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Economy and Finance

How the Economic and Monetary Union works

The Economic and Monetary Union (EMU) is not an end in itself. It is a means to provide stability and for stronger, more sustainable and inclusive growth across the euro area and the EU as a whole for the sake of improving the lives of EU citizens.

Economic activities involved in EMU

The operations and management of the economic and monetary union (EMU) are designed to support sustainable economic growth and high employment through economic and monetary policy. This involves four main economic activities:

  • implementing an effective monetary policy for the euro area with the objective of price stability
  • coordinating economic and fiscal policies in EU countries
  • ensuring the single market runs smoothly
  • supervising and monitoring financial institutions

Why these activities are important

Monetary policy involves influencing interest rates and exchange rates to benefit a country’s economy. This is done by a central bank controlling the supply of money in the economy.

However, if each EU country operated its own monetary policy, then

  • the single market would be much less effective
  • trade could be disrupted
  • the benefits would be fewer

For this reason, under EMU, monetary policy is closely coordinated, and within the euro area it is centralised and independent.

Role of national governments

National governments control other economic policy areas. These include

  • fiscal policy that concerns government budgets
  • tax policies that determine how income is raised
  • structural policies that determine pension systems, labour- and capital-market regulations

However, the EMU brings more economic integration, especially in the euro area. As a consequence, economic policy-making becomes a matter of common concern to all EU countries. To ensure the smooth operation of the EU economy as a whole, it is important that all  countries coordinate their economic and fiscal policies with the common objective of stability and growth.

A single currency supports the single market

As well as bringing the benefits of economic stability, the EMU and the single currency also support a more effective single market which benefits people and enterprises. If national economic policies discourage the free movement of goods, services, capital and labour, then these benefits, including jobs and growth, would be reduced. Therefore, economic policy-making in EU countries should act to support the single market.

A single banking system is the mirror image of a single currency. Since bank deposits make up  the vast majority of money, a currency can only be truly single  if confidence in the safety of bank deposits is the same whichever country a bank operates in. This requires single bank supervision, single bank resolution and single deposit insurance.

This is also crucial to address the bank sovereign negative feedback loops which were one of the main causes of the recent global economic crisis.

The treaty defines the instruments for managing EMU. These instruments cover the main economic activities described above.

Monetary policy

Monetary policy for the euro area is managed through the European Central Bank (ECB) and the national central banks of the euro area countries, which together make up the Eurosystem.

Decisions on monetary policy in the euro area can only be taken by the governing council of the ECB, made up of

  • the governors of the national central banks of the euro area  countries
  • the members of the ECB’s executive board

These decisions are made free from outside influence. EU countries outside the euro area coordinate their monetary policy with the ECB within the European system of central banks.

The treaty lays down the ECB’s mission which is to ensure price stability within the euro area. The ECB aims to keep price inflation in the euro area below but close to 2% over the medium term. This 2% inflation target is considered optimal for promoting growth and employment.

For more details, visit the dedicated pages on the website of the ECB

The Stability and Growth Pact

Economic policy-making in EU countries is coordinated in the Council. The Stability and Growth Pact (SGP), laid down in the Treaty, is a central element of this coordination. The SGP helps enforce fiscal discipline within EMU and ensure sound and sustainable public finances.

The SGP requires

  • government deficits to be less than 3% of GDP
  • government debt to be less than 60% of GDP

For more details, visit the pages dedicated to the stability and growth pact

TSCG/Fiscal Compact

The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG) was formally concluded on 2 March 2012, and entered into force on 1 January 2013. It was part of the broader policy response to the euro area crisis. The TSCG is an intergovernmental Treaty and is thus not part of the Union legal order. The Contracting Parties had to introduce in their domestic legal order by 1 January 2014 the necessary transposing provisions.

The Fiscal Compact per se is one part of the TSCG (Title III). Within the Fiscal Compact, Article 3 requires a balanced budget rule to be enshrined in national legislation alongside national surveillance (by an independent monitoring institution) and a correction mechanism (in case of deviation). More detailed features of this requirement were presented in a 2012 Commission communication setting common principles.

Out of the 25 Contracting Parties to the TSCG (all Member States except Czechia and Croatia), 22 are formally bound by the Fiscal Compact (the 19 euro area Member States plus Bulgaria, Denmark and Romania). The Fiscal Compact runs alongside the other requirements concerning fiscal policy and governance included in the Stability and Growth Pact as enhanced by the Two-Pack and Six-Pack.

Based on the mandate granted in the TSCG itself, the Commission has published in February 2017 - after extensive consultation of the Member States concerned - a Report assessing the compliance of the national provisions adopted by each of them in relation to the Fiscal Compact (specifically, with Article 3(2) of the TSCG). It is accompanied by a Communication from the Commission putting in perspective the origin of the Fiscal Compact and its possible incorporation into EU law, as well as with country annexes for each of the 22 Contracting Member States.

To date, all Contracting Member States have significantly adapted their national fiscal frameworks as a result of the Fiscal Compact requirements.

On 6 December 2017, the Commission put forward a proposal to incorporate the TSCG into EU law in order to increase democratic accountability and legitimacy across the Union. This incorporation was already foreseen by the intergovernmental treaty with the deadline of 1 January 2018. Bringing the thrust of the Fiscal Compact within the EU legal framework would ensure the more effective monitoring of the implementation and enforcement of fiscal rules at both EU and national level.

The broad economic policy guidelines

Wider coordination is achieved through annual cycles of economic policy discussions between EU countries and EU institutions. This policy coordination is consolidated into the broad economic policy guidelines (BEPG) which are adopted by the EU Council on the basis of a Commission recommendation. The BEPG are updated annually and cover the coming three years.

The BEPG are non-binding guidelines for the EU and each Member State aimed at promoting macroeconomic stability, sustainable finances, structural reform and the smooth functioning of EMU. The guidelines serve the aim of the European Semester of economic policy coordination, as they frame the scope and direction for EU countries’ national reform programmes (NRP) and serve as reference for the development for Country Specific Recommendations (CSR).