 123.5).

The European Central Bank was formed at the start of the Third Stage. The capital of the ECB is initially ECU 5,000 million, subscribed by the national central banks of the Member States which enter the Third Stage. In addition, the foreign reserves of the Member States will be passed to the ECB, up to an initial amount of ECU 50,000 million (Protocol of the ESCB and the ECB: Articles 28 and 30).

The calculation of the amounts which each country would have to pay would be based on the relative size of the national population and GDP (Protocol of the ESCB and the ECB: Article 29).

Member States which do not join the Single Currency
Those States which do not meet the criteria will remain in the Second Stage. The United Kingdom and Denmark are not obliged to enter the Third Stage without separate decisions by their respective governments and parliaments and these 'opt-outs' are described in Protocols attached to the Treaty.

The countries which remain in the Second Stage (the "pre-ins") are not involved in the decisions of the Council concerning the ESCB and the ECB now that the Third Stage has started. This also applies to the calculation of the conversion rates of the national currencies of the joining Member States with the Euro, and only those countries which are included in the Single Currency are eligible to vote (Article 123).

The actions of the ESCB and the ECB will not apply and will not have direct effect on the monetary policy of the countries which do not enter Monetary Union. As a result, the national central banks of these countries will be independent of the ECB (Article 122.5 and Protocol of the ESCB and the ECB: Article 43).

The national central banks of these countries will not be required to provide the appropriate portion of funds for the European Central Bank. However, the national central banks may have to contribute to the operational costs of the ECB by paying a minimal percentage of the costs, if the General Council of the ECB decides that they should (Protocol of the ESCB and the ECB: Article 48).

In this situation, the General Council will act by a majority of at least two-thirds majority and half of the shareholders, all of whom will be Member States which have entered the Single Currency (Protocol of the ESCB and the ECB: Article 10).

At least once every two years, the Commission and the ECB will report to the Council on the fulfilment of the convergence criteria by the Member States remaining in the Second Stage, other than the UK. The Council, acting by qualified majority, will decide which of these Member States may join the Single Currency.

The Economic and Financial Committee will continue to monitor the Member States which remain in the Second Stage as regards their monetary and financial situation and general payments system and report regularly to the Council and the Commission (Article 114.4).

The United Kingdom and the other Member States which do not enter the Third Stage will continue to use and issue their own national bank notes.

Each Member State which remains in the Second Stage will continue to treat its exchange rate policy as a matter of common interest and shall respect the framework of the European Monetary System (Article 124).

The Opt-out of the United Kingdom
The opt-out secured by the United Kingdom means that the country does not have to proceed to the Third Stage without a separate decision by the Government and Parliament. As a result, the United Kingdom will maintain its powers in monetary policy and the provisions of the ESCB and the ECB will not directly apply (Protocol on certain provisions relating to the United Kingdom: Articles 4 and 8).

In order for the opt-out to take effect, the UK must notify the Council of its decision not to proceed to the Third Stage (Protocol on certain provisions relating to the United Kingdom: Article 2).

If the United Kingdom does decide to join the Single Currency before the start of the Third Stage (i.e. before the Single Currency has begun), then it must notify the Council within the specified time limits depending on the particular situation:
(1): If the date for the start of the Single Currency has not been finalised before the end of 1997 (and therefore EMU will start on 1 January 1999), the United Kingdom must notify the Council by 1 January 1998.
(2): If the date for the start has been finalised, the United Kingdom must notify its intention to join the Single Currency before the Council of Ministers makes its assessment on which Member States fulfil the criteria for entry into the Single Currency (Protocol on certain provisions relating to the United Kingdom: Article 1).

The terms of the Maastricht Treaty have to a certain extent been over-ridden by the agreement at the Madrid Summit. As a result, the United Kingdom has to inform the Council of its intention to join the Third Stage by 1 January 1998.

If the United Kingdom chooses to enter monetary union after the start of the Single Currency, the Council will be notified and, if the conditions are met, the UK will join the Single Currency and the Bank of England will pay its appropriate share of the capital for the ECB (Protocol on certain provisions relating to the United Kingdom: Article 10).

As the United Kingdom will be represented in the Council and Committees meetings, it will be involved in the discussions leading up to the formation of the Single Currency and the start of the Third Stage, irrespective of whether or not it decides to join the Single Currency.

However, the UK will not be able to vote in matters relating to the ESCB or the ECB, including the appointment of the officials of the ECB. In addition, it will not be involved in the decisions regarding the agreeing of the conversion rates of the national currencies and the ECU (Protocol on certain provisions relating to the United Kingdom: Articles 5 and 7).

Process to introduce the Single Currency
The completion of the transition to EMU is expected to take four years, to July 2002, owing to the complexity of the operation and to allow time for the changes of management and information systems in the participating countries.
The process has been organised into three distinct phases:

Phase A:
This was the period leading up to 1 January 1999 and the start of the Third Stage. This included the European Counci deciding which Member States fulfilled the entry criteria and which should participate in the Single Currency.

During this Phase, the framework for the ESCB and the ECB to operate in Euros was tested, the operational instruments required to conduct monetary and exchange rate policy in the Euro introduced and the transfer of funds from the national central banks to the ESCB took place.

Additional measures included the preparation of the technical specifications of the notes and coins of the Euro and the preparation of each country's transition plans for the introduction and use of the Euro.

Phase B:
This is the effective start of EMU and corresponds to 'Stage Three' described in the Maastricht Treaty. This Phase, also called the 'transitional period', consists of the irrevocable fixing of parities of the national currencies and the introduction of the Euro (in a non-cash form) as from 1 January 1999.

The ECU, representing the 'basket of currencies', was replaced by the Euro at an exchange rate of 1:1.

In order to provide momentum to the introduction of the Single Currency, a 'critical mass' of activities in the Euro would be encouraged.

These activities included the progressive change-over of the banking and financial sector, monetary and exchange rate policy and capital markets to begin operating in the Euro.

During this Phase, private businesses are able to conduct some of their business in Euros, while consumers will continue to use their national currencies and dual pricing is intended to steadily appear.

Phase C:
The Euro and the national currencies would circulate in parallel in this Phase, which would last the few months necessary to complete the final transition to the Single Currency. This period would include the completion of the change-over of the private non-bank sector and the withdrawal of national banknotes and coins.

Legal Framework
A Council Regulation will provide the legal framework for the introduction and use of the Euro and came into force on 1 January 1999. This framework is based on Articles 123.4 and 308 of the Treaty and will apply to all countries in the European Union.

Article 308 is a general enabling provision of the Treaty and is used where there are no specific powers available to the Community in the area under consideration. Article 308 states that the Council may take appropriate measures to attain the objectives of the Community in the course of the operation of the common market.

Article 123.4 will apply to those countries in EMU after 1 January 1999 and Article 308, introduced by the Treaty of Rome, affects all Member States. The Council will act unanimously under both of these Articles, but only those Member States participating in EMU will be eligible to vote under Article 123.4.

Under the terms of the legal framework, the conversion rates of the national currencies to the Euro are rounded to six significant figures. The framework also states that the introduction of the Euro will not disrupt contracts, therefore the terms of any legal instrument will not be altered and debt can be paid in Euros or national currencies.

Stability Pact
The Stability Pact operates from 1 January 1999 and is intended to ensure that the Euro will be able to maintain its value. The convergence criteria of the Maastricht Treaty are incorporated into 'convergence contracts', committing the participating countries to form stability programmes to ensure medium-term budgetary discipline.

The stability programmes should have been submitted to the Council before 1 January 1999, covering at least the following three years; updated programmes would be submitted on an annual basis. The programmes would contain inter alia:
* medium-term objectives for the surplus/deficit as a ratio of GDP;
* summary of measures to achieve the objectives and methods of adjustment to prevent any divergence from the objectives;
* main assumptions about expected economic developments, including real GDP growth, unemployment and inflation.

The structure of the Stability Pact is intended to allow the participating countries room to manoeuvre in adapting to exceptional and cyclical pressures while avoiding excessive deficits. The approach is to be both preventative and dissuasive.

Penalties for Breach of Stability Pact Criteria:
The Stability Pact would be monitored by the Council, acting with the advice of the Commission and the Economic and Financial Committee, and enforced by imposing a series of penalties on a Member State where it exceeded the criteria of government budget deficit of 3% of GDP or government debt of 60%, unless there were temporary and exceptional circumstances (e.g. an economic recession of 'unusual magnitude' or an unusual event outside the Member State's control).

Penalty for Government Deficit:
The penalty would consist of the Member State lodging a compulsory non-interest bearing deposit with the Commission, and would be composed of two parts:
(a): Fixed: 0.2% of the country's GDP;
(b): Variable: 0.1% of GDP for every 0.1% excess over the deficit criteria.
There would be a ceiling for the penalties on each Member State of 0.5% of GDP.

Penalty for Government Debt:
This would be a fixed penalty of 2% of the Country's GDP.

A Member State would have 10 months to finalise and ratify a programme of correcting measures, before the penalties would be applied. If the excessive deficit remains after two years, the deposit would become a definitive fine, paid to the EU budget; at the same time, a new non-interest bearing deposit would be required from the Member State, calculated on the same basis as the first deposit.

The penalty is required to be approved by a two-thirds majority vote by the Member States participating in EMU. The penalty may be cancelled by the Council if the Member State is making significant progress to correct the excess deficit or debt.

New Exchange Rate Mechanism
A new Exchange Rate Mechanism was formed on 1 January 1999, based around the Euro, to act as a framework to support the final stages in convergence for the countries which are not participating in EMU.

The central rates and fluctuation margins are set by the Council, the ECB, the national central banks of the non-participating countries and the Commission. Under the terms of the Resolution adopted by the European Council at Amsterdam, the fluctuation margins will be 15%.

Any Member State wishing to join, but not participating in, the Single Currency would have to be a member of the new ERM and would be required to submit convergence programmes before 1 January 1999. These programmes would have the same structure as the stability programmes for the Countries in EMU and would be monitored by the Community institutions

There would be a system of penalties put in place in order to prevent a Member State, which did not join the Single Currency, from devaluing its currency and gaining a competitive advantage against the Euro.

'Stability' Committee
The Economic and Financial Committee, described in Article 114.2, would be formed at the start of the Third Stage, consisting of representatives of the ECB, the Commission and the countries participating in the Single Currency.

It would act as a 'Stability Council' to monitor the stability and convergence programmes and enforce the Stability Pact. This committee would act as an advisor to the Council and the Commission and attempt to reconcile the Treaty commitments for the fifteen Member States and the commitments of the Single Currency for the fewer countries which would join.