European Monetary System celebrates thirtieth birthday

On 13 March 1979, the former EEC decided to set up the European Monetary System (EMS) culminating in the introduction of the euro. One of the objectives was to reduce economic differences between the participating countries. In the past decades, the prosperity gap between the various countries which have adopted the euro as their currency has indeed narrowed.

Prosperity gap is narrowing . . .

Differences in prosperity level – measured in GDP per capita – between the countries which have adopted the euro have been reduced. In 2007, the standard of living in most member states was closer to the eurozone average than in 1995. Ireland is the most prominent exception. The Irish GDP per capita improved more and is now the highest after Luxembourg.

Spain, Greece and countries like Slovenia and Slovakia, which joined the EU in a later stage, performed a major catch-up operation, but Portugal and Cyprus have not improved noticeably. In the Netherlands, the relatively high level of prosperity above the eurozone average has improved even further.

Per capita GDP, adjusted for price differences (eurozone=100)

. . .  and price differences are also leveling off

Price differences between the various eurozone countries have been reduced considerably. In countries where the price level was relatively low in the period 1995-2007, the inflation rate was much higher. Prices rose most rapidly in Slovakia, but price increases were also above average in Spain, Greece and Portugal in the period 1995-2007. In Ireland, the increase was so remarkable that the price level of 2007 was one of the highest across the eurozone in 2007. In the Netherlands, the relative price level was marginally lower, approximating the eurozone average.

Relative price levels (eurozone=100)

Interest on government bonds converged substantially, but difference recently gone up

As a result of the introduction of the euro, the exchange rate risk ceased to exist and interest on government bonds was converged substantially. Due to the current recession, a reverse process can be observed since October 2008 for ten-year interest rates. The interest surcharge, i.e. the difference with the interest rate paid by the German government, is particularly high in countries with a large national debt. The market considers these countries to be less credit-worthy. In Greece, Ireland and Italy, interest surcharge currently amounts to 1.5 to 2.5 percentage points. In February, the Dutch government paid approximately 0.7 percentage points more than the German government.

Difference with Germany with respect to interest on government bonds

Rita Bhageloe-Datadin and Linda Koeman