Why were't the SGP/Maastricht Conditions Able to Prevent the Eurozone Crisis?

Written in April, 2021

Abstract: The essay outlines the four main criteria of the Maastricht Treaty for Eurozone entry and argues that the lack of supervision by the EMU led to countries failing to meet these criteria, resulting in issues such as high debt ratios, fraudulent budget deficit reporting, policy inflexibility, and economic disadvantages for certain member states.

      There are four major criteria stated by the Maastricht Treaty for entering the EMU. The first one is price stability that the average price inflation shall not be more than 1.5 percentage points above the best three performing members. The second one is budget deficit that ratio of the annual government deficit relative to GDP must not exceed 3%. The third one is debt-to-GDP ratio that the ratio of gross government debt relative to GDP must not exceed 60%. The last one exchange rate stability that it should not have devalued the central rate of their euro-pegged currency.

      To start off, there is one simple explanation for why Maastricht did not work out. EMU failed to supervise the entrance and the performance of EZ countries. The reality did not meet up the criteria. Before the crisis, Portugal and Greece have already surpassed the 60% debt-ratio. Greece’s burden reached 103% and Portugal went into the crisis with a debt ratio of 68%(page.30.) Moreover, in terms of budget deficit, the number are fraud and artificially made to be temporarily lower than 3%. The false reported deficit means that the country is incapable to paying back the amount borrowed plus interest.

      In terms of fixed exchange rate, which is the ultimate exchange rate policy adopted by the EZ countries, it caused the problem of policy inflexibility that government could not adjust and conduct solutions independently. Under fixed exchange rates, there are no easy way to correct imbalances in the balance of payment. Since Greece is already in huge deficit, they require a large quantity of foreign currency reserves or access to foreign borrowing. However, because of the “sudden stop” and simply EZ are all down, borrowing is not readily available, leaving the country of contractionary policies. As the current account deficits persist, the country has to devalue its currency, and trap in the debt forever. Therefore, fixed exchange rate gives rise to inflexibility of monetary policy.

      Moreover, policies undertaken to maintain the fixed exchange rate could also result in inflexibility. Methods for maintaining fixed rate include using federal reserve, imposing exchange control, borrowing from abroad. The consequence is that extensive borrowing results in huge debt. Contractionary monetary and fiscal policy limit impots and create recession and unemployment.

      Sharing currency could facilitate trade, investment and simplifies financial transaction. But it eliminates the ability to conduct monetary policy independently. The more disjoint countries’ business cycle, the less advantage of a common currency. Vice versa, the closer economic activities between countries, the more reason to join OCA. In the case of GIPS, these countries start off disadvantageous positions in the first place. A fixed exchange rate system only hurts them more.