Countries seeking to adopt the euro as their currency must meet certain criteria
ID: 1194828 • Letter: C
Question
Countries seeking to adopt the euro as their currency must meet certain criteria, including the requirements to keep their government budget deficit equal to 3% or less of GDP, and to hold government indebtedness to less than 60% of GDP.
a. Discuss why there are fiscal policy criteria for joining a monetary union.
b. For countries that exceed or are near these limits (e.g., Greece, Portugal, Cyprus, etc.), the EU imposes so-called “austerity” measures (such as increased taxes and reduced government spending). What is the rationale for imposing austerity measures and what are their likely macroeconomic effects (especially on growth)?
Explanation / Answer
a) European Union is the so far strongest economic integration. It has its own currency that is dollar. For a member to have euro as a currency it is required to fulfill some criteria as these are already mentioned in the question. Although the fiscal criteria has been set up to join this monetary union, there are some basis on which such steps have been taken.
Such limits have been set up to keep European Monetary Union small by setting tough standards; that is few members grouped this union, so that the rsik of crises of one member country over others gets reduced. The main idea is to make sure that that participating countries would be fiscally prudent
b) Austerity measures includes various techniques like spending cuts, tax increases, or a mixture of both. The rationale for impsing such measures is to reduce the government budet deficits and may be undertaken to demonstrate the government's fiscal discipline to creditors and credit rating agencies by bringing revenues closer to expenditures.
Several severe implications are there of such measures. There would be loss of employment with reduced government spending and increased tax. Less employment drives towards other ill macroeconomic results like reduced national output, productivity, investment and hence growth as well. Consumptions gets reduced with more taxes to be paid as disposable income decreases and hence so output generation and growth as well.