BUS614: International Finance

Overview

The convergence criteria ensure that a member state is ready to introduce the euro, and that its joining the euro area is not going to cause economic risks for the member state itself or for the entire euro area.

Economic convergence criteria

The economic conditions for joining the euro area help to ensure that a country is ready for integration into the monetary regime of the euro area.

There are four economic convergence criteria.

1. Price stability

The inflation rate cannot be higher than 1.5 percentage points above the rate of the three best-performing member states.  

2. Sound and sustainable public finances

The country should not be under the excessive deficit procedure.

• Excessive deficit procedure (European Commission)

3. Exchange-rate stability

The country has to participate in the Exchange Rate Mechanism (ERM II) for at least two years, without strong deviations from the ERM II central rate and without devaluing its currency's bilateral central rate against the euro in the same period.

4. Long-term interest rates

The long-term interest rate should not be higher than two percentage points above the rate of the three best-performing member states in terms of price stability.

Legal convergence

Candidates to join the euro area must also ensure that national legislation is compatible with the Treaty and the Statute of the European System of Central Banks (ESCB) and the European Central Bank (ECB).

The Treaty and Statute provide for the independence of central banks.

What is the Exchange Rate Mechanism?

The purpose of the Exchange Rate Mechanism (ERM II) is to demonstrate that a country's economy can function smoothly without recourse to excessive currency fluctuations.

When a non-euro area country enters the ERM II, its national currency is tied to the euro at a central rate that is agreed with the euro area member states, the non-euro area countries already participating in ERM II and the ECB, with the involvement of the Commission. The currency is then allowed to fluctuate within the standard limit of 15% above or below this agreed central exchange rate.

Participation in ERM II is voluntary, but is a mandatory step towards joining the euro area.

Since 2018, the countries willing to join the ERM II are also required to have entered into close cooperation with the European Central Bank Single Supervisory Mechanism and to have implemented specific policy commitments.