Impacts of EMU on non participant countries and their banks

         Features of the economic environment of countries outside
           of the monetary union

    
     It is probable that, within the group of those member states who, in accordance with article 109K, 1 of the Maastricht Treaty, will not be participating in the monetary union, the features of the economic environment will show a greater variance than seen in the first group of member states Indeed, on the basis of their economic situation, at the time of the Treaty, and the magnitude of the efforts made since then to comply with the Maastricht criteria, there will be varying gaps between individual members of this group and the economic performance achieved in the first group.
    However, it can be expected that most of these member states will be anxious to bridge these gaps, either because they intend to participate in the monetary union as soon as conditions allow or, because they wish to reserve the right to participate at a later date.
    However, the Maastricht Treaty did not lay down the exact nature of the exchange relationship that would exist between those countries participating in the third phase of monetary union and those not participating.
    Regarding the future exchange relations between the euro and currencies of nonparticipating countries, the Commission's view in the interim report was that they should be governed by a exchange rate agreement, the existence of which, according to the Commission, is implied by the terms of the Treaty. An exchange agreement should both underpin the convergence process and promote the efficient management of the single market. In any event, in order to stabilise exchange rates, it must be supported by national policies geared to stability.
    Since the European Summit in Madrid, the various bodied concerned have continued their work in defining the characteristics of a "revised EMS" and how it could serve to govern the relationship between the euro and the currencies of nonparticipant member states. A number of options have been raised, including that of a "variable geometry" EMS, where the bands within which currencies can rise or fall in relation to a fixed parity with the euro, could vary according to the currency and, in particular, taking into account the extent of convergence already reached. An unanswered question remains: Would membership to such a mechanism be a prerequisite for membership of the monetary union? At least, the United Kingdom vehemently contests such a suggestion as well as the necessity to be a member of the current Exchange Rate Mechanism in order to conform with the Maastricht criteria on exchange rate stability.
    On the assumption that an agreement can be reached on such a mechanism, clearly it will not by itself guarantee that the level of monetary stability in non-participant countries will approach that of the first group of member states. For this to be the case, the unquestionable credibility of the mechanism must be such that the markets would be discouraged from testing its strength. This would assume that the future European Central Bank would be prepared to intervene without limits in such a mechanism to support currencies under attack. However, it is difficult to imagine the European Central Bank accepting such a commitment without fearing negative repercussions for the image of the euro and its stability towards other currencies.
    It can be expected, nevertheless, that internal monetary stability will be weaker in those countries outside of the monetary union. Indeed, occasionally their currencies could become targets for speculation, which would foster, more or less permanently, expectations of, currency devaluation and higher inflation. Accordingly, interest rates will, on average be higher and, ceteris paribus, the servicing of public debt more expensive and wage inflation harder to prevent. The probable macro-economic developments in these countries could serve to illustrate the view of Paul De Grauwe, according to whom it is far easier to attain and remain in line with the convergence criteria once inside the monetary union than it is by remaining outside.
    The timescalle is indeed of crucial importance here, because the credibility gap could widen as the length of time as a non-participant in the monetary union progresses. The Commission's proposal sweeps away this problem by supposing that nonparticipation is a short-term transitional phase. If the political willingness on the part of the first group of participating countries to expand their number as quickly as possible and overcome the obstacles to such expansion were missing, one could legitimately be concerned regarding the duration of this transitional phase.
    For as long as this continues, the risk arises that the advantages of participation become less and less clear for non-participants. As stated by Philippe Martin: 1n the case of monetary union, the gains of participation for the high inflation countries would decrease over time, and are likely to modify their optimal monetary policies. This is because entry into EMU will eliminate all possibilities for countries to use their exchange rates to export shocks to their partners. Outside the union, however, the excluded countries will be able to take advantage of the more restricted monetary policy within the EMU, by making strategic use of exchange rate movements against the single currency. If the exclusion lasts too long, or if the conditions for entry remain too stringent, then the credibility gains of joining the union may turn out to be less than the gains of adopting a free-rider strategy based on possible devaluations.
    Such a process would not only render the expansion of monetary union more problematic in due time, but would also increase its fragility and impair its in the view of certain members.