Criteria for Joining the Euro Zone

▪ 2005

      When the European Union's 10 newest members (Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia) officially joined the EU on May 1, 2004, they faced many challenges, but perhaps the largest was financial—when, if ever, they would be able to meet the criteria for entry to the euro zone. The euro, the single European currency that came into being at the start of 1999, was the most ambitious project launched by the European Union in recent years. Of the EU's 15 older member states, 12 (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands, Portugal, and Spain) had joined the economic and monetary union (EMU), replaced their own national currencies with the euro, and approved the European Central Bank (ECB) to monitor the single currency. As of 2004, Denmark, Sweden, and the U.K., had chosen not to join, though domestic debates continued over their future plans.

      The conditions for joining the euro were set out in European Treaty articles agreed to in the early 1990s when the EU began planning a possible monetary union.

● 1. Government deficit must not exceed 3% of GDP. If it does exceed that level, it must have declined “substantially and continuously and have reached a level close to 3%.”

● 2. Gross government debt must not exceed 60% of GDP. If this is not the case, the ratio must have declined significantly and be moving rapidly toward 60%.

● 3. The member state must have achieved exchange-rate stability for at least two years according to the rules of the European exchange-rate mechanism, which defines the permitted levels of fluctuation.

● 4. The nominal long-term interest rates of applicant nations must not have exceeded by more than 2% the average of the interest rates in the three member states with the best records on price stability.

      In 1997 the EU agreed to a further measure to enforce fiscal and budgetary discipline inside the euro zone. This was the Stability and Growth Pact, which defined a series of checks and potential financial penalties (fines) for any euro-zone member that allowed its deficits to exceed 3% of GDP. The European Commission was granted the power to fine a member state if it failed to stay in line.

      The Stability and Growth Pact, however, had proved to be highly controversial, with several countries—and even the European Commission—arguing that it was unnecessarily rigid. Both France and Germany had exceeded their 3% limits but had avoided fines. Greece had admitted not only that the cost of mounting the Olympic Games in August had pushed its annual budget deficit beyond the 3% cap every year since 2000 but also that it had used inaccurate earlier numbers in order to be admitted to the EMU in 2001. In 2004 there was heated but unresolved debate about whether the rules of the pact should be changed to allow countries to overshoot for short periods of the economic cycle if this was judged in their economic interests. The ECB, which set interest rates in the euro zone, was strongly opposed to loosening the pact's rules. Many of the new EU members expressed concern that they would be held to tighter standards than the old member states, and in November 2004 the ECB president, Jean-Claude Trichet, said that rewriting the rules would be “dangerous” and would not contribute to the “solidity and soundness” of the EMU.

Toby Helm

* * *