lit** 
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* lir COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 06.11.1996 
COM(96) 560 final 
REPORT ON CONVERGENCE IN THE EUROPEAN UNION 
IN 1996 
(prepared in accordance with Article 109j(l) of the Treaty) 
(presented by the Commission) 

CONTENTS 
Page 
1. INTRODUCTION 5 
2. COMPATIBILITY OF NATIONAL LEGISLATION WITH THE 
TREATY AND THE STATUTE OF THE EUROPEAN SYSTEM 
OF CENTRAL BANKS 7 
2.1 Adaptation of national law since the signing of the Treaty 
2.2 Recapitulation of relevant provisions of the Treaty and the 
ESCB Statute 
2.3 Review of national legislation 
2.4 Current legislative initiatives 
Box: Review of central bank legislation: some illustrative cases 
3. PRICE STABILITY7 19 
3.1 Treaty provisions 
3.2 Price stability as assessed by the IICPs 
3.3 Inflation performance during the second stage of EMU 
3.4 The sustainability of price convergence 
Box: Calculation of the inflation reference value 
Box: Differences between IICPs and CPIs 
4. GOVERNMENT BUDGETARY POSITION 32 
4.1 Existence of an excessive deficit 
4.2 Budgetary developments in 1996 
4.3 Progress with budgetary consolidation during the second stage of EMU 
4.4 Sustainability of budgetary convergence 
Box: Excessive deficit procedure 
5. EXCHANGE RATES 45 
5.1 Treaty provisions 
5.2 Further analysis of exchange rate stability 
6. LONG-TERM INTEREST RATES 50 
6.1 Interest rate convergence 
6.2 Recent developments in long-term interest rates 
6.3 Explanatory factors and assessment 
Box: Data and reference value for the interest rate convergence criterion 
7. SUPPLEMENTARY INFORMATION 59 
7.1 Development of the ECU 
7.2 Results of the integration of markets 
7.3 Situation and development of balances of payments on current account 
7.4 Examination of development of unit labour costs and other price indices 
8. CONCLUDING SUMMARY 72 
8.1 General assessment 
8.2 Summary by Member States 
TABLES: 
3.1 Inflation convergence 
3.2 The average rate of inflation 
3.3 Private consumption deflator and consumer price index 
3.4 Inflation convergence according to alternative methods for the calculation of the 
reference value, IICP 
3.5 Difference between IICPs and CPIs 
3.6 Inflation convergence using IICPs and CPIs 
4.1 General government deficit 
4.2 General government gross debt 
4.3 Changes from previous year in the actual and cyclically adjusted general 
government deficit 
4.4 Cyclical adjustment of government deficit in 1996 
4.5 Factors, other than the deficit, adding to the debt stock 
4.6 Revenue and expenditure shares, 1993 and 1996 
4.7 Government investment and deficit 
4.8 Objectives for the general government deficit in 1997 
6.1 Long-term interest rate convergence in the .Member States 
6.2 Development of long-term interest rates 
6.3 Recent evolution of long-term interest rates 
7.1 Current account balance 
7.2 Labour costs 
7.3 Import price inflation 
7.4 Contribution of import prices to the change of the final uses deflator 
7.5 Nominal effective exchange rate changes relative to 23 industrial countries 
7.6 Effects of indirect tax changes on consumer price inflation 
8.1 Performance of the Member States in relation to convergence in 1996 
GRAPHS: 
3.1 nCP for EUR and Member States 
3.2 Interim indices of consumer prices (IICP) 
4.1 General government deficit 
4.2 General government gross debt 
4.3 Government deficit and debt ratios, 1993-96 
4.4 Actual and cyclically adjusted government deficit, EUR 
5.1 ERM grid spread 
5.2 Movements within the ERM band 
5.3 Stability of exchange rate vis-à-vis the DM 
6.1 Recent evolution of long-term interest rates 
6.2 Long-term interest rate convergence 
6.3 Average of government bond yields in the EC 
7.1 International commodity prices 
1. INTRODUCTION 
# 
This report has been prepared in accordance with Article 109j(l) of me Treaty which 
requires the Commission to report to the Council on the progress made in the fulfilment 
by the Member States of their obligations regarding the achievement of economic and 
monetary union (EMU). The European Monetary Institute (EMI) is similarly required to 
report to the Council. 
These reports are the first steps of the procedure set out in Article 109j which leads to 
the Council, meeting in the composition of the Heads of State or Government, deciding 
for the first time, not later than 31 December 1996, whether a majority of the Member 
States fulfils the necessary conditions for the adoption of a single currency and whether 
it is appropriate for the Community to enter the third stage. 
In practice it has been clear for some time that, despite the considerable progress made 
by Member States with all aspects of convergence and with other preparations for EMU, 
a majority of Member States has not yet achieved a sufficiently high degree of 
sustainable convergence. This is notably because many Member States have not yet 
reached a satisfactory situation as regards the sustainability of the government financial 
situation. The European Council in Madrid in December 1995 already came to the 
conclusion that conditions would not be appropriate for an early start to the third stage 
but confirmed that the third stage of EMU would indeed begin on 1 January 1999. This 
agreement on the starting date was reiterated by the European Council in Florence in 
June 1996. The decisions about which Member States will be in the first group adopting 
the single currency will be made as early as possible in 1998. 
The role of the present report, apart from meeting the formal requirements of the Treaty, 
is thus, first, to examine the current state of convergence and of the compatibility of 
national legislation with Treaty obligations and, second, to review the progress that has 
been made since the beginning of stage two of EMU on 1 January 1994. 
The structure of the report follows that established by Article 109j(l). Chapter 2 
examines the compatibility between each Member State's national legislation (including 
the statutes of its national central bank) and Articles 107 and 108 of the Treaty and the 
Statute of the ESCB. The following four chapters (Chapters 3-6) examine in turn the 
convergence performance of the Member States in relation to each of the four criteria, 
concerning price stability, the government budgetary position, exchange rates and long-
term interest rates. Chapter 7 looks at developments in several other areas that are to be 
taken account of in the Commission and EMI reports: development of the ECU, the 
results of the integration of markets, the balances of payments on current account, and 
unit labour costs and other price indices. A final chapter (Chapter 8) summarises the 
conclusions of the report. 
According to the Edinburgh agreement, Denmark has announced that it will not 
participate in the third stage of EMU, but that it remains fully committed to taking part 
in economic and monetary cooperation during the second stage of EMU. With this in 
mind, developments in Denmark have been included in this report. 
Similarly, although the United Kingdom has notified the Council, in accordance with 
paragraph 1 of Protocol No 11, that it does not intend to move to the third stage in 1997, 
it might do so later and developments in the United Kingdom have also been included in 
this report. 
On the basis of this report and that of the EMI the Commission is separately submitting 
to the Council a recommendation for the assessment by the Council in accordance with 
Article 109j(2). 
2. COMPATIBILITY OF NATIONAL LEGISLATION WITH THE TREATY 
AND THE STATUTE OF THE EUROPEAN SYSTEM OF CENTRAL BANKS 
According to the second sentence of Article 109j(l) of the Treaty, the reports drawn up 
under this article "shall include an examination of the compatibility between each 
Member State's national legislation, including the statutes of its national central bank, 
and Articles 107 and 108 of this Treaty and the Statute of the ESCB". 
The present chapter is devoted to this examination. The first section summarizes 
adaptations of national law since the signing of the Treaty on European Union in 
February 1992. The second section includes a recapitulation of the relevant provisions 
of the Treaty and the ESCB Statute. The third section summarizes the results of a 
review of national central bank legislation in the light of these provisions; it indicates 
types of provisions which are still found to be incompatible with the requirements of the 
Treaty or the Statute and which are expected to'be changed before the establisliment of 
the ESCB. The fourth section indicates legislative reforms which are at present planned 
in the perspective of the third stage. 
2.1 Adaptation of national law since the signing of the Treaty 
Since the signing of the Treaty on European Union and its entry into force, statutes of 
many national central banks (NCBs) have been adapted in order to comply with the 
Treaty. 
Some of these changes aimed at ensuring compliance with Article 104 which prohibits 
central bank credit to the public sector and with Article 104a which prohibits the 
granting of privileged.access by governmental or public bodies to financial institutions. 
These rules are in force since the beginning of the second stage. Member States have 
adapted their regulatory framework in a satisfactory manner to these requirements, so 
that no significant difficulties have occured. 
The statute of the Banque de France was amended in 1993. The responsibility for the 
formulation and the implementation of monetary policy has been vested in a "Monetary 
Policy Council", which must not seek or accept instructions from the government or any 
other body, whilst a "General Council" carries out all other management responsibilities 
at the bank. Furthermore, the objective of the bank to ensure price stability has been 
redefined. 
The legal regime of the Banco de Espafia was adapted in 1994. The law established 
price stability as the primary objective of monetary policy which is to be defined and 
implemented by the bank. Neither the government nor any other public authority may 
give instructions to the bank regarding either the objectives or the implementation of 
monetary policy. 
In Belgium, an amendment in 1993 restricted opposition and suspension rights of the 
Government Commissioner and the Minister of Finance in matters concerning the 
definition and implementation of monetary policy, the conduct of foreign exchange 
operations, the holding and management of official foreign reserves and the promotion 
of the smooth operation of payment systems. 
In Italy, the authority to determine the discount rates has been transferred from the 
Minister of the Treasury to the Governor of the Banca d'ltalia in 1992. Furthermore, the 
Banca d'ltalia has been given the responsibility for setting reserve requirements within 
certain limits and for overseeing payment systems. 
In Portugal, the amendments of the law on the Banco de Portugal were adopted in 1995. 
The law, inter alia, redefined the primary objective of the bank, i.e. to maintain price 
stability, taking into account the overall economic policy of the government. 
2.2 Recapitulation of relevant provisions of the Treaty and the ESCB Statute 
Article 107 of the Treaty ensures that the ESCB will operate free from instructions from 
third parties. It reads as follows: 
"Wlien exercising the powers and carrying out the tasks and duties conferred upon them 
by this Treaty and the Statute of the ESCB, neither the ECB nor a national central bank, 
nor any member of their decision-making bodies shall seek or take instructions from 
Community institutions or bodies, from any government of a Member State or from any 
other body. The Community institutions and bodies and the governments of the Member 
States undertake to respect this principle and not to seek to influence the members of the 
decision-making bodies of the ECB or of the national central banks in the performance 
of their tasks. " 
Article 108 of the Treaty obliges Member States to adapt national legislation in 
accordance with the requirements of EMU: 
"Each Member State shall ensure, at the latest at the date of the establishment of the 
ESCB, that its national legislation including the statutes of its national central bank is 
compatible with this Treaty and the Statute of the ESCB. " 
The article refers to the compatibility of national legislation with the Treaty's provisions 
in general. This includes compatibility with Article 105(1) of the Treaty which defines 
the objectives of the ESCB, the first two sentences of which read as follows: 
"The primary objective of the ESCB shall be to maintain price stability. Without 
prejudice to the objective of price stability, the ESCB shall support the general 
economic policies in the Community with a view to contributing to the achievement of 
the objectives of the Community as laid down in Article 2." 
The Statute of the ESCB* includes in its Article 14.2 rules on the security of tenure: 
See Protocol (No 3) of the Treaty. 
"The statutes of the national central banks shall, in particular, provide that the term of 
office of a Governor of a national central bank shall be no less than five years. 
A Governor may be relieved from office only if he no longer fulfils the conditions 
required for the performance of his duties or if he has been guilty of serious 
misconduct... " 
By each of these four provisions, limits are put on national central bank legislation: 
• The prohibitions and obligations formulated in Article 107 apply equally to both the 
ECB and the NCBs in so far as the performance of ESCB-related tasks is concerned. 
While the prohibitions formulated in the first sentence of Article 107 are addressed to 
the NCBs and to their decision-making bodies, it appears that rights of third parties 
to give instructions in some form or other are incompatible with the prohibitions. 
Furthermore, any national provisions of which the purpose or effect is for the 
government to seek to influence the members of the decision-making bodies of the 
NCB in the performance of their tasks therefore need to be brought; in line with the 
second sentence of Article 107. The term "decision-making bodies" should be 
understood to mean any organ of an NCB whose decisions may have an impact on 
the fulfilment of its ESCB-related tasks. 
• The primary objective formulated in Article 105(1) is assigned to the ESCB, which 
according to Article 1.2 of the Statute is composed of the ECB and the NCBs. 
Therefore, the objective of each member of the ESCB must be compatible with 
Article 105(1). 
• Article 14.2 of the ESCB Statute is exclusively addressed to NCBs; non-compliance 
with the limits set therein will require adaptations of national law. 
• Apart from these specific provisions in the Treaty and the Statute which require 
compatibility, there are likely to exist a number of national provisions - often of a 
technical nature - which may prove to be at odds with the prerogatives of the ECB 
vis-à-vis NCBs and which should be eliminated so that the new compatible 
provisions become effective at the start of Stage Three for Member States without a 
derogation and at the start of their full participation in Monetary Union for Member 
States with a derogation initially or with a special status. 
It is worth recalling some provisions which refer to the time-frame for any adjustments 
of national law and to the geographical coverage of the respective rules. Right from its 
establishment in early 1998, the ECB will have to take decisions which predetermine 
the conduct of its monetary policy as from 1 January 1999. Article 108 therefore 
stipulates that compatibility shall be achieved at this date at the latest. Besides, Article 
109e(5) calls upon Member States, as appropriate, to start the process leading to the 
independence of its central bank during the second stage. 
10 
In relation to the application of Article 107 of the Treaty on central bank independence and 
Article 108 of the Treaty on the adaptation of national legislation and NCBs' statutes, the 
Treaty does not make a distinction between Member States with or without a derogation (see 
Article 109k(3) of the Treaty). 
Denmark will be treated as a Member State with a derogation (Article 2, Protocol No 12). Its 
central bank statute will therefore have to be compatible with Articles 107 and 108. 
In the event that the United Kingdom will not participate in Stage Three, Article 2, 
Protocol No 11 will exempt the United Kingdom from the application of Articles 107 and 108 
of the Treaty. Given the formulation of Article 109e(5), until it notifies that it intends to move 
to the third stage, the United Kingdom is therefore exempted from the obligation to start the 
process leading to the independence of its central bank. 
It is made clear in Article 107 that the requirements for compatibility with the Treaty and the 
Statute are limited to ESCB-related tasks. Among these are the basic tasks, laid down in 
Article 105(2) of the Treaty and Article 3.1 of the Statute, which are to define and implement 
the monetary policy of the Community, to conduct foreign exchange operations consistent with 
the provisions of Article 109 of the Treaty, to hold and manage the official foreign reserves 
of the Member States and to promote the smooth operation of payment systems. 
2.3. Review of national legislation 
Central bank statutes reflect different national traditions and institutional frameworks and vary 
significantly between Member States with respect to many of their characteristics like the legal 
form of the central bank, the definition of its objectives and tasks, monetary policy 
instruments, relations with the national parliament and socio-economic groups, the structure 
and composition of decision-making bodies, and financial rules. Taking Articles 105 and 107 
of the Treaty and Article 14.2 of the ESCB Statute as benchmarks, a review of present 
legislation in the Member States leads to the following conclusion: Many characteristics of 
national legislation are within the limits drawn by EC law. However, in a number of cases 
adaptations are called for. Legislative initiatives for such adaptations have reached an 
advanced stage in several Member States (see section 2.4). 
In a few Member States, legislation allows other bodies to give instructions to the central bank 
in matters of monetary policy. This is incompatible with the requirements in the third stage 
of EMU. 
In many Member States, other legislative provisions are in force the effect of which may come 
close to the right of third parties to give straightforward instructions. Such provisions include 
a right of other bodies to interfere in a decision taken by the ECB, a right to participate in the 
voting on monetary policy, a right to be consulted before the central bank takes a decision, 
insufficient financial autonomy of the central bank, or membership in decision-making bodies 
of the central bank and in bodies outside the ESCB. In some cases, the borderline between 
compatible and non-compatible provisions is difficult to draw; however, it is clear that most 
of the existing provisions of this type need to be amended. 
11 
In a few Member States, the provisions on the security of tenure for the Governor are not 
compatible with the provisions of Article 14.2 of the ESCB Statute. 
The box on "Review of central bank legislation: some illustrative cases" provides examples 
of provisions in national legislation which serve to illustrate the issues at stake. 
2.4 Current legislative initiatives 
In Ireland, Luxembourg, the Netherlands, Finland and - with a more substantial revision than 
in 1993 - in Belgium, preparatory work on amendments to national legislation concerning 
central banking is well under way. 
In Ireland, draft legislation on the Central Bank of Ireland includes provisions on the Bank's 
involvement in payment systems, the collection of statistics, prudential supervision and the 
position of the members of decision-making bodies, including the term of office of Directors, 
which is fixed at five years. 
In Luxembourg, a draft law on the Institut Monétaire Luxembourgeois and the monetary status 
of Luxembourg was submitted to Parliament in December 1993. The law which is still 
pending covers inter alia the IML's objectives and tasks. 
In the Netherlands, discussions between the Ministry of Finance and the Nederlandsche Bank 
with a view to adapting the central bank legislation to the requirements of EMU have reached 
an advanced stage. 
In Finland, draft legislation in particular addresses the future role of the Parliamentary 
Supervisory Council in monetary policy, the minimum term of office for the Governor and 
the grounds for dismissal. 
In Belgium, the government is planning to propose a comprehensive reform of central bank 
legislation in the near future. The draft law aims at compatibility between the Treaty and the 
ESCB Statute on the one side and the statute of the National Bank of Belgium on the other. 
12 
REVIEW OF CENTRAL BANK LEGISLATION: 
SOME ILLUSTRATIVE CASES 
Compliance with Article 107 of the Treaty 
The following rights of third parties seem to be at odds with or to impinge upon the 
prohibitions and commitments formulated in Article 107: 
a. A general right to give instructions 
Provisions which subordinate NCBs to instructions are in contradiction with their 
obligation not to seek or take instructions. 
Section 4 of the Bank of England Act2 
"The Treasury may from time to time give such directions to the Bank as, after 
consultation with the Governor of the Bank, they think necessary in the public 
interest. " 
The right to give such instructions is also incompatible with the Treaty, when the 
central bank may object but eventually can be defeated. 
Article 26 of De Nederlandsche Bank Act 
"1. The Minister may, after consultation with the Bank Council, give such directions 
to the Governing Board as he thinks necessary for the Bank's policy to be properly 
co-ordinated with the Government's monetary and financial policies. Except as 
provided in paragraph 2 below, the Governing Board shall comply with such 
directions. 
2. If the Governing Board has any objections to the directions as referred to in 
paragraph I above, it may communicate said objections to the Crown in writing 
within three days of receiving directions. The Crown shall decide whether or not the 
directions are to be complied with. 
3. (...) 
2 As already indicated, the provisions of Protocol No 11 exempt the United Kingdom from the 
application of Article 107, unless the United Kingdom notifies that it intends to move to the third 
stage. 
13 
4. If the Crown decides that the directions are to be complied with, the Governing 
Board's objections and the decisions of the Crown shall be published in the 
Nederlandsche Staatscourant, if in the opinion of the Crown this is not contrary to 
the national interest. " 
Article 15 of the Act on the Bank of Finland 
"The administration of the Bank and management of the affairs thereof shall be 
under the surveillance of the Parliamentary Supervisory Board in accordance with 
this Act and the Regulations confirmed by Parliament " 
Article 17 of the same Act 
"It is the duty of the Parliamentary Supervisory Board to fix the base rate of the bank 
and other rates of interest applied by the bank and the limits thereof. 
b. A right to approve, suspend, annul or defer a NCB's decision 
Any such provisions constitute a right to give instructions of a specific type; the 
assessment is the same as for generally formulated rights to give instructions. 
Article 13(2) of the Bundesbank Act 
"The members of the Federal Cabinet are entitled to attend the meetings of the 
Central Bank Council. They have no right to vote, but may propose motions. At their 
request, a decision shall be deferred for up to two weeks. " 
c. A right to censor decisions on legal grounds 
A right of the Government to control the legality of decisions of a central bank seems 
incompatible with Article 107. This also applies when the Government's right can 
only be exerted indirectly. 
Article 43 of the Organic Law of the Banco de Portugal 
"1. The Governor shall have a casting vote at the meeting which he chairs and may 
suspend the effectiveness of the decisions taken by the Board of Directors or by 
executive committees which, in his judgement , are contrary to the law, to the 
interests of the country or of the bank. 
2. The suspension shall be notified to the Government, through the Finance Minister, 
and shall be considered waived, should the Cabinet not confirm it \\ithin fifteen days 
after its imposition. " 
14 
d. A right to participate in decision-making bodies of a NCB with a right to vote. 
A right of third parties to vote in decisions related to the tasks of the ESCB as 
defined in Article 105(2) is inconsistent with their commitment not to seek to 
influence such decisions. 
Article 14 of the Central Bank Act of Ireland 
"Tlie Bank shall be conducted and managed in accordance with this Act by a Board 
of Directors consisting of (a) a Governor and (b) such number of other Directors 
(not exceeding nine and not including at any time more than two service Directors) 
as the Minister shall from time to time determine.... Every sendee Director shall hold 
office at the pleasure of the Minister and may be removed by the Minister at any 
time. " 
e. A right to be consulted before a NCB takes a decision 
Article 107 of the Treaty does not, of course, preclude cooperation and dialogue 
between NCBs and government, parliament or other state bodies. In fact the Treaty 
provides for such contacts and reporting in a number of provisions. The point is 
whether the government avails itself of any formal mechanism of which the purpose 
is to influence the final decision of the NCB. An explicit duty to consult political 
bodies prior to the decision provides for such a mechanism and appears not to be 
compatible with the second sentence of Article 107. 
Article 42 ofSveriges RiksbankAct 
" Prior to the Riksbank making a monetary policy decision of major importance, the 
Cabinet Minister appointed by the Government shall be consulted. If such 
consultation is not possible and there is exceptional cause, the Riksbank may make 
such a decision without consultation. " 
f. A right to control ex ante the central bank's budget 
As for the previous point, the borderline between constraints to which NCBs must be 
subjected and attempts to influence the members of their decision-making bodies in 
the performance of their tasks is not easy to draw in each case. A NCB must, of 
course, be financially accountable. On the other hand, a requirement to have its 
budget approved beforehand may create a situation where a NCB is unable to avail 
itself autonomously of the appropriate means to fulfil its mandate. 
15 
Article 4.2 of the Law of Autonomy of the Banco de Espana 
"The Bank's draft budget for operating expenses and investments, once approved by 
its Governing Council according to Article 21. lg), shall be submitted to the 
Government, which will send it to the Spanish parliament for approval. The Bank's 
budget shall be estimative in nature, and shall not be consolidated with other state 
public sector budgets. " 
g. Membership of members of decision-making bodies in bodies outside the ESCB 
Membership in external bodies may entail conflicts of interests between the duties vis-
à-vis a NCB (for Governors additionally vis-à-vis the ECB) and the external function. 
However, it appears to be difficult to establish a general rule with respect to 
compliance or non-compliance of such membership with Article 107. The point in 
question is whether the member of the NCB body executes other tasks which might 
jeopardise his personal independence. 
Article 22 of the Osterreichische Nationalbank Act 
"(3) Only persons holding Austrian citizenship who are not debarred from being 
elected to the National Council (Nationalrat) may be members of the General 
Council. The members of the General Covncil shall be persons prominent in some 
branch of economic activity or jurists or economists. They shall include 
representatives of: 
1. banks; 
2. industry; 
3. trade and small businesses; 
4. agriculture; and 
5. salaried employees and wage-earners. 
(4) No person who is in the active service of the Federal Republic or a Land or who 
is a member of the Nationalrat, the Federal Government or the government of a 
Land may be a member of the General Council. The restriction with regard to 
persons in the active service of the Federal Republic shall not apply to university 
professors in law and economics. Not more than four members of the General 
Council may in their main occupation be a member of the management of banks; 
such persons may not be a President or Vice President of the Bank. " 
Compliance with Article 14.2 of the ESCB Statute 
In Article 14.2 of the Statute, the security of tenure for Governors is addressed under the 
aspect of their term of office and the grounds for their dismissal. 
16 
a. Term of office for Governors 
Article 14.2 of the Statute requires a minimum term of office for Governors, i.e. five 
years. Consequently, statutes with a shorter term of office need to be revised. 
Statutes which do not explicitly provide for a minimum term of office meet the 
minimum term requirement, provided that the grounds for dismissal are limited to the 
cases specified in the second sub-paragraph of Article 14.2 of the Statute (see below). 
Article 29 of the statutes of the Bank of Greece 
"The Governor and the Deputy Governors (...) shall be appointed (...) by an Act of 
the Cabinet, for a period of four years on proposal of the Board of Directors of the 
Bank (...)." 
The statute of the Banca dTtalia is silent about the term of office of the Governor and 
about grounds for dismissal. 
Article 19 of the Statute of the Banca d'ltalia 
"The Board of Directors may appoint and dismiss the Governor, the General 
Manager and the two Deputy General Managers. " 
Article 7(3) of the Bundesbank Act 
"The President, the Vice-President and the other members of the Directorate are 
nominated by the Federal Cabinet and appointed by the President of the Federal 
Republic. Before making such nominations, the Federal Cabinet shall consult the 
Central Bank Council. Members of the Directorate are appointed for eight years, or 
in exceptional cases for a shorter term of office, but not less than two years. " 
b. Grounds for dismissal of a Governor 
Article 14.2 of the Statute seeks to avoid the arbitrary dismissal of the Governor by 
the authorities involved in the appointment procedure. As in this case the Statute 
contains an explicit requirement on the content of national legislation, any 
contradictory provision would have to be amended. 
17 
Article 12(3) of the Act on the establishment of the Institut Monétaire 
Luxembourgeois 
"The Government may propose to the Grand-Duke the dismissal of the Management 
if there is a fundamental disagreement between the Government and the 
Management over the policy of the Institut and the performance of its tasks. In this 
event, the proposal of dismissal shall relate to the Management collectively. 
Likewise, the Government may propose to the Grand-Duke the dismissal of a 
member of the Management who becomes permanently unable to perform his duties. 
Before transmitting a proposal to the Grand-Duke, the Government shall consult the 
Council of the Institut. " 
Article 44 of the Statutes of the National Bank of Belgium 
"The governor is appointed and can be dismissed or suspended by the King. " 
Compliance with Article 105 of the Treaty 
The requirement that the objectives of all members of the ESCB must coincide with 
Article 105(1) does not imply the need to copy in all instances the wording of this 
paragraph into national statutes. In fact, the formulation of a central bank's objectives is 
quite disparate among Member States. This to some extent reflects the fact that central 
bank statutes date from different decades. However, any formulation must avoid casting 
doubt as to whether the bank in question is bound by the primary objective as laid down 
in the Treaty. 
Article 1 Act n. 116 on Danmarks Nationalbank3 
"Danmarks Nationalbank shall have the object to maintain a safe and secure 
currency system in this country, and to facilitate and regulate the traffic in money 
and the extension of credit. " 
Since Denmark has notified the Council that it will not participate in the third stage, there is no 
need to adapt the statute of Danmarks Nationalbank in this respect. 
18 
Further statutory requirements to be fulfilled for NCBs to become an integral part of the 
ESCB 
According to Article 14.3 of the Statute, national central banks are an integral part of the 
ESCB and shall act in accordance with the guidelines and instructions of the ECB. The 
scope of necessary adaptations of national law - either in central bank statutes or in other 
parts of law - which this principle implies will emerge more clearly in the process of 
preparatory work for the ECB's regulatory framework. It is obvious that national 
peculiarities may continue to exist to the extent that the effectiveness and uniformity of 
the single monetary policy are not affected. 
An example where national statutory provisions do not respect the prerogatives of the 
ECB are rules which provide for competencies of government bodies in the process of 
issuing banknotes. 
19 
3. PRICE STABILITY 
3.1 Treaty provisions 
The price stability criterion is defined in the first indent of Article 109j(l) of the Treaty: "The 
achievement of a high degree of price stability [...] will be apparent from a rate of inflation 
which is close to that of, at most, the three best performing Member States in terms of price 
stability. " 
Protocol No 6 on the convergence criteria develops Article 109j(l), by stipulating in Article 1 
that a Member State is convergent in terms of inflation if it "has a price performance that is 
sustainable and an average rate of inflation, observed over a period of one year before the 
examination, that does not exceed by more than 1'A percentage points that of, at most, the 
three best performing Member States in terms of price stability. Inflation shall be measured 
by means of the consumer price index on a comparable basis, taking into account differences 
in national definitions. " 
National consumer price indices (CPIs) diverge substantially in terms of concepts, methods 
and practices. Thus, to meet the requirement of Protocol No 6 that inflation must be measured 
on a comparable basis, the Council adopted on 23 October 1995 a framework Regulation 
(No 2494/95) which provides for a harmonisation of national CPIs in two steps. 
The first step required for the purpose of the report referred to in Article 109j(l), i.e. the 
present document, was the production by March 1996 of a set of so-called "interim indices of 
consumer prices" (IICPs), adjusted to reduce differences in coverage of goods and services 
observed between existing national indices. 
The monthly IICPs have been published as from January 1996 with the time series going back 
to January 1994. As a first step in the harmonisation process, IICPs exclude those categories 
of the national indices for which existing practices differ most markedly across Member 
States. As such, IICPs do not include imputed rents of owner-occupied housing, health and 
educational services, and various other items like mortgage interest payments, financial 
services, insurance, package holidays and certain local authority services. On the other hand, 
IICPs incorporate some components, such as prices of alcohol and tobacco, which are 
excluded from the national CPIs in some Member States. Though not strictly comparable, 
IICPs are for the time being considered to constitute a more comparable basis for the 
assessment of inflation convergence among Member States than the national CPIs. 
The second step, scheduled for January 1997, will be the launch of comparable harmonised 
indices (HICPs) based on common definitions and methods such as the use of a common 
coverage of goods and services for all Member States and harmonisation of the reference 
period, standards for sampling, frequency of updating weights, demographic and geographical 
coverage, etc. 
20 
3.2 Price stability as assessed by the IICPs 
3.2.1 Recent trends 
The time series for the IICPs are available only from January 1994. As a result, the analysis of 
the inflation trend based on this index cannot start before January 1995. Since early 1995, a 
general tendency towards lower and more convergent inflation has prevailed. Inflation in the 
Community as a whole as measured by the IICP (percentage change on a year earlier) stood at 
2.8% in January 1995 and declined to 2.4% in September 1996. This figure is historically low 
and not far from what could be called price stability. 
In the seven Member States where the annual inflation rate was below 2.5% in January 1995 
(Belgium, Denmark, Germany, France, Luxembourg, the Netherlands and Finland), the pace of 
price increases either eased further or stabilised at a low level during the subsequent 20 months 
(see Graph 3.1). In three of the four countries where the annual inflation rate ranged between 
2.5%» and 3% at the beginning of 1995 (Ireland, Austria and Sweden, the exception being the 
United Kingdom), it edged down to below 2% in mid-1996. The deceleration was most 
noticeable in Sweden where the annual inflation rate eased to below 1% since August of this 
year. In the United Kingdom, progress towards price stability has proved to be gradual and 
somewhat erratic, but the downward trend has been confirmed during the course of 1996, 
despite the context of a sustained recovery and earlier downward pressure on sterling. 
In the remaining Member States, visible progress has been achieved with inflation performance, 
but the degree of price stability and price convergence is not yet satisfactory. Spain and Italy 
experienced a worrying upward movement in inflation during the first half of 1995 due to both 
the surge in import prices following the marked depreciation of their currencies in the spring 
and increases in indirect taxation. However, in both countries inflation peaked in the middle of 
1995 and since then a steady downward trend has been clearly discernible. Inflation stood at 
3.5%o in Italy and at 3.6% in Spain in September of this year.But in Spain the deceleration in 
inflation has stalled in recent months, although underlying inflation (excluding prices of 
unprocessed food and energy) has continued to edge down. An upward blip in inflation also 
took place in Portugal in the spring of last year, but the upturn was much smaller and reversed 
more quickly than in the previous two countries. However, after having eased to close to 2% 
in March of this year, inflation has accelerated in recent months, reaching 3.2% in September. 
In Greece, inflation has declined from 10.9% in January 1995 to 8.1% in September 1996, but 
it is still well above the Community average. 
21 
22 
3.2.2 Price convergence measured against a reference value 
In this report, the following operational definitions have been used (for a discussion of the 
issues involved see the box on the "Calculation of the inflation reference value"). A Member 
State's inflation is measured by the percentage change 
in the arithmetic average of twelve monthly indices 
relative to the arithmetic average of the twelve 
monthly indices of the previous period*. The reference 
value is calculated as the arithmetic average of the 
inflation rates of the three best performing Member 
States plus 1.5 percentage points. 
Over the period for which a reference value can be 
calculated2, the reference value declined marginally 
from 2.7% in December 1995 to 2.6% in 
September 1996 (see Table 3.1). Over the period 
concerned, the composition of the reference group of 
the three best performers shows little change. The 
Netherlands and Finland have invariably been part of 
the group whereas Germany replaced Belgium as from 
June 1996. 
In September 1996, ten Member States had an average 
inflation rate below the reference value (Belgium, 
Denmark, Germany, France, Ireland3, Luxembourg, 
the Netherlands, Austria, Finland and Sweden), while 
in two other countries (Portugal and the 
United Kingdom), the average inflation rate was 
0.4 percentage points above the reference value. In 
Spain and Italy, the average inflation rate exceeded the 
reference value by 1.2 percentage points and 
2.1 percentage points, respectively. In the case of 
Greece, the gap from, the reference value amounted to 
5.8 percentage points (see Table 3.2) I Table 3.1 I 
Inflation convergence 
(inflation measured by the percentage change 
in the IICP) 
Interim indices of 
consumer prices 
Three best December September 
performers 1995 1996 "i n -
D 1.3 
NL 1.1 1.2 
FIN KO 0.9 
Reference 2.7 2.6 
valued) 
Member States respecting the reference 
value 
Number: I 9 10 
out of: 15 15 
~B ÏÂ ÏT 
DK 2.3 2.2 
D 1.5 1.3 
F 1.7 2.1 
IRL<3) 2.4 2.1 
L 1.9 1.3 
NL' 1.1 1.2 
A 2.0 1.7 
FIN 1.0 0.9 
J3 J - I 1.6 
(1) Measured by the percentage change in 
the arithmetic average of twelve 
monthly indices relative to the 
arithmetic average of the twelve 
monthly indices of the previous period. 
(2) Definition adopted in this report: 
arithmetic average of the three best 
performers in terms of inflation plus 
1.5 percentage'points. 
(3) Measured on the basis of quarterly data 
Source: Commission services. 
It should be noted that this measure is different from that usually referred to as the inflation rate (calculated 
as the percentage change in an index in the latest month over the index of 12 months before), which has 
been used in Section 3.2.1. and Graph 3.1. 
The time series for the IICP are available only from January 1994. As a result, the earliest reference value 
which can be calculated is for December 1995. 
For Ireland the IICP and national CPI are only available quarterly. 
23 
Table 3.2 
The average rate of inflation 
(measured by IICP; percentage change) 
B 
DK 
D 
EL 
E 
F 
IRL(2) 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR Interim indices of consumer 
p_rices 
December 
(i) 
1995 
1-4 
2.3 
1.5 
9.0 
4.7 
1.7 
2.4 
5.4 
1.9 
1.1 
2.0 
3.8 
1.0 
2.9 
3.1 
3.0 September 
1996(1) 
1.6 
2.2 
1.3 
8.4 
3.8 
2.1 
2.1 
4.7 
1.3 
1.2 
1.7 
3.0 
0.9 
1.6 
3.0 
2.7 
(1) Measured by the percentage change in the 
arithmetic average of twelve monthly indices 
relative to the arithmetic average of the 
twelve monthly indices of the previous 
period. 
(2) Measured on the basis of quarterly data 
Source: Commission services. The convergence situation was better in 
September 1996 than in December 1995, when nine 
countries enjoyed average inflation rates below the 
reference value, and when the distance from the 
reference value in the other countries was larger 
than is currently the case. 
Graph 3.2 Interim indices of consumer prices (IICP) 
li (Arithme&c average of twelve monthly indices relative to tfee ari&metic average of the 
twelve monâîly indices of the preceding j>erM) 
Percentage change 
HHDec. 1995 
S3 Sep. 1996 
B DK P S& B F ML I 
* Average of 3 best performers^ 1,5 percentage points. 
Source: Commission services, Ht, A P FîN S OK 
24 
3.3 Inflation performance during the second stage of EMU 
The limited time-span covered by the IICPs does not allow more recent inflation 
developments to be seen in perspective. To ensure a comprehensive and balanced examination 
of the degree of price stability and the sustainability of the inflation performance, some other 
inflation indicators must be considered, including private consumption deflators and CPIs. 
The box on the "Differences between IICPs and CPIs" examines the scale of such differences. 
Developments with regard to private consumption deflators and CPIs confirm that substantial 
progress in inflation convergence has been achieved in the Community since the start of Stage 
Two of EMU on 1 January 1994. Between 1993 and 1995, inflation for the Community as a 
whole, fell from 4% to 3%, as measured by the private consumption deflator, and from VA% 
to 3%, as measured by the CPI. This downward trend has continued in 1996, with inflation in 
the Community on average expected to be just over IViVo on both measures this year (see 
Table 3.3). 
At the country level, the picture painted by the evolution of the private consumption deflator 
and the CPI is similar to that outlined by the IICPs. The decline in inflation is observed in all 
the Community countries, although to varying degrees. During Stage Two, Member States 
which have long participated in the exchange-rate mechanism (ERM) (Belgium, Denmark, 
Germany, France, Ireland, Luxembourg and the Netherlands) have consolidated their already 
good initial inflation performances, while the three new Member States (Austria, Finland and 
Sweden) have converged in terms of price stability towards this first group. 
In the United Kingdom, the CPI evolution is strongly influenced by movements in mortgage 
rates. The latter largely explains the drop to 1.6% in 1993 and the subsequent rise to 3.5% up 
to 1995. Again, most of the slowdown in the CPI inflation during the first half of 1996 is due 
to the fall in mortgage rates. However, the private consumption deflator showed an easing in 
inflation from 3.5% in 1993 to 2.6% in 1995, and it is expected to be slightly lower in 1996. 
25 
Table 3.3 
Private consumption deflator and consumer price index 
(national currency, percentage change) 
B 
DK 
D 
EL 
E 
F 
BRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR 
CV 
CVERM 
CV 
Non-ERM 
(1) Autumn 1< 
(2) Measured 
twelve mo 
monthly ir 
CV = Coeffici 
of the data). 
CV ERM is t 
P for 1993 an< 
1996. 
The Non-ERN 
included in th 
Source: Comn Private consumption 
deflator 
1993 
3.0 
0.3 
3.9 
13.7 
5.5 
2.2 
1.9 
5.4 
7.0 
2.1 
3.4 
7.1 
4.2 
5.7 
3.5 
4.1 
0.73 
0.62 
0.59 1994 
3.2 
1.7 
2.7 
10.8 
4.9 
2.1 
2.6 
4.6 
2.4 
2.7 
3.0 
4.8 
1.4 
3.1 
2.5 
3.3 
0.63 
0.35 
0.59 1995 
1.6 
2.1 
2.0 
9.3 
4.7 
1.7 
2.0 
5.8 
2.0 
0.9 
2.3 
4.2 
0.2 
2.7 
2.6 
3.0 
0.75 
0.48 
0.76 1996 
0) 
2.0 
2.0 
1.8 
8.5 
3.6 
1.9 
2.0 
3.9 
1.7 
1.9 
2.0 
3.3 
0.9 
1.7 
2.5 
2.6 
0.66 
0.34 
0.63 Consumer price index 
1993 
2.8 
1.3 
3.6 
14.4 
4.6 
2.1 
1.4 
4.5 
3.6 
2.6 
3.6 
6.4 
2.2 
4.6 
1.6 
3.4 
0.85 
0.49 
0.81 1994 
2.4 
2.0 
2.7 
10.9 
4.7 
1.7 
2.3 
4.0 
2.2 
2.8 
3.0 
5.2 
1.1 
2.2 
2.5 
3.1 
0.68 
0.40 
0.63 1995 
1.5 
2.1 
1.8 
9.3 
4.7 
1.8 
2.6 
5.2 
1.9 
1.9 
2.2 
4.1 
1.0 
2.5 
3.4 
3.1 
0.66 
0.41 
0.67 Sep. 96 
(2) 
1.8 
2.0 
1.6 
8.6 
3.8 
2.1 
1.8 
4.6 
1.3 
1.9 
1.8 
3.3 
0.5 
1.2 
2.6 
2.7 
0.74 
0.43 
0.66 
?96 economic forecasts. 
by the percentage change in the arithmetic average of 
nthly indices relative to arithmetic average of the twelve 
idices of the previous period. 
ent of variation (ratio of the standard deviation to the mean 
le coefficient of variation for ; B, DK, D, E, F, IRL, L, NL, 
i 1994. A is included in 1995 and 1996. FIN is included in 
1 includes EL, I, UK for 1993 and 1994. FIN and S are 
e CV Non-ERM for 1995 and S also for 1996. 
lission services. In the remaining Member 
States (Spain, Greece, Italy 
and Portugal), a clear 
improvement has been 
observed since 1993, but in 
Spain and Portugal the 
downward trend in inflation 
was interrupted in the spring 
of 1996. 
The generalised reduction in 
inflation throughout the 
Community has been 
accompanied by a narrowing 
in inflation differentials 
between Member States. One 
indication of how inflation in 
the Member States has tended 
to converge is provided by the 
coefficient of variation4 , a 
statistical measure of 
dispersion. The coefficient of 
variation for inflation, 
measured by the private 
consumption deflator, 
declined from 0.73 in 1993 to 
0.66 in 1996 for the 
Community as a whole. The 
convergence process has been 
even greater within the ERM 
group, with the coefficient of 
variation declining from 0.62 
in 1993 to 0.34 in 1996. On 
the other hand, substantially 
greater variability continues to 
characterise inflation within 
the non-ERM group. 
The coefficient of variation shows the dispersion of individual Member State's inflation around the average 
rate of inflation for each year; the higher the value, the greater the dispersion of inflation in any given year. 
26 
3.4 The sustainability of price convergence 
The process of inflation convergence which has been evident in the Community for more than 
a decade results in large part from fundamental changes in the attitude of all economic actors 
towards inflation. 
The most important structural change has undoubtedly been the determined implementation of 
monetary policies targeted at price stability. Several Member States have adopted explicit 
inflation targets, or indirect objectives (like a money growth target or an exchange rate target), 
and accordingly they have conducted their monetary policies credibly. 
Institutional changes such as the prohibition of central bank financing of budget deficits and 
the prohibition of privileged access of the public sector to financial institutions (which entered 
into force with the start of Stage Two) as well as the granting of independence to central 
banks (as required by the Treaty by the end of Stage Two, see Chapter 2) have helped to 
strengthen the effectiveness and credibility of a stability-oriented monetary policy in the 
Member States. 
Besides its direct effect on inflation, monetary policy also exerts a curbing impact on price 
increases through its influence on economic agents' behaviour. By remaining firm on an anti-
inflation policy, monetary authorities raise the credibility of price stability objectives and 
strongly contribute to reduce inflation expectations. Nominal wage moderation has been 
progressively achieved over the past ten years (see section 7.4.1). This trend suggests that the 
Social Partners have increasingly internalised the price-stability objective in their wage 
settlements. 
But other key structural factors have contributed importantly to the low inflation environment 
currently prevailing in the Community. The completion of the single market has exerted - and 
will continue to do so - downward pressure on price inflation at the firm and sectoral level 
mainly through two channels. Firstly, the removal of national trade barriers has increased 
competition in many markets for goods and services, with a subsequent squeeze of rents 
which resulted from imperfect market situations. Secondly, greater competition has also 
induced a more efficient allocation of resources within the Community, fostering the 
efficiency of the supply side. Production costs have thus been curbed, with an obvious 
downward impact on prices. 
Since the 1980s, most Member States have re-oriented their budgetary policy. The use of 
discretionary budgetary instruments for regulating economic activity has been increasingly 
regarded as inefficient and even damaging, as persistent excessive deficits and the 
accumulation of public debt have been accompanied by serious adverse supply-side and 
inflation effects. Initially, the success of budgetary consolidation policies was mixed, but, in 
recent years, efforts to reduce budget deficits have intensified and have proved to be more 
credible, as examined in Chapter 4. The shift towards greater budgetary discipline, aimed at 
balanced positions in the medium term, has fostered low and stable inflationary expectations, 
thereby facilitating the task of monetary policy to achieve and maintain price stability with 
lower interest rates. 
27 
Beside structural factors, cyclical forces have also helped to bring about the current favourable 
inflation performance in the Community. The persistence of output levels below full capacity 
has exerted a strong disincentive for companies to raise prices or to allow significant wage 
increases. 
28 
CALCULATION OF THE INFLATION REFERENCE VALUE 
Protocol No 6 states that the inflation reference value should be calculated on the basis of "an 
average rate of inflation, observed over a period of one year of, at most, the three best 
performing States ' '. 
As to the question of the average, in this report preference is given to an arithmetic average as 
opposed to a geometric one as it is the most commonly used method. Furthermore, the 
difference between the arithmetic and geometric average is very small, especially if inflation is 
low. 
Regarding the period of one year, two main approaches are possible: either using the year-on-
year change of a monthly indicator (for instance, September 1996/September 1995), or using 
the average change of the last twelve months over the preceding twelve months. The 
advantage of the first approach is that it is straightforward and easy understandable. But 
disadvantages outweigh this advantage. Indeed, results may vary importantly from month to 
month, because of possible base effects due for instance to changes in indirect taxes. 
Furthermore, and more importantly, as the criterion should assess the sustainability of price 
stability and of inflation convergence, taking into account a longer period seems more 
appropriate. 
Concerning the number of countries to be included in the calculation of the reference value, 
different approaches are conceivable. A first group takes one country to calculaate the 
reference value: 
Method 1: the best performing country +1.5 percentage points. 
Method 2: the second best performing country +1.5 percentage points. 
Method 3: the third best performing country +1.5 percentage points. 
A second group of interpretations would take an average of two or three countries: 
Method 4: an unweighted average of the two best performing countries +1.5 percentage 
points. 
Method 5: the unweighted average of the three best performing countries +1.5 percentage 
points. 
Method 6: a weighted average of the three best performing countries +1.5 percentage 
points. 
29 
Table 3.4 
Inflation convergence according to alternative methods for the calculation of the reference value, 
ncp 
1. The best performing country 
+1.5 percentage points. 
2. The second best performing country 
+1.5 percentage points. 
3. The third best performing country 
+ 1.5 percentage points. 
4. The two best performing countries, 
unweighted average 
+1.5 percentage points. 
5. The three best performing countries, 
unweighted average 
+1.5 percentage points. 
6. The three best performing countries, 
weighted® average +1.5 percentage 
points. December 1995 0) 
Reference 
value 
2.5 
2.6 
2.9 
2.5 
2.7 
2.7 Number of 
member states 
respecting the 
reference value 
(?) 
9 
9 
9 
9 
9 
9 September 1996(I) 
Reference 
value 
2.4 
2.7 
2.8 
2.6 
2.6 
2.8 Number of 
member states 
respecting the 
reference value 
(3) 
10 
10 
10 
10 
10 
10 
(1) Measured by the percentage change in the arithmetic average of twelve monthly indices relative to the 
arithmetic average of the twelve monthly indices of the previous period. 
(2) Weighted according to shares of private consumption in 1995 at current prices, PPS. 
(3) 9 countries respecting the reference value in December 1995: B, DK, D, F, KL, L, NL, A, FIN. 
10 countries respecting the reference value in September 1996: B, DK, D, F, ERL, L, NL, A,-FIN, S. 
Source: Commission services. 
A reference value has been calculated according to these six methods both for December 1995 
and for September 1996. For the purpose of this report, the Commission has adopted 
method 5. Table 3.4 shows that the number of countries with inflation below the reference 
value is the same, both in December 1995 and in September 1996, whatever the method used. 
These results may be explained by two factors. First, there is an important group of countries 
which has achieved low and convergent inflation in a sustained way. As a result, neither the 
number of countries taken into account nor the composition of the reference group has a major 
effect on the magnitude of the reference value. Secondly, the inflation performance of the 
remaining Member States is still too distant from the low inflation group such that small 
variations in the reference value do not a1low these countries to be below the reference value. 
30 
DIFFERENCES BETWEEN IICPS AND CPIS 
The differences between IICPs and CPIs depend very much on the existing structure of 
national CPIs. 
For countries where the CPIs incorporate items like health care or imputed rents on owner-
occupied housing, the IICPs will tend to be lower than the CPIs as the prices of these items 
tend to rise faster than those of internationally traded goods. On the other hand, for countries 
where alcohol and tobacco prices are excluded from the CPIs, the difference with the IICPs 
will be positive as price increases on these goods are typically higher than average. Countries 
where mortgages are included in the national CPIs will see erratic differentials. At the 
Community level and for a number of countries, differences between the CPI and the IICP are 
minor, with the discrepancy in the range of ±0.1 percentage point to ±0.3 percentage point (see 
Table 3.5). But for some countries, differences vary from ±XA percentage point to nearly 
1 percentage point (Ireland, the Netherlands, Finland, Sweden and the United Kingdom). 
Table 3.5 
Difference between IICPs and CPIs 
( percentage change) 
B 
DK 
D 
EL 
"E . 
F 
IRL(3) 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR 1995(1) 
IICP 
1.4 
2.3 
1.5 
9.0 
4.7 
1.7 
2.4 
5.4 
1.9 
1.1 
2.0 
3!8 
1.0 
2.9 
3.1 
3.0 CPI 
1.5 
2.1 
1.8 
9.3 
4.7 
1.8 
2.6 
5.2 
1.9 
1.9 
2.2 
4.1 
1.0 
2.5 
3.4 
3.1 Difference 
ncp-cpi 
-0.1 
0.2 
-0.3 
-0.3 
0.0 
-0.1 
-0.2 
0.2 
0.0 
-0.8 
-0.2 
-0.3 
0.0 
0.4 
-0.3 
-0.1 March 1996(2) 
ncp 
1.7 
2.3 
1.4 
8.9 
3.4 
2.5 
2.1 
4.4 
1.3 
1.5 
1.8 
2.1 
1.1 
1.5 
3.0 
2.7 CPI 
2.0 
2.1 
1.7 
9.1 
3.4 
2.3 
2.0 
4.5 
1.2 
2.1 
1.8 
2.4 
0.6 
1-5. 
2.7 
2.7 Difference 
ncp - CPI 
-0.3 
0.2 
-0.3 
-0.2 
0.0 
0.2 
0.1 
-0.1 
0.1 
-0.6 
0.0 
-0.3 
0.5 
0.0 
0.3 
0.0 September 1996(2) 
ncp 
2.1 
2.5 
1.3 
8.1 
3.6 
1.6 
2.2 
3.5 
1-5 
1.4 
2.2 
3.2 
1.2 
0.6 
2.9 
2.4 CPI 
1.9 
2.3 
1.4 
8.5 
3.6 
1.6 
1.4 
3.4 
1.4 
2.0 
2.0 
3.4 
0.6 
-0.1 
2.1 
2.3 Difference 
HCP - CPI 
0.2 
0.2 
-0.1 
-0.4 
0.0 
0.0 
0.8 
0.1 
0.1 
-0.6 
0.2 
-0.2 
0.6 
0.7 
0.8 
0.1 
(1) Annual percentage change. 
(2) Percentage on a year earlier, T/T-l2. 
(3) Measured on the basis of quarterly data. 
Source: Commission services. 
31 
Table 3.6 
Inflation convergence using IICPs and CPIs 
(percentage change) 
Three best 
performers 
B 
D 
F 
NL 
L 
FIN 
S 
Reference 
valued) Interim indices of 
consumer prices (') 
Dec. 
1995(1) 
1.4 
1.1 
1.0 
2.7 Sep. 
(i) 
1996 
1.3 
1.2 
0.9 
2.6 Consumer Price Index 
(1) 
Dec. 
1995(I) 
1.5 
1.8 
1.0 
2.9 Sep. 
(i) 
1996 
1.3 
0.5 
1.2 
2.5 
Member States respecting the reference value 
Number: 
Out of: 
B 
DK 
D 
F 
ERL(3) 
L 
NL 
A 
FIN 
S 
(1) Measured t 
of twelve n 
twelve mor 
(2) Defmition 
three best ] 
points. 
(3) Measured < 
Source: Commi. 9 
15 
1.4 
2.3 
1.5. 
1.7 
2.4 
1.9 
1.1 
2.0 
1.0 10 
15 
1.6 
2.2 
1.3 
2.1 
2.1 
1.3 
1.2 
1.7 
0.9 
1.6 10 
15 
1.5 
2.1 
1.8 
1.8 
2.6 
1.9 
1.9 
2.2 
1.0 
2.5 10 
15 
1.8 
2.0 
1.6 
2.1 
1.8 
1.3 
1.9 
1.8 
0.5 
1.2 
y the percentage change in the arithmetic average 
lonthly indices relative to arithmetic average of the 
ithly indices of the previous period, 
adapted in this report: arithmetic average of the 
jerformers in terms of inflation plus 1.5 percentage 
an the basis of quarterly data. 
ssion services. Furthermore, since the inflation 
criterion is defined in relative and not 
in absolute terms, the use of the IICPs 
does not significantly influence the 
results. As indicated in Table 3.6, the 
number of countries respecting the 
reference value does not differ if the 
CPI is used instead of the IICP. 
However, the group of the three best 
performing countries is different. 
32 
4. GOVERNMENT BUDGETARY POSITION 
4.1 Existence of an excessive deficit 
Fulfilment of the criterion on the sustainability of the government financial position 
depends, as the second indent of Article 109j(l) makes clear, on a Member State 
having achieved a government budgetary position without a deficit that is excessive as 
determined in accordance with Article 104c(6). Protocol No 6 on the convergence 
criteria further states, in Article 2, that: 
"The criterion on the government budgetary position referred to in the second indent 
of Article 109j(l) of this Treaty shall mean that at the time of the examination the 
Member State is not the subject of a Council decision under Article 104c(6) of this 
Treaty that an excessive deficit exists". 
The role of this report, therefore, is not to make an independent assessment of 
whether or not Member States currently fulfil the criterion on the government 
budgetary position. This is already determined by the Council decisions on the 
existence of an excessive deficit. The first section of this chapter describes the 
application of the excessive deficit procedure during the second stage of EMU and the 
decisions on the existence of an excessive deficit which are currently in force. In the 
remaining sections of this chapter recent budgetary developments in the Member 
States are reviewed. 
The provisions of the excessive deficit procedure (Article 104c with the exception of 
paragraphs 1,9, 11 and 14, together with the associated Protocol (No 5)) have applied 
since the beginning of the second stage of EMU in January 1994. The practice since 
then has been for the Commission and Council to implement the procedure on an 
.annual basis. Each year the various steps of the procedure have been applied following 
the March reporting of budgetary data by Member States (as required by Council 
Regulation (EC) No 3605/93). The box on the "Excessive deficit procedure" describes 
the main features of the procedure during the second stage. 
In the first application of the procedure in 1994 the Council decided1 in accordance 
with Article 104c(6) on the existence of an excessive deficit in ten of the then twelve 
Member States. Only Ireland and Luxembourg were not the subject of such a decision: 
in Ireland the government deficit was below the reference value of 3% of GDP and the 
government debt ratio, while above the reference value of 60% of GDP, had been 
declining significantly; in Luxembourg the government balance was in surplus and the 
debt ratio was far below the reference value. All the other ten Member States were 
judged not to satisfy one or both of the criteria for government deficit and debt. 
In 1995 the procedure was applied for the first time to the three new Member States 
(Austria, Finland and Sweden) and the Council decided2 that an excessive deficit 
Council decisions of 26 September 1994. None of the documents for the application of the 
procedure has been published in the Official Journal. 
Council decisions of 10 July 1995. 
33 
existed in each of them. At the same time the Council decided3 in accordance with 
Article 104c(12) to abrogate the decision on Germany: the government deficit in 
Germany had fallen below the reference value in 1994 and was expected then to 
remain below in 1995, and the government debt ratio remained below the reference 
value. 
In the application of the procedure in 1996 the Council adopted a new decision4 on the 
existence of an excessive deficit in Germany: as it had turned out, the government 
deficit in Germany rose above the reference value in 1995 and was expected to remain 
above in 1996. The Council also decided5 to abrogate the decision on Denmark: the 
government deficit in Denmark fell well below the reference value in 1995 and was 
expected to remain at a low level in 1996, and the government debt ratio, while still 
above the reference value, declined significantly in 1994 and 1995. 
Thus twelve Member States are currently the subject of a Council decision that an 
excessive deficit exists. At present, only three Member States (Denmark, Ireland and 
Luxembourg) are not the subject of such a decision and so fulfil the criterion on the 
government budgetary position. 
Graph 4.1 
General government deficit 
(%o£GDF) 
B DK D EL E 
Source iC<imm$$i0û servfcç& F rci, Î t w, A ? if s ii 
4.2 Budgetary developments in 1996 
Efforts at budgetary consolidation in 1996 have been made within the context of a 
pause in economic growth. The Commission services forecast real GDP growth of 
1.6% this year for the European Union as a whole, and growth rates below this 
3 Council decision of 10 July 1995. 
4 Council decision of 27 June 1996. 
5 Council decision of 27 June 1996. 
34 
average are expected for Belgium, Germany, France, Italy and Austria. Despite the 
unfavourable economic climate almost all Member States are expected to make 
further progress in reducing government deficits in 1996. According to the latest 
forecasts of the Commission services (see Table 4.1 and Graph 4.1), only Germany is 
likely to see a widening of its deficit in 1996. In all the other Member States and in the 
European Union as a whole the deficit is expected to decline (in Luxembourg, the 
surplus is likely to be smaller). Particularly large reductions in the deficit of more than 
1% of GDP are likely in Greece, Spain, the Netherlands, Austria, Portugal, Finland, 
Sweden and the United Kingdom. 
On present estimates, it seems 
likely that in 1996 one more 
Member State (the 
Netherlands) will succeed in 
reducing its deficit to below 
the 3% of GDP reference 
value, thus joining the three 
Member States which have 
already achieved this 
- Denmark, Ireland and 
Luxembourg (in surplus). 
Two Member States (Belgium 
and Finland) are likely to 
achieve a deficit of between 
3% and VA% of GDP this 
year and a further six 
(Germany, Spain, France, 
Austria, Portugal and 
Sweden) are expected to have 
a deficit below 41/2% of GDP. 
Persisting government deficits 
and relatively low growth of 
nominal GDP (due to both 
poor real growth and a good or improving inflation performance) imply that the 
government gross debt ratio, all other things being equal, is likely to continue rising in 
several Member States in 1996 and in the European Union as a whole (see Table 4.2 
and Graph 4.2). However, in Belgium, Denmark, Greece, Ireland, Italy, the 
Netherlands, Portugal and Sweden the debt ratio is expected to decline this year. Table 4.1 
General government deficit 
(%ofGDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L(2) 
NL 
A 
P 
FIN 
S 
UK 
EUR 1993 
7.5 
3.9 
3.5 
14.2 
6.8 
5.6 
2.4 
9.6 
-1.7 
3.2 
4.2 
6.9 
8.0 
12.3 
7.8 
6.2 1994 
5.1 
3.5 
2.4 
12.1 
6.3 
5.6 
1.7 
9.0 
-2.6 
3.4 
4.4 
5.8 
6.2 
10.8 
6.8 
5.4 1995 
4.1 
1.6 
3.5 
9.1 
6.6 
4.8 
2.0 
7.1 
-1.5 
4.0 
5.9 
- 5.1 
5.2 
8.1 
5.8 
5.0 1996(1) 
3.3 
1.4 
4.0 
7.9 
4.4 
4.0 
1.6 
6.6 
-0.9 
2.6 
4.3 
4.0 
3.3 
3.9 
4.6 
4.4 
(1 ) Autumn 1996 economic forecasts. 
(2) Negative sign indicates a surplus 
Source: Commission services. 
35 
Table 4.2 
General government gross debt 
(%ofGDP) 
B 
DK(2) 
D(3) 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR Level 
1993 
137.0 
80.1 
48.2 
111.8 
60.5 
45.6 
94.5 
119.3 
6.2 
80.8 
62.8 
68.2 
57.3 
76.0 
48.5 
66.1 1994 
135.0 
76.0 
50.4 
110.4 
63.1 
48.4 
87.9 
125.5 
5.7 
77.4 
65.1 
69.6 
59.5 
79.3 
50.4 
68.1 1995 
133.7 
71.9 
58.1 
111.8 
65.7 
52.8 
81.6 
124.9 
6.0 
79.7 
69.0 
71.7 
59.2 
78.7 
54.1 
71.3 1996(1) 
130.6 
70.2 
60.8 
110.6 
67.8 
56.4 
74.7 
123.4 
7.8 
78.7 
71.7 
71.1 
61.3 
78.1 
56.3 
73.5 Change 
94/93 
-2.0 
-4.1 
2.2 
-1.4 
2.6 
2.8 
-6.6 
6.2 
-0.5 
-3.4 
2.3 
1.4 
2.2 
3.3 
1.9 
2.0 95/94 
-1.3 
-4.1 
7.7 
1.4 
2.6 
4.4 
-6.3 
-0.6 
0.3 
2.3 
3.9 
2.1 
-0.3 
-0.6 
3.7 
3.2 96/95 
-3.1 
-1.7 
2.7 
-1.2 
2.1 
3.6 
-6.9 
-1.5 
1.8 
-1.0 
2.7 
-0.6 
2.1 
-0.6 
2.2 
2.2 
(1) Autumn 1996 economic forecasts. 
(2) Government deposits with the central bank, government holdings of non­
governmental bonds and public enterprises related debt amounted to some 
18 percent of GDP in 1995. 
(3) The sharp increase in the German debt ratio in 1995 is mainly caused by 
the take-over by the government of off-budget unification-related 
liabilities, the most important of which is the debt of the 
'Treuhandanstalt". 
Source: Commission services. At the end of 1996 
the debt ratio is 
expected by the 
Commission 
services to be below 
the 60% of GDP 
reference value in 
three Member 
States - France, 
Luxembourg and 
the United 
Kingdom. The debt 
ratio is likely to rise 
to just above the 
60% level in 
Germany and 
Finland and to be in 
the range between 
60 and 70% of GDP 
also in Spain. In 
Denmark, Ireland, 
the Netherlands, 
Austria, Portugal 
and Sweden the 
debt ratio is likely 
to be in the 
between 70 
80% of 
Finally, in 
Member range 
and 
GDP. 
three 
States 
(Belgium, Greece and Italy) the debt ratio will remain higher than 110% of GDP. 
Graph 4.2 
General government gross debt 
&»KD£Lfc ? StCL ï L XL A 1? m "$ V& 
jfouror; ûomnu $KK>8 services 
'•""••f 11 
36 
4.3 Progress with budgetary consolidation during the second stage of EMU 
At the beginning of the second stage of EMU budgetary positions in most Member 
States were in very serious imbalance; deficits had risen in many cases to record levels 
in 1993 as a result of the sharp recession and debt ratios were on an upward trend in 
all Member States except Ireland and Luxembourg. 
During the last three years efforts by Member State governments at budgetary 
consolidation have been intensified on a broad front. There has been a rising awareness 
of the risks for inflation, interest rates and economic growth from uncorrected 
budgetary imbalances generating debt trends which are very difficult to reverse. During 
this period financial markets have tended more clearly to attach a risk premium to 
countries with untackled budgetary problems. In addition, policy in the Member States 
has drawn support from the need for a high degree of convergence in view of the 
single currency. 
All the Member States with high levels of deficits #have adopted ambitious medium-
term programmes for budgetary consolidation. Reducing budgetary imbalances is at 
the core of the convergence programmes presented by Member States at Community 
level. 
Although in several cases progress has not been as rapid as originally planned and 
there have been a few setbacks, the experience since 1993 in most Member States has 
been one of steady narrowing of government deficits (see Table 4.1 and Graph 4.3). 
The only exceptions are Germany, where after the deficit declined in 1994 it has risen 
again in both 1995 and 1996, Spain, where the deficit increased in 1995 before 
declining again in 1996, the Netherlands, where the deficit widened in 1994 and 1995 
before declining in 1996, and Austria, which also saw its deficit continue to rise in 
1994 and 1995 before a reduction in 1996. The surplus in Luxembourg has fluctuated 
from year to year. 
Especially large deficit reductions of over 4% of GDP have been achieved between 
1993 and 1996 in Belgium, Greece, Finland and Sweden, while reductions of between 
2% and 4% of GDP have been seen in Denmark, Spain, Italy, Portugal and the United 
Kingdom. Nonetheless many of these countries started from very high deficits and 
have not yet reached satisfactory deficit levels. Although the short-term focus is on 
bringing deficits down to 3% of GDP, this has to be seen as only a step on the way 
towards re-establishing sound budgetary positions. As shown by the recent discussions 
about a stability pact on which proposals were adopted by the Commission on 
16 October 1996, the 3% of GDP deficit reference value is to be considered not as a 
target but as a ceiling; it would be appropriate for Member States to aim in the medium 
term for budgetary positions close to balance or in surplus so as to foster growth and 
employment. 
Graph 4.3 
Debt Government deficit and debt ratios - 1993-96 
(%ofGDP) 
SIB 
120 
110 
100 
90 
80 
70 
60 
50 
40 
100 
90 
80 
70 
60 
50 h 
40 
30 h 
20 
10 I-01993 
*1994 
•1995 
#1996 #' &^--<--°B 
soi GR 
..* — -«--€> 
#' IRLl 
V i DK 
-^r 
#- — ^—Q A **©*L 
*>©D ^ %F 
-1 0 1 2 3 4 5 6 7 8 9 10 11 . 12 13 14 15 
Deficit 
Debt 
0 01993 
*1994 
D1995 
#1996 -B- -*~-^~. O 
#-<£t 
#• _l<f ."f-JÈl-^-OP 
#-«----© FIN 
*^0UK 
-3 -2-10 1 
Source: Commission services. 5 
Deficit 10 11 12 : 13 
38 
4.3.1 Influence of the economic cycle 
Just as deficits in 1993 were swollen by the impact of recession, so part of the 
improvement in deficits since then can be ascribed to the effects on spending and tax 
revenues of the recovery in economic activity. In 1994 and 1995 more than half of the 
f| Graph 4.4 
Actual and cyclically adjusted government deficit - EUR 
(%ofGDP) 
mm-—Actual deficit 
•••Cyclically adjusted deficit 
I9«0 ©82 39S4 WM mm mmm ®&m MM mm 
jj Saurce^Commts^on. $emce$ 
deficit reduction in the EU as a whole can be ascribed to these cyclical influences, 
according to the prudent cyclical adjustment method used by the Commission services 
(see Table 4.3 and Graph 4.4). Between mid-1995 and mid-1996 there was a pause in 
growth which has generally depressed GDP growth rates for 1996 and in several 
countries has had an adverse impact on budget balances. According to latest estimates, 
while for the EU as a whole a reduction of 0.6% of GDP in the government deficit is 
expected in 1996, cyclical influences have had a negative impact on this figure of 0.2% 
of GDP, and the decline in the cyclically adjusted deficit is estimated at 0.8% of GDP. 
39 
Table 4.3 
Changes from previous year in the actual and 
cyclically adjusted general government deficit 
(% of GDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L(l) 
NL 
A 
P 
FIN 
S 
UK 
EUR Change in deficit 
1994 
-2.3 
-0.4 
-1.0 
-2.1 
-0.4 
0.0 
-0.7 
-0.5 
-1.0 
0.2 
0.2 
-1.1 
-1.8 
-1.5 
-1.0 
-0.7 1995 
-1.0 
-1.8 
1.1 
-3.0 
0.3 
• -0.8 
0.3 
-1.9 
1.1 
0.7 
1.5 
-0.7 
-1.0 
-2.7 
-1.0 
-0.4 1996 
-0.8 
-0.2 
0.5 
-1.2 
-2.2 
-0.8 
-0.4 
-0.5 
0.6 
-1.4 
-1.6 
-1.1 
-1.9 
-4.1 
-1.1 
-0.6 Change in cyclically-
adjusted deficit 
1994 
-2.0 
1.1 
-0.8 
-2.2 
-0.6 
0.5 
0.1 
-0.2 
n.a. 
0.7 
0.7 
-1.7 
0.1 
-0.4 
-0.1 
-0.2 1995 
-1.0 
-1.3 
0.9 
-2.9 
0.6 
-0.6 
2.8 
-1.2 
1.5 
0.4 
1.2 
-0.7 
1.0 
-1.3 
-0.7 
-0.2 1996 
-1.0 
-0.3 
0.0 
-0.9 
-2.3 
-1.2 
0.4 
-0.9 
0.3 
-1.4 
-2.0 
-1.0 
-1-7 
-3.8 
-1.1 
-0.8 
A negative (positive) sign indicates a reduction 
(increase) in the deficit; 
(1 ) Luxembourg has a surplus, thus a negative (positive) 
sign indicates an increase (a reduction) in its surplus. 
Source: Commission services; figures for 1996 from 
Autumn 1996 economic forecasts. Table 4.4 
Cyclical adjustment of government deficit in 
1996 
(% of GDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR Government 
deficit 
3.3 
1.4 
4.0 
7.9 
4.4 
4.0 
1.6 
6.6 
-0.9 
2.6 
4.3 
4.0 
3.3 
3.9 
4.6 
4.4 Cyclical 
component 
0.6 
0.2 
0.5 
0.4 
0.9 
0.6 
-2.0 
0.4 
0.4 
0.3 
0.2 
0.8 
1.1 
0.9 
0.6 
0.5 Cyclically 
adjusted 
deficit 
2.7 
1.2 
3.5 
7.5 
3.5 
3.4 
3.6 
6.2 
-1.3 
2.3 
4.1 
3.2 
2.2 
3.0 
4.0 
3.9 
Source: Commission services, Autumn 1996 
economic forecasts. 
Because of the recession in the early 1990s and the hesitant recovery since then, levels 
of GDP in 1996 still remain below their trend in all Member States except Ireland. 
Such a negative output gap implies that the deficit adjusted for cyclical influences is 
not as high as the recorded deficit. Using the cyclical adjustment method of the 
Commission services, three Member States (Belgium, Finland and Sweden) which are 
likely to record deficits over 3% of GDP this year are estimated to have cyclically 
adjusted deficits equal to or below 3% of GDP (see Table 4.4).6 
This method is, however, rather prudent: according to figures from the IMF published in the 
World Economic Outlook of October 1996 for instance, of the Member States with deficits over 
3% of GDP this year, the structural deficit was estimated to be below or equal to 3% in Belgium, 
Germany, Spain, France, the Netherlands, Portugal, and the United Kingdom. 
40 
4.3.2 Trends in the debt ratio 
Although there has been widespread progress in reducing budget deficits, this has only 
been sufficient in a few cases to clearly reverse the upward trend in the debt ratio (see 
Table 4.2 and Graph 4.3). In Belgium the debt ratio has fallen each year from the very 
high level of 137.0% of GDP reached in 1993 and is 
expected to decline to 130.6% in 1996. In Denmark, 
similarly, the ratio peaked at 80.1% of GDP in 1993 
and is likely to be at 70.2% in 1996. The earlier 
decline in the debt ratio in Ireland has continued since 
1993, from 94.5% of GDP in that year to an 
estimated 74.7% in 1996. Table 4.5 
Factors, other than the deficit, 
adding to the debt stock 
(stock/flow adjustment) 
(%ofGDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR 1989-93 
annual 
average 
1.0 
3.7 
2.1 
8.1 
2.8 
0.9 
1.7 
1.8 
2.5 
0.1 
1.4 
3.4 
7.6 
5.1 
-0.4 
0.9 1994-96 
annual 
average 
-1.4 
-2.0 
2.9 
1.7 
0.6 
0.5 
-0.3 
1.3 
2.6 
-0.7 
0.8 
0.6 
-0.5 
-2.9 
-0.6 
0.6 
Source: Commission services. In Greece the debt ratio expected in 1996 at 110.6% 
of GDP is below its level in 1993. In the Netherlands 
the debt ratio in 1996 is also expected to be below its 
level of 1993. 
Elsewhere debt ratios have risen significantly over the 
last three years; by at least 5% of GDP in Germany, 
Spain, France, Austria and the United Kingdom. In 
Italy, after a sharp rise in 1994 the debt ratio fell 
marginally in 1995 and is expected to do so again in 
1996. A decline in the debt ratio is also expected in 
Portugal in 1996. In Finland, after a small decline in 
1995, the debt ratio is likely to rise again this year. In 
Sweden the debt ratio will have fallen in both 1995 
and 1996 but remains above the level in 1993 
The change in the absolute level of the government 
gross debt is, according to Treaty definitions, affected not only by the borrowing to 
finance the government deficit each year, but also by a variety of other factors which 
are reflected in the liabilities in the government balance sheet. Thus, the value in 
national currency of debt denominated in foreign currency may change because of 
exchange rate movements; liabilities may be added to in order to finance on-lending to 
other sectors of the economy; the proceeds of privatisation sales or the running down 
of stocks of financial assets may be used to reduce the level of gross debt, etc. In most 
Member States these factors taken together have in the past tended to add regularly to 
the level of the debt stock. Indeed, in the period 1989-93, they added more than 
2 percentage points of GDP per year on average to the level of the debt stock in eight 
Member States and had an appreciable upward effect in all but the Netherlands and the 
United Kingdom (see Table 4.5). On average in the three years 1994-96 the annual 
impact on the debt stock has been reduced compared with the previous period in 
almost all Member States, with the notable exception of Germany where there have 
been large unification-related debt assumptions. Indeed the average annual effect has 
been negative (i.e. reducing the debt stock) in seven Member States in this recent 
period and has only exceeded a positive effect of 1% of GDP per year in four Member 
States. There are a number of explanations for this change, including reduced exchange 
rate turbulence after 1993 and less need for the emergency financing of banking and 
41 
other sectors which had occurred in several countries. However, there is also evidence 
that, since the gross debt ratio has become more closely monitored during the second 
stage, governments have been managing their balance sheets more carefully. 
4.3.3 The sources of budgetary adjustment 
For the European Union, as a whole the reduction in the government deficit of 1.8% of 
GDP between 1993 and 1996 has been achieved through a reduction in the share in 
GDP of non-interest government expenditure. Between these two years the shares of 
current revenues and of interest payments have remained almost unchanged (see 
Table 4.6). 
Table 4.6 
Revenue and expenditure shares, 1993 and 1996 
(% of GDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR Current revenues 
1993 
49.2 
58.3 
46.4 
34.4 
42.8 
49.5 
37.8 
47.4 
44.7 
52.9 
49.4 
37.7 
53.8 
60.3 
35.9 
46.2 1996(1) 
50.5 
58.8 
45.7 
38.0 
40.3 
50.6 
34.7 
46.3. 
41.7 
48.3 
48.2 
41.5 
55.3 
63.0 
37.7 
46.2 Change 
96/93 
+1.3 
+0.5 
-0.7N 
+3.6 
-2.5 
+1.1 
-3.1 
-1.1 
-3.0 
-4.6 
-1.2 
+3.8 
* +1.5 
+2.7 
+1.8 
+0.0 Non-interest expenditure 
1993 
45.9 
54.5 
46.6 
35.7 
44.4 
51.7 
33.8 
44.9 
42.5 
49.9 
49.4 
38.1 
57.2 
66.4 
40.8 
47.1 1996(1) 
45.3 
53.8 
45.9 
34.1 
39.4 
50.9 
31.8 
42.4 
40.4 
45.3 
48.0 
41.0 
52.8 
59.4 
38.6 
45.2 Change 
96/93 
-0.6 
-0.7 
-0.7 
-1.6 
-5.0 
-0.8 
-2.0 
-2.5 
-2.1 
-4.6 
-1.4 
+2.9 
-4.4 
-7.0 
-2.2 
-1.9 Interest payments 
1993 
10.8 
7.8 
3.3 
12.8 
5.2 
3.4 
6.5 
12.1 
0.4 
6.2 
4.3 
6.8 
4.6 
6.2 
2.9 
5.4 1996 (1) 
8.5 
6.4 
3.8 
11.9 
5.4 
3.8 
4.5 
10.5 
0.3 
5.6 
4.5 
4.9 
5.9 
7.5 
3.8 
5.4 Change 
96/93 
-2.3 
-1.4 
+0.5 
-0.9 
+0.2 
+0.4 
-2.0 
-1.6 
-0.1 
-0.6 
+0.2 
-1.9 
+1.3 
+1.3 
+0.9 
+0.0 
(1) Autumn 1996 economic forecasts. 
Source: Commission services. 
The pattern at the level of individual Member States is more varied. Most Member 
States have benefited from lower interest rates. Those Member States with steadily 
declining debt ratios have enjoyed a marked decline in their interest payments 
(Belgium, Denmark, Ireland) and some others have benefited from declining nominal 
interest rates to an extent that has also cut their interest payments (Greece, Italy, the 
Netherlands and Portugal). In most of the remaining Member States the rising debt 
ratio has outweighed any favourable impact from lower nominal interest rates ai;d the 
siiare of interest payments has risen - particularly sharply in Finland and Sweden. 
Non-interest government expenditure has been reduced as a share of GDP between 
1993 and 1996 in all Member States except Portugal. Especially large declines of more 
than 4% of GDP have been achieved in Spain, the Netherlands, Finland and Sweden. 
42 
Several of the Member States have increased taxation to achieve part of their 
budgetary adjustment. The share in GDP of current government revenues has risen 
between 1993 and 1996 in Belgium, Denmark, Greece, France, Portugal, Finland, 
Sweden and the United Kingdom. Elsewhere this share has declined;there have been 
particularly sharp declines in this revenue ratio in Ireland, Luxembourg and the 
Netherlands. 
In most Member States, however, the major part of budgetary adjustment has come 
from a reduction in the total expenditure ratio. Some Member States have used part or 
almost all of the reduction in expenditure to finance lower taxation. By contrast, other 
Member States have supplemented their expenditure-cutting efforts by also raising 
taxation. The reduction in the deficit between 1993 and 1996 achieved through higher 
revenues has been at least as important as the reduction due to a lower total 
expenditure ratio in Greece, France and the United Kingdom. Portugal stands out from 
the other Member States during this period, in that it has used a sharp rise in tax 
revenues, albeit starting from a relatively low level, to finance both a rise in the 
expenditure ratio and deficit reduction. 
4.3.4. Deficits and fixed investment 
Table 4.7 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L(2) 
NL 
A 
P 
FIN 
S 
UK 
EUR Government investment and deficit 
(% of GDP) 
Government fixed 
investment Government deficit In its monitoring of budgetary developments for the excessive deficit procedure the 
Commission, as well as examining compliance with the government deficit and debt 
criteria, has also to take into 
account whether the 
government deficit exceeds 
government investment 
expenditure. Table 4.7 shows 
figures for gross fixed capital 
formation by general 
government in 1995 and latest 
estimates for 1996 in each of 
the. Member States and 
compares these with the 
corresponding government 
deficits. 1995 
1.3 
2.0 
2.5 
2.9 
3.6 
3.0 
2.3 
2.3 
4.6 
2.7 
3.1 
4.0 
2.7 
3.3 
1.8 
2.6 1996 
1.2 
2.0 
2.3 
2.9 
3.2 
3.1 
2.3 
n.a. 
4.8 
2.7 
3.1 
4.3 
2.7 
3.2 
1.5 
2.5 (3) 1995 
4.1 
1.6 
3.5 
9.1 
6.6 
4.8 
2.0 
7.1 
-1.5 
4.0 
5.9 
5.1 
5.2 
8.1 
5.8 
5.0 1996 (1) 
3.3 
1.4 
4.0 
7.9 
4.4 
4.0 
1.6 
6.6 
-0.9 
2.6 
4.3 
4.0 
3.3 
3.9 
4.6 
4.4 
(1) Autumn 1996 economic forecasts. 
(2) Negative figure indicates a surplus. 
(3) Excluding Italy 
Source: Commission services; In those Member States 
where the government deficit 
remains above the 3% of 
GDP reference value, the 
deficit is larger than 
government expenditure on 
fixed investment (with the 
exception of Portugal in 
1996). Apart from the 
Member States already with 
low deficits (Denmark, 
Ireland and Luxembourg), 
43 
current government expenditure elsewhere is in part being financed through borrowing 
(i.e. government saving in most Member States is negative). 
4.4 Sustainability of budgetary convergence 
Budgetary consolidation efforts have been strengthened during the course of 1996. 
Most Member States, including all of those with deficits currently still above the 3% of 
GDP reference value, are aiming for a further reduction in their deficits in 1997. 
Budget plans presented so far during the Table 4.8 
Objectives for the general government 
deficit in 1997 
(%ofGDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK(1) 2.9 
0.6 
2.5 
4.2 
3.0 
3.0 
<3 
3.0 
n.a. 
2.2 
3.0 
2.9 
1.4 
2.6 
3 
(1) Financial year 1997/98. 
Source: National convergence programmes or 
more recent budget statements. autumn of 1996 have made clearer how 
governments intend to achieve this.Table 
4.8 shows the objectives for the general 
government deficit in 1997 announced 
by Member State governments in their 
latest convergence programmes or in 
more recent budget statements. 
Several Member States expect to be 
clearly below the 3% level in 1997. 
Another group is aiming at a deficit next 
year in line with the reference value. 
Only Greece is targeting a deficit in 1997 
higher than 3% of GDP; in its revised 
convergence programme Greece set the 
objective of bringing the deficit below 
the reference value in 1998. 
Beyond 1997 many Member States are 
already aiming for further reductions in 
their budget deficits, often with balance 
or surplus as a medium-term goal. 
Achieving sound and sustainable budgetary positions, leading to declining debt ratios 
where they are too high, is an essential condition for maintaining stability, keeping 
interest rates low and fostering the growth of output and employment. The 
Commission's proposals for a stability pact involve a firm implementation of Treaty 
provisions so as to ensure budgetary discipline in the third stage. 
44 
EXCESSIVE DEFICIT PROCEDURE 
The excessive deficit procedure set out in Article 104c of the Treaty and the associated 
Protocol No 5 determines the steps to be followed to reach a decision by the Council 
that an excessive deficit exists. 
The Commission is required (in paragraph 2 of Article 104c) to monitor the 
development of the budgetary situation and of the stock of government debt in the 
Member States with a view to identifying gross errors. In particular, compliance with 
budgetary discipline is to be examined by the Commission on the basis of the following 
two criteria: 
"(a) whether the ratio of the planned or actual government deficit to gi'oss 
domestic product exceeds a reference value (specified in the Protocol as 3%), 
unless: 
- either the ratio has declined substantially and continuously and reached a 
level that comes close to the reference value; 
- or, alternatively, the excess of the reference value is only exceptional and 
temporary and the ratio remains close to the reference value; 
(b) whether the ratio of government debt to gross domestic product exceeds a 
reference value (specified in the Protocol as 60%), unless the ratio is 
sufficiently diminishing and approaching the reference value at a satisfactory 
pace. " 
The Commission is required to prepare a report if a Member State does not fulfil the 
requirements under one or both of these criteria. The report shall also take into 
account whether the government deficit exceeds government investment expenditure 
and all other relevant factors, including the medium-term economic and budgetary 
position of the Member State (paragraph 3). 
Subsequent steps in the procedure include the formulation by the Monetary Committee 
of an opinion on the report of the Commission (paragraph 4); the addressing of an 
opinion to the Council by the Commission, if it considers that an excessive deficit 
exists (paragraph 5); and then a decision by the Council after an overall assessment 
whether an excessive deficit exists (paragraph 6). Finally, the Council makes non­
public recommendations to the Member State for which the existence of an excessive 
deficit has been decided with a view to bringing that situation to an end within a given 
period (paragraph 7). The Council may subsequently make its recommendations 
public, where it establishes that there has been no effective action in response to its 
recommendations within the period laid down (paragraph 8). When, in the view of the 
Council, the excessive deficit in the Member States concerned has been corrected, the 
Council abrogates its decision (paragraph 12). The provisions of Article 104c in 
paragraphs 9 and 1 \ are not applicable during the second stage of EMU 
45 
5. EXCHANGE RATES 
5.1 Treaty provisions 
The exchange rate criterion, as set out in the third indent of Article 109j(l) of the Treaty, 
is defined as "the observance of the normal fluctuation margins provided for by the 
exchange-rate mechanism of the European Monetary System for at least two years, 
without devaluing against the currency of any other Member State ". The fourth indent of 
the same Article refers to "the durability of convergence achieved by the Member State 
and of its participation in the exchange-rate mechanism of the European Monetary 
System being reflected in the long-term interest-rate levels". In addition, Article 3 of the 
Protocol (No 6) on the convergence criteria specifies that: "The criterion on participation 
in the exchange-rate mechanism of the European Monetary System referred to in the 
third indent of Article 109j(l) of this Treaty shall mean that a Member State has 
respected the normal fluctuation margins provided for by the exchange-rate mechanism 
of the European Monetaiy System without severe tensions for at least the last two years 
before the examination. In particular, the Member State shall not have devalued its 
currency's bilateral central rate against any other Member State's currency on its own 
initiative for the same period". 
Eleven currencies are currently participating in the ERM. The Austrian schilling joined the 
ERM at the beginning of 1995 and has continued to trade in its traditional, very narrow 
range against the DM. The Finnish markka joined the ERM on 14 October 1996. The 
drachma and the Swedish krona have remained outside the ERM, while the lira and 
sterling have not re-joined since leaving the mechanism in September 1992. 
| Graph 5.1 
ERM grid spread 
I £s!2£g£oTOmj$SK>n serviced - m ,W6 
46 
Graph 5.2 
Movements within the ERM band 
(% deviation torn ECU central rate) 
\A 
Hi Hill III! 
mm MM Hi! 
FMK 
J994 Whurce: Commission services H!i iiii 
47 
In the first half of 1995, exchange rate tensions emerged at the international level, 
reflecting mainly the financial crisis in Mexico and US-Japan trade tensions; these caused a 
pronounced weakening of the US dollar which, combined with country-specific problems 
in Europe, contributed to a strengthening of the DM against many of the ERM currencies 
and to the increase in the volatility of these currencies. As a result, tensions emerged 
within the ERM that led to a realignment on 6 March 1995: at the request of the Spanish 
authorities, the Ministers and Central Bank Governors decided the devaluation of the 
peseta by 7%; by the same decision, the escudo was devalued by 3.5%. 
Tensions in the ERM are reflected in the spread between the strongest and the weakest 
currencies in the mechanism, as shown in Graph 5.1. The spread widened to about 12% in 
February 1995. As international financial markets stabilised the spread declined to just 4% 
in late Summer 1995. After a temporary increase in September, mainly caused by a 
weakness of the US dollar, the spread resumed its downward trend by the end of 1995. By 
June 1996 the spread had narrowed to below 2%. This rather promising performance 
continued until the autumn. In general, although temporary tensions occurred, the ERM 
has been characterised by a high degree of stability during most cf 1996. 
Within the ERM band (see Graph 5.2), the DM, the guilder, the schilling and the Belgian 
franc have been strong throughout the two-year period. In 1995, the peseta recovered 
sharply in the two months after its devaluation, and it has remained strong in 1996. By 
contrast, the Irish punt, affected by the course of the dollar and sterling, weakened 
considerably in the first quarter of 1995 and, though it strengthened thereafter, it remained 
below its central rate until May 1996, but it has since recovered strongly. The French franc 
traded in the lower part of the band for most of the two years, but more recently the 
French franc recovered closer to its central rate. The escudo and the Danish krone 
generally remained close to their central rates. 
In sum, currently nine currencies have been members of the ERM for over two years: 
DKR, BFR, DM, PTA, FF, IRL, LFR, HFL and ESC. The Austrian schilling will have 
completed two years of membership by the end of 1996. With the exception of the PTA 
and the ESC, these currencies have not modified their central ERM parities over the past 
two years and, while large fluctuations have taken place in the band, none of these eight 
currencies can be said to have undergone severe tensions. The central rate of the peseta 
was devalued, in March 1995, at the request of the Spanish authorities. The central rate of 
the Portuguese escudo was also adjusted downwards following the decision to change the 
central rate of the Spanish currency1. Since the middle of October 1996 the Finnish 
markka has also been a member of the ERM. 
5.2 Further analysis of exchange rate stability 
Similar indications are obtained if stability of exchange rates is considered in terms of the 
coefficient of variation2 , which enables cross-currency comparisons. Graph 5.3 depicts 
variability against the DM. 
1 EU Communique, 6 March 1995 
2 Defined as the standard deviation divided by the mean 
48 
It can be seen that, after the turbulence of the first half of 1995, the variability of most 
currencies returned to previously prevailing levels. Also, ERM currencies varied by less 
than those outside: in the two-year period, on average, the five currencies outside the 
ERM are also the ones that displayed the greatest variability; among these, the Finnish 
markka has fluctuated the least and has been comparatively stable in 1995 and 1996. The 
lira and the Swedish krona were the most volatile. Inside the ERM, the guilder, the 
schilling and the Belgian franc have displayed minimal variability and the Danish krone 
joined that group from November 1995. The variability of the other ERM currencies has 
also tended to be lower in 1996 than in earlier years. 
Domestic causes of foreign exchange unrest include concern over the capacity of countries 
or the willingness of governments to achieve the high degree of convergence required for 
a single currency. In addition, the development of fundamentals, mainly public finance and 
inflation but also unemployment, exerted direct influence on exchange rate developments. 
Some influence, mostly towards appreciation and stability, was exerted on the Finnish 
markka and the Italian lira, as a result of expectations for joining the ERM. 
In 1996, a number of factors contributed to the easing of tensions in foreign exchange 
markets. Firstly, the recovery of the US dollar played a most important role: from below 
1.40 DM in late 1995, the dollar rose to about 1.54 DM in June 1996; the dollar pulled 
upwards mainly sterling and the punt and generally reinforced the weaker European 
currencies against the stronger group. This also had a considerable bearing on the 
functioning of the ERM by reducing the spread between the weakest and the strongest 
currencies. Subsequently, a temporary weakening of the dollar, which fell to 1.48 DM in 
July 1996, did not have a substantial effect on the ERM spread; renewed strength in the 
dollar in September and October 1996 was accompanied by a slight widening of the 
spread as the punt appreciated further and became the strongest currency in the ERM. 
Secondly, a more synchronised cycle in the European economies and prospects for 
disinflation in the higher inflation countries allowed parallel monetary policy moves and 
reduced the scope for speculative behaviour. 
Finally, trading in relation to convergence prospects was a very important factor. From the 
second half of 1995, governments increasingly took conspicuous measures to improve 
their convergence situation. At the same time, the European authorities demonstrated 
repeatedly their determination to proceed to Monetary Union; particularly after the Madrid 
European Council, where the realisation of EMU in 1999 became a certainty. These 
prospects contributed to the calming of exchange rates and to the substantial reduction of 
. interest rate differentials. 
49 
50 
6. LONG-TERM INTEREST RATES 
6.1 Interest rate convergence 
The criterion addressed here, as defined by the fourth indent of Article 109j(l) of the 
Treaty, is "the durability of convergence achieved by the Member State and of its 
participation in the exchange rate mechanism of the European Monetary System being 
reflected in the long-term interest rate levels". This criterion on the convergence of 
interest rates is developed further in the Protocol No 6 on the convergence criteria, 
Article 4 of which states that the criterion "shall mean that, observed over a period of 
one year before the examination, a Member State has had an average long-term interest 
rate that does not exceed by more than 2 percentage points that of, at most, the three 
best performing Member States in terms of price stability ". It goes on to say that 
"Interest rates shall be measured on the basis of long-term government bonds or 
comparable securities, taking into account differences in national definitions. " 
The unweighted arithmetic average of the 12-month average of the long-term interest 
rate of the three best performers in terms of inflation has been used in this report for 
the calculation of the reference value (see also analysis of Chapter 3). For most 
Member States, the yield on the ten-year benchmark bond is the one used in the 
calculations. Efforts have been made to make these data as comparable as possible. 
Further details on the interest rates used for each Member State are contained in the 
box on "Data and reference value for the interest rate convergence criterion". All 
references to the long-term interest rate in this section refer to the average over the 
latest 12 months of the nominal long-term interest rate. 
The three best performing Member States with respect to consumer price inflation1 in 
September 1996 were: Germany, the Netherlands and Finland. The average nominal 
long-term interest rates for these countries in September were, respectively: 6.3%, 
6.3% and 7.4%, producing a reference value of 8.7% (see Table 6.1). Two of these 
three countries also had the lowest average interest rates, namely, Germany and the 
Netherlands. In all, eleven Member States had average interest rates below the 
reference value in September 1996. These were: Belgium, Denmark, Germany, France, 
Ireland, Luxembourg, Netherlands, Austria, Finland, Sweden and the United Kingdom. 
Four Member States (Greece, Spain, Italy, and Portugal) had average interest rates 
above the reference value. Sweden's average interest rate was above the reference value 
at the end of 1995 but, having declined during 1996, it moved below the reference 
value in August 1996. 
1 The price index used to establish the three best performers is the interim index of consumer prices 
(IICP) from December 1995 and the consumer price index (CPI) before then (see Chapter 3). 
51 
Table 6.1 
Long-term interest rate convergence in the 
Member States 
12-month average 
1993 1994 1995 1996(1) 
Three best price performers 
B 
DK 
D 
F 
IRL 
L 
NL 
FIN 
UK 
Reference 
value 2 7.3 
7.7 
7.5 
9.5 7.9 
7.2 
7.7 
9.6 7.5 
6.9 
8.8 
9.7 6.3 
6.3 
7.4 
8.7 
Member States respecting the reference value 
Number: 
out of: 
B 
DK 
D 
F 
IRL 
L 
NL 
A 
FIN 
S 
UK 8 
12 
7.2 
7.3 
6.5 
6.8 
7.7 
6.5 
6.3 
7.5 8 
12 
7.9 
7.9 
7.1 
7.2 
7.9 
7.7 
6.9 
8.2 10 
15 
7.5 
8.3 
6.9 
7.5 
8.3 
7.6 
6.9 
7.1 
8.8 
8.3 11 
15 
6.7 
7.4 
6.3 
6.6 
7.5 
7.0 
6.3 
6.5 
7.4 
8.5 
8.0 
(1) Oct. 1995 to Sep. 1996 
(2) Definition adopted in this report: arithmetic average of 
the 12-month average of interest rates of the three best 
performing Member States in terms of price stability 
plus 2 percentage points. 
Source: EMI. This impression of an improvement in 
the convergence situation since the end 
of 1995 is confirmed when the 
underlying situation of individual 
Member States is considered (see 
Graph 6.1 and Table 6.2). During this 
period, the. reference value gradually 
declined, and the dispersion around this 
reference value diminished from 2.0 at 
the end of 1995 to 1.6 by 
September 1996 (see Table 6.2). 
Underlying this general trend are 
somewhat different developments in 
Member States satisfying the criterion 
and those not satisfying the criterion at 
the end of 1995. Although all countries 
experienced falling average rates, the 
pace of the fall was considerably less 
among those Member States in the 
former group than those in the latter 
group. Finland, with a fall in the 
average rate of 1.4 percentage points 
between the end of 1995 and September 
1996, provided an exception to this 
latter observation. Indeed, the fall in 
Finnish rates accounts for the major 
part of the fall in the reference value, 
while the falls in the five Member 
States not respecting the reference value 
at the end of 1995 help to explain the 
reduction in dispersion. Compared with 
December 1995, the interest rate 
convergence gap (the difference 
between the average domestic interest 
rate and the reference value) fell for 
Greece, Italy, Spain and Portugal, 
respectively to 6.4 percentage points 
(-1.3), 1.6 percentage points (-0.9), 
0.8 percentage points (-0.8), and 
0.7 percentage points (-1.1). Greece 
remains the least convergent Member State, while Sweden moved from a divergence of 
0.5 percentage points at the end of 1995 to being 0.2 percentage points below the 
reference value in September 1996. 
52 
Development of long-term interest rates 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
Average of 3 
best price 
performers 
Dispersion 
from average 
of 3 best price 
performers (3) 12-month average 
1993 (1) 1994(1) 1995(1) 1996(1) (2) Table 6.2 II Within the group of 
countries meeting the 
criterion, the picture was 
somewhat different. In 
general, the pace of the 
decline in average long-
term rates over the review 
period was less than in the 
group of countries not 
satisfying the criterion. 
This was to be expected 
since long-term rates in 
these countries were 
already low (see 
Graph 6.1). Finland 
provides an exception to 
the general trend. The 
strong decline in Finnish 
long-term rates, together 
with the levelling off of 
rates in the 
United Kingdom, saw the 
latter replacing Finland as 
the Member State in this 
group with the highest 
long-term rates.2 The 
dispersion within the 
group itself declined. 
Excluding Sweden, the 
spread between the lowest 
interest rate (Germany: 
6.9%) and the highest 
interest rate (Finland: 
8.8%) was 1.9 percentage 
points at the end of 1995. This fell to 1.7 percentage points (=8.0% for the 
United Kingdom less 6.3% for the Netherlands) in September 1996. Including Sweden, 
the spread in September 1996 was higher at 2.2 percentage points. 7.2 
7.3 
6.5 
23.3 
10.2 
6.8 
7.7 
11.2 
6.5 
6.3 
6.7 
9.7 
8.8 
8.5 
7.5 7.9 
7.9 
7.1 
20.8 
10.0 
7.2 
7.9 
10.5 
7.7 
6.9 
7.0 
10.5 
9.1 
9.7 
8.2 7.5 
8.3 
6.9 
17.4 
11.3 
7.5 
8.3 
12.2 
7.6 
6.9 
7.1 
11.5 
8.8 
10.2 
8.3 6.7 
7.4 
6.3 
15.1 
9.5 
6.6 
7.5 
10.3 
7.0 
6.3 
6.5 
9.4 
7.4 
8.5 
8.0 
pro memona 
7.5 
1.6 7.6 
1.5 7.7 
2.0 6.7 
1.6 
(1) For 1993, data are non-comparable for Luxembourg (January -September) and 
Portugal (January-June). For Greece data are non-comparable. 
(2) Average of October 1995 to September 1996. 
(3) Measured by the standard deviation around the average of the 3 best price 
performers (Greece omitted from calculations in all years; Luxembourg 
omitted from calculations in 1993). 
Source: EMI. 
Uiitil Sweden became a member of this group in August 1996. 
53 
54 
6.2 Recent developments in long-term interest rates 
In this section, the recent evolution of long-term interest rates is analysed by a 
consideration of the paths followed by monthly nominal long-term interest rates (as 
opposed to the 12-month averages of the previous section) in the Member States and at 
the level of the Union as a whole. The sharp upward movement in nominal long-term 
rates in the European Union in 1994, was followed by a steady downward trend in 
1995. After a brief interruption at the beginning of the year, this downward path has 
continued in 1996 (see Graph 6.3). Falling long-term interest rates in 1995 were 
generally seen as an international phenomenon stemming from a slowdown of growth 
in the USA, deflationary pressures in Japan, and perceptions of lower inflationary 
pressures in Europe. 
Revisions in market expectations about the likelihood of official interest rates cuts in 
Germany and the US were widely cited as the reason for the upward spike in long-term 
interest rates at the beginning of 1996. Expectations that a policy of monetary easing in 
Germany had reached a turning point surfaced towards the end of January. This was 
compounded in February by expectations of a tightening of monetary policy in the 
USA, the effect of which spilled over from US to European bond markets. This 
international trend was driven partly by market fears of excess global liquidity 
following the sustained reduction in interest rates in the major economies throughout 
1995. 
55 
The resumption of downward trend in average nominal long-term rates in the EU since 
April 1996 may be explained by a number of factors. These include: a decoupling of 
trends in the USA and some European bond markets in the second quarter of 1996; 
and, in the third quarter, another shift in market expectations concerning US and 
Japanese monetary policy, this time away from a near-term tightening, which resulted 
in internationally falling long-term rates. In September 1996, the average level of bond 
yields in the EU recorded a level of 7.2%, 1 percentage point lower than in 
September 1995 and below the level of 7.3% recorded in January 1996. 
A number of features in the evolution of long-term interest rates across Member States 
may be highlighted. First, although long-term rates fell in all EU countries over the 
period between September 1995 and September 1996, the size of the fall varied across 
countries (see Table 6.3). In general, those countries with the highest long-term rates 
experienced the largest falls: Italy, Portugal, Spain and Sweden recorded reductions in 
the range of 1.8-2.9 percentage points. 
56 
Table 6.3 
Recent evolution of long-term interest rates 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR (1) Monthly average of daily data 
September 
1995 
7.0 
7.8 
6.6 
15.8 
10.8 
7.4 
8.0 
11.5 
.7.4 
6.6 
6.9 
11.2 
8.0 
9.6 
8.1 
8.2 September 
1996 
6.5 
7.2 
6.2 
14.8 (Feb) 
8.4 
6.2 
7.2 
9.2 
6.8 
6.1 
6.3 
8.3 
6.9 
7.8 
8.0 
7.2 Change(pps) 
-0.5 
-0.6 
-0.4 
-1.0 
-2.4 
-1.2 
-0.8 
-2.3 
-0.6 
-0.5 
-0.6 
-2.9 
-1.1 
-1.8 
-0.1 
-1.0 
(1) : weighted average using 1995 GDP weights 
Source: EMI. In Greece the decline was less, so 
that long-term rates remain high3 
. Among the countries already 
with lower interest rates, Finland, 
also benefiting from lower 
inflation expectations, recorded a 
substantial reduction 
(1.1 percentage points). Given 
that the largest interest rate 
reductions, over the year to 
September 1996, were realised by 
those Member States with the 
highest nominal long-term rates, 
interest rate differentials over 
corresponding German bonds 
narrowed4 during the year, with 
Spain, Italy, Portugal and Sweden 
experiencing the largest 
reductions. 
Second, while all EU countries 
shared common trends in nominal 
long-term rates between 
August 1995 and March 1996, 
there has been some divergence 
of experience among Member States since then. Following the brief upward blip in the 
first quarter, all countries except the United Kingdom recorded reductions once again 
during April. For Belgium, Denmark, Germany, Luxembourg and Austria, long-term 
rates rose over the period May-June, before dropping once again in July-August. On 
the other hand, the downward trend persisted in the high-yield countries, namely, 
Spain, Italy and Portugal. 
6.3 Explanatory factors and assessment 
Progress was made over the last year in terms of interest rate convergence, with 
Sweden satisfying this convergence criterion from August 1996 and the remaining four 
countries (Greece, Spain, Italy and Portugal) moving nearer the reference value. 
Spain, Italy and Portugal also recorded considerable narrowing of their interest rate 
convergence gaps. Indeed, if the current levels of interest rates were to be maintained, 
the average long-term rates for Spain and Portugal would very shortly come under the 
3 It should be noted that the data for Greece are not comparable to the data for other Member States. 
In the absence of a long-term capital market a bond with an original maturity of 5 years is used. In 
addition, the existence of a reporting lag in the receipt of the data hampers up-to-date comparisons. 
4 For all countries except the United Kingdom. 
57 
reference value. This favourable development may be attributed to a number of 
underlying factors. One important factor is the declining inflation rates in these 
countries, which in turn helped to reduce inflation expectations. This is particularly the 
case for Spain, Portugal and Sweden, which recorded sizeable reductions in average 
inflation rates between December 1995 and September 1996. Compared to the previous 
year, the rapid reduction in inflation in Portugal appears to have affected long-term 
interest rates. Greece's less spectacular progress in terms of inflation, given the high 
starting point, may help explain the slower progress in terms of reducing the interest 
rate gap in this country. 
A second important explanatory factor was the efforts made in these countries in terms 
of reducing government deficits. Such progress in government deficit consolidation 
contributed to a more balanced policy mix and thus to reducing the credit risk 
premium. The progressive calming of exchange rate markets during the 1996 created 
conditions for a stabilising of bond markets. 
58 
DATA AND REFERENCE VALUE FOR THE INTEREST RATE 
CONVERGENCE CRITERION 
Data 
According to Article 4 of the Protocol on the convergence criteria: 
"Interest rates shall be measured on the basis of long-term government bonds or 
comparable securities, taking into account differences in national definitions. " 
According to Article 5 of the same Protocol, the Commission shall provide the statistical 
data for the application of the interest rate convergence criterion. In agreement with the 
European Monetary Institute, which has a comparative advantage in the analysis of 
financial statistics and has advised the Commission on the issue, interest rates with the 
following characteristics have been deemed the most appropriate for the examination of 
the interest rate criterion: 
- maturity: residual maturity close to 10 years (9 to 10.5 years) 
- issuer: central government (in Germany including Treuhandanstalt) 
- choice of bonds: liquidity is the main selection criterion; the choice between a single 
benchmark or the average of a sample should be based on this requirement; most 
(eleven) Member States choose a benchmark (Belgium, Denmark, France, Ireland, 
Italy, Luxembourg, Netherlands, Austria, Finland, Sweden, United Kingdom), while 
three Member States choose an average (Germany, Spain, Portugal) 
- aggregation: simple average should be used if there is more than one bond in the 
sample 
- gross of tax 
- yield calculation: ISMA-formula for yield to maturity 
- coupon: fixed 
In Greece, in the absence of a long-term capital market a bond with an original maturity 
of 5 years was selected. Its coupon is indexed to the 12-month treasury bill and adjusted 
yearly. Contrary to the other Member States where daily quotations are available, an end-
of-month figure is used. 
The present evaluation of the long-term interest rate criterion is based on harmonised 
long-term interest rates, incorporating the above characteristics. 
Reference value 
According to Article 4 of the Protocol on the convergence criteria, the criterion on the 
convergence of interest rates "shall mean that, observed over a period of one year before 
this examination, a Member State has had an average nominal long term interest rate 
that does not exceed by more than 2 percentage points that of, at most, the three best 
performing Member States in terms of price stability. " 
The unweighted arithmetic average interest rate of the three best performers in terms of 
price stability is used in this examination of the interest rate criterion for the calculation 
of the reference value. 
59 
7. SUPPLEMENTARY INFORMATION 
This chapter reviews developments is several other areas which are required by 
Article 109j(l) to be taken account of by the Commission (and the EMI) in their reports. 
The following sections examine the developments of the ECU, the results of the 
integration of markets, the situation and development of the balances of payments on 
current account and the development of unit labour costs and other price indices. 
7.1 Development of the ECU 
The ECU markets encountered difficult conditions in 1995 and much of 1996. Primary 
bond market activity contracted to historically low levels, though secondary market 
turnover proved to be more robust. A degree of stability was provided by sovereign 
issuers through the continuation of regular debt programmes in ECU but, with private 
issuers largely ignoring the ECU, liquidity in the market was much reduced. From the 
start of the second half of 1996 interest in the ECU began to recover as confidence in the 
EMU process developed and perceived uncertainties, like the start date of monetary 
union, the 1:1 substitution of the euro for the ECU and continuity of ECU contracts, 
began to crumble. With the release of the regulations on the legal framework for the euro 
positive market sentiment towards the ECU has firmed, and market analysts now 
anticipate a return to growth in the ECU markets in the run up to 1 January 1999 and the 
start of monetary union. 
One manifestation of the ECU's difficulties was the emergence from the middle of 1994 
of a persistent spread, in excess of 50 basis points, between the market exchange rate 
value of the ECU and its theoretical value. In an historical context, ±20 basis points had 
been considered to be the normal trading range of the spread; moreover, on those 
occasions when the spread exceeded its normal range, in particular during the ERM crises 
in 1992 and 1993, it had done so for only a short period of time before arbitrage activity 
by the so-called "basket makers" brought the spread rapidly down to more normal levels. 
Towards the end of 1994, the spread -though still volatile- had contracted, reaching 
around 20 basis points. However, with the subsequent re-emergence of ERM tensions in 
early 1995 the spread rapidly increased reaching a high of 152 basis points by the end of 
March 1995. Though it subsequently fell to under 100 basis points this was only a 
temporary respite. The spread reached over 300 basis points at the end of 1995. During 
the first half of 1996 confidence began to return to the ECU markets and the spread 
tended to fluctuate between 150 and 250 basis points, with a slow fall commencing in 
May. During the second half of 1996 the spread stabilised at approximately 100 basis 
points during July and August, and then fell to below 60 basis points by the end of 
September. Subsequently the spread has contracted further to between 30 to 20 basis 
points. 
The underlying reasons, and their relative importance, for the behaviour of the spread are 
difficult to determine precisely, but a number of factors have demonstrably played a role. 
First, exchange rate tensions in the ERM have had a negative impact on the ECU. 
Second, there has been an increase in the perceived risk of running open positions in 
60 
ECU, which has been reflected in the switch by the basket maker banks from a long-term 
strategy, in which they were willing to hold open positions in ECU for considerable 
periods of time, to a short-term strategy in which profits are taken as soon as possible 
even though greater profits would potentially have been generated by holding the position 
for longer. 
In part also, the increase in perceived risk stems from a growing awareness that since 
1987 there has been no institutionalised link between the market ECU and the basket 
apart from the conversion of ECU into euro at 1:1 upon the start of Stage Three, on 
1 January 19991. For many market operators the level of uncertainty, over the EMU 
timetable and legal issues, was such that they took little comfort from the 1:1 provision in 
the Treaty. Thus uncertainty over EMU fed through to concerns over the future value of 
the ECU. However, since the European Council in Madrid in December 1995, market 
confidence has been growing as the high level of political commitment to monetary union 
has been repeatedly demonstrated and the uncertainties over legal issues, such as the 
continuity of contracts and the 1:1 conversion of ECU into euro, have largely been 
removed by the regulations proposed by the Commission. 
The exchange rate value of the ECU may also have been damaged by the high level of net 
redemptions of ECU denominated bonds in 1995 and 1996. Given a contraction in the 
stock of outstanding ECU denominated bonds, the proceeds from repayments, funded by 
the drawing down of existing ECU deposits, have tended to be exchanged for other 
currencies for reinvestment. This has put downward pressure on the exchange rate value 
of the ECU; however, as confidence in EMU has grown so too confidence in the ECU 
markets has slowly been returning and the spread has reduced. 
During 1995, the amount of bond issues denominated in ECU was significantly lower 
than the amount of maturing paper with the result that the stock of outstanding debt in 
ECU declined by 6% to ECU 127 billion (excluding Greek ECU-linked bonds). This 
compares to a historic peak of ECU 140 billion stock outstanding in 1993. During the 
first nine months of 1996, demand for ECU from institutional investors remained 
subdued and private issuers were few in number and wary. Issue activity was therefore 
low, with periods of no issuing. The total amount issued during the first nine months of 
1996 amounted to ECU 10.9 billion compared with ECU 13.5 billion over the same 
period in 1995. Thus with ECU 18.9 billion of maturing paper the stock of outstanding 
ECU denominated debt fell to ECU 119 billion by the end of September 1996. 
In the secondary market, average turnover in ECU bonds rose in value terms by 8% in 
1995, its highest level since 1992. In the first nine months of 1996 there was a further 
rise of 4%. As a percentage of the total secondary market the share of the ECU declined 
from 5.6% in 1993 to 5.2% in 1994 and 1995, but rose slightly to 5.3% in 1996 (up to the 
end of September). 
Until 1987 the institutionalised link was also provided by the acceptance by the ECU Banking 
Association of delivery of the basket in the settlement of ECU positions in the clearing 
61 
In contrast to the steady contraction of the ECU bond markets other ECU markets have 
performed better but have nevertheless registered decreases in activity. The approximate 
measure of commercial and financial activity provided by the daily average turnover in 
the EBA ECU Clearing System has experience a modest fall in activity, from 
ECU 50.0 billion during 1994 to ECU 46.8 billion during 1995, a year on year decrease 
of 6.5%. For the first nine months thé average daily turnover in 1996 is some 2.1% lower 
than for 1995 at ECU 45.8 billion. 
Studies of ECU flows related to commercial transactions (i.e. purchase of goods and 
services) as opposed to purely financial transactions suggest that commercial payments 
account for a small portion of total payments (1996 results: 7.1% in volume terms, 0.7% 
value), but that nevertheless commercial ECU payments can be estimated to be in the 
region of ECU 50 billion to ECU 75 billion. 
7.2 Results of the integration of markets 
With an average of about 93% of Single Market legislation transposed into domestic 
legislation by all Member States, the Single Market is becoming reality. It is not yet 
complete, but the achievement so far should not be underestimated. It has already made 
the European Union the most economically integrated collection of nation states in the 
world. Evidence of this deepening integration is accumulating. 
7.2.1 Market integration through trade 
By removing trade barriers between countries, the Single Market was expected to expand 
trade among EU Member States. In fact, between 1985 and 1995, the share of intra-EU 
imports in total manufacturing imports has indeed increased on average by 6.7 percentage 
points from 61.2% in 1985 to 67.9% in 1995. Furthermore, intra-EU penetration ratios 
increased much more in fifteen manufacturing industries identified ex ante as particularly 
sensitive to the Single Market project (SMP) than in all other manufacturing sectors. For 
services during the same period 1985-1995, the share of intra-EU exports in total services 
exports has increased on average by 3.1 percentage points from 46.9% in 1985 to 50.0% 
in 1995. Direct and pro-competitive effects of the SMP on trade almost fully explain 
these changes in the market share of intra-EU imports. 
Increasing economic integration may lead to greater country specialisation on the basis of 
their respective comparative advantages (inter-industry trade) or it may favour intra-
industry trade, the simultaneous import and export of similar product lines between 
Member States. 
Inter-industry trade between different countries carries efficiency gains, with each country 
specialising' in those activities in which it is relatively more efficient, and consumers 
gaining lower prices as a consequence. However, this would imply a deeper specialisation 
between the less developed Member States and the more advanced, each country 
experiencing a contraction of some sectors and expansion of others, which may imply 
significant adjustment Costs. 
62 
By contrast, intra-industry trade benefits the consumer by leading to a much wider variety 
of products, whilst producers face lower adjustment costs. Here, adjustments would take 
place amongst firms inside industries rather than amongst industries. 
At the beginning of the 1980s, most trade within the Community could be classified as 
inter-industry2 (around 45%). However, the preparation phase of the Single Market was 
accompanied by a decrease in the share of inter-industry trade in Europe and a rise in 
intra-industry trade - which itself could be further subdifferentiated: either intra-industry 
trade in similar products in terms of prices and quality or intra-industry trade in products 
differentiated by price and quality (for example, one country expoiting brand-name 
expensive shirts and the other inexpensive low quality shirts). The rise in intra-industry 
trade has predominantly been the latter type (from less than 35% in 1985 to more than 
42% in 1994), whilst intra-industry trade in similar products3 remained rather stable 
(around 20% of total intra-EU trade). The SMP has therefore increased the range of 
products available to consumers in terms of prices and quality, and encouraged differing 
business strategies: either emphasising design, research and development, and advertising 
in some cases (high price-quality) or production cost-minimising in others (low price). 
In the period 1985-94, all EU countries have experienced a decrease in inter-industry 
trade, but especially Spain, the United Kingdom, France and Germany. Nevertheless, in 
1994, inter-industry trade still accounted for over 58% of the total manufacturing trade of 
Greece, Portugal, Ireland and Denmark. At the same time, conversely, intra-industry trade 
in price and quality-differentiated products represented over 42% of total trade for the 
United Kingdom, Germany, France, Belgium, Luxembourg and the Netherlands, a share 
which grew between 1987 and 1994 for all this group of countries plus Spain and 
Portugal. 
Analysis of price and quality-differentiated intra-industry trade shows a striking 
difference between northern and southern countries. Scrutiny of the contribution to the 
trade balance of low, medium and high price quality product ranges spotlights different 
country groupings. Germany has a comparative advantage in high price and quality 
product ranges, France in medium to high price and quality ranges, the United Kingdom, 
the Netherlands, Belgium, Luxembourg and Denmark only in medium price and quality 
ranges, Spain in medium to low price and quality ranges, and Greece and Portugal only in 
low price and quality ranges. These specialisations have been unaffected by monetary 
fluctuations. 
In the period 1985-94, the share of medium price and quality products in overall intra-EU 
trade has declined (by some 10 percentage points) to the benefit of high price quality 
Ihere is inter-industry trade between two countries when one country's trade flow (imports or exports) 
with the other in a sector represents less than 10% of the other country's trade flow (imports or exports) 
with it in the same sector. 
There is intra-industry trade in similar products when export and import unit values differ by less than 
15% and there is intra-*industry trade in differentiated products when unit values differ by more man 
15%. 
63 
products (plus 7 percentage points) and low price and quality products. This is especially 
so for the most advanced European economies, but even in the southern Member States, 
specialisation has changed and the share of low price and quality products has generally 
fallen whilst the share of high price and quality products has increased. 
Growing intra-industry trade with price differentiation implies that Member States are 
more and more specialised inside industries on products with differing price level ranges. 
For most advanced countries such an evolution involves growing intangible investment in 
R&D, training, innovations to compete in traditional mature industries, and for less 
advanced countries, the possibility of entering high tech and high value added sectors and 
competing on price. 
7.2.2 Market integration through foreign direct investment 
Trade is not the only mechanism by which markets can become more integrated. Foreign 
direct investment (FDI) is an alternative to trade as a way of supplying foreign markets. 
Multinational companies are the main source of FDI flows, and the sales of multinational 
foreign affiliates are now by some estimates worth double the value of world exports. 
In fact, impact on FDI of the SMP seems to have been even more positive than its impact 
on trade. The European Union absorbed 44.4% of FDI inflows from all countries in the 
world at the beginning of the 1990s, compared to 28.2% in the period 1982-87. 
Moreover, intra-EU FDI (i.e., FDI flows between Member States) increased four times 
faster than intra-EU trade in the period 1984-92. Altogether, between 1984-85 and 1992-
93, EU FDI inflows from all sources increased five times (seven times for intra-EU 
inflows). 
The impact on the domestic economy of FDI (FDI inflows relative to GDP) differs 
widely amongst Member States. At the beginning of the 1990s, annual Irish FDI inflows 
were worth over 9% of GDP. In Belgium and Luxembourg, the ratio was 4.7% a year. 
The Netherlands (2.7%) came next, then Portugal (2.6%), the UK (1.8%) and Spain 
(nearly 1.8%). By contrast, in Germany (less than 0.4%), Italy (0.4%) and Greece (0.6%) 
these figures were very low. Over the period 1986-93, two Member States (Belgium and 
Ireland) have gained considerable ground in terms of attractiveness as locations for FDI. 
In general, Ireland, Portugal, Spain and the Benelux countries are among the ones which 
have benefited most from the Single Market in terms of FDI. 
7.2.3 Market integration and competition conditions inside the EU 
Cost reductions related to size achieved over the period 1985-93 have been mostly the 
result of exploiting scale advaixtages linked to fixed investments in marketing, brand 
development, R&D spending and development of new production processes. Few 
efficiency improvements have been the consequence of exploiting purely technical 
efficiency gains related to the size of establishments. 
64 
Nevertheless, sectors such as distribution and road freight transport do show remarkable 
productivity gains. Productivity and efficiency gains in the more regulated sectors 
(telecommunications, banking, airlines) have been less pronounced and, in general, it is 
very uncertain the extent to which observed changes can be linked to the SMP. Large 
gains have been observed only in liberalised telecommunication services. 
Evidence on price cost margins and business perceptions seems to indicate that the 
efficiency gains associated with large size have been passed on to consumers and users 
thanks to increased competition associated with the SMP. Over the period 1980-1992, 
European manufacturing industry registered a trend recovery of price-cost margins, at a 
yearly rate of about 2%, controlling for the evolution of the economic cycle and the 
diverging industrial structures of the EU Member States. Within this overall trend, 
however, statistical analysis confirms that implementation of the SMP imposed 
increasing pressure on price-cost margins, thus ensuring that cost reductions have been 
passed on to consumers and downstream users. It is estimated that the SMP has led to a 
yearly 1% reduction in margins since 1986/87. That is, in the absence of the SMP, 
margins would have grown faster over the period. 
Competitive conditions in services have also been significantly altered by the SMP. A 
significant increase in competition is noticeable in sectors such as telecommunication 
services or retail banking, but also in airlines, where implementation of the SMP has only 
been partial so far. Overall, however, the increase in competition seems to be less strong 
than in manufacturing sectors, reflecting that many regulations are still maintained on 
services and that the SMP has not been fully implemented in several domains. This 
increased competition has resulted in substantial and quite general reductions in prices in 
sectors such as telecommunications, and a more selective decline of prices in segments of 
the airline and banking industries. 
In road freight transport, the margins for cross-border traffic have declined sharply over 
the period 1986-94. The result has been a reduction in real transportation prices which, 
together with efficiency gains in the distribution sectors, have led to substantial changes 
in the sourcing patterns of manufacturing and retailing firms. A wider range of sourcing 
possibilities has contributed to declines in input costs. 
The changes in structures and the degree of competition of European markets prompted 
by the implementation of the SMP have also resulted in increased price convergence 
across the EU for many goods. Between 1990 and 1993 the variation between Member 
States in prices (including taxes) has decreased from 22.8% to 19.6% in consumer goods 
and from 31.8% to 28.6% in services, but increased 28% to 31.7% in energy. 
65 
7.3 Situation and development of balances of payments on current account 
Following deficits in both 1991 and 1992, the current account of the Union as a whole 
has recorded either a zero balance, in 1993 and 1994, or a small surplus, in 1995; a larger 
surplus is expected in 1996. These balances, apart 
from being indicators of the amount of national 
savings, have in recent years become signals of the 
state of domestic absorption relative to domestic 
output. With complete liberalization of capital 
movements, and the removal of residual exchange 
controls by some Member States in the past two 
years, financial integration has continued to 
progress, and the Union's financial markets are now 
closely integrated with international financial and 
capital markets. Consequently, the international 
allocation process of excess domestic savings or 
excess domestic spending is facilitated. Several 
Member States have systematically recorded current 
account surpluses since the beginning of the 1990s 
(Belgium, Denmark, France, Ireland, Luxembourg 
and the Netherlands), while in others current account 
deficits of earlier years have become surpluses 
(Spain, Italy, Finland and Sweden); in five Member 
States (Germany, Greece, Austria, Portugal and the 
United Kingdom) the current account has remained 
in deficit since the beginning of the decade (see 
Table 7.1). 
In a majority of Member States the current account balance has been improving, despite 
the recovery of economic growth, since the end of the recession of the early 1990s. An 
important factor in this has been the reduction of fiscal imbalances and the consequent 
increase in national savings. Balance of payments positions relative to GDP in 1996 are 
not estimated to change markedly compared to the previous year; latest estimates by the 
Commission services show reductions in the surplus in Belgium, Ireland, Luxembourg, 
the Netherlands and Finland, and a widening of the deficit in Greece and Portugal. The 
surplus is likely to rise in 1996 in Denmark, France, Italy and Sweden, and the deficit is 
expected to narrow in Germany and Austria. The current account surplus in Spain and the 
deficit in the United Kingdom are likely to be similar in scale in 1996 to the previous 
year. 
7.4 Examination of development of unit labour costs and other price indices Table 7.1 
Current account balance 
(national accounts definition, % of 
GDP) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR 1993 
3.8 
2.9 
-1.1 
-1.7 
-1.0 
1.0 
5.3 
1.0 
15.2 
4.9 
-0.4 
-2.1 
-1.3 
-1.4 
-2.5 
0.0 1994 
4.0 
1.6 
-1.4 
-1.0 
-1.2 
1.0 
3.4 
1.5 
15.9 
5.2 
-1.0 
-1.8 
1.3 
-0.7 
-2.1 
0.0 1995 
4.5 
0.6 
-1.2 
-2.7 
0.9 
1.6 
4.3 
2.4 
17.9 
5.2 
-2.3 
-0.2 
4.5 
0.6 
-1.8 
0.2 1996 
(D 
4.1 
1.0 
-0.9 
-3.0 
0.9 
1.7 
3.7 
3.6 
16.3 
4.9 , 
-1,9. 
-1.0 
4.0 
1.2 
-1.8 
1.0 
1) Autumn 1996 economic forecasts. 
Source: Commission services. 
Developments in various consumer price indices (IICP, CPI, private consumption 
deflator) contain important, albeit incomplete, information on the inflation environment 
prevailing in an economy (see Chapter 3). To ensure a comprehensive and balanced 
examination of the degree of price stability and the sustainability of the inflation 
66 
performance, the Treaty (Article 109j (1)) also requires that "the development of unit 
labour costs and other price indices " should be considered. 
7.4.1 Unit labour costs 
Developments in unit labour costs take on a particular importance in the inflation process. 
They reflect trends in labour productivity and nominal compensation of employees per 
head. The latter not only play a key role in the determination of input costs and thus of 
consumer prices, but also reflect private agents' inflation expectations. They therefore 
serve as an important indicator, amongst others, of the credibility of the anti-inflationary 
policy stance pursued by the monetary authorities. 
At the Community level, growth in nominal compensation per employee has slowed 
down steadily from 4.2% in 1993 to 3.4% in 1996, thereby reaching a level never attained 
over the past 35 years. This deceleration was common to most Community countries, 
though to a varying extent (see Table 7.2). The salient exceptions are Italy, Sweden, and, 
to a lesser extent, Denmark. Over the same period, the increase in nominal compensation 
per employee accelerated from 3.7% to 6.2% in Italy, and from 4.4% to 6.6%.in Sweden. 
This means that wage growth is now above the inflation rate, which could generate 
wage/price tensions when economic activity speeds up. 
Three major factors seem to explain the generally observed moderation in nominal wages. 
Firstly, as already noted, wage settlements appear to increasingly incorporate inflation 
expectations consistent with the price objectives announced by the monetary authorities. 
Secondly, wage negotiations seem to have increasingly taken into account developments 
in the real side of the economy (output growth, labour market situation, profitability 
concerns). Thirdly, actions to improve labour market flexibility have been undertaken in 
several Member States, including among others incentives for unemployed people to look 
for a job more actively, reforms of the educational and training system, measures to 
increase flexibility of working time and of rules governing employment conditions, and 
measures to improve the efficiency of employment services. This set of structural 
measures should help to avoid excessive upward pressure on wages when activity speeds 
up, allowing unemployment to come down. 
The second element which influences unit labour costs is labour productivity. The latter 
has shown the usual cyclical pattern over the past few years. After slowing down during 
the recession of 1993, gains in labour productivity picked up in 1994, along with the 
rebound in economic activity. However, the growth slowdown experienced in the 
Community from mid-1995 again drove down apparent labour productivity growth, both 
in 1995 and in 1996. 
As a result, growth in nominal unit labour costs was very modest over the 1994-1995 
period. In 1994, eight countries showed an actual decline in unit labour costs, while in 
1995, growth in unit labour costs was at or below 2XA% in all Member States, with the 
exception of Greece. Thus, apart from Greece, growth in unit labour costs was below the 
inflation rate in all the Community countries over this two year period. This favourable 
67 
evolution is mainly the result of moderate wage increases but is helped by the cyclical 
rebound in labour productivity growth. 
The moderate trend in unit labour costs has continued in 1996. While an acceleration is 
noticeable, the increase in unit labour costs remains consistent with continued favourable 
inflation trends in the Community and in most Member States. An acceleration in unit 
labour costs is expected in Spain, Italy and Sweden, and to a lesser extent in Denmark, 
Portugal, Finland, and the UK. For most of these countries, this acceleration remains 
moderate and leaves the increase in labour costs below or close to the inflation rate, with 
the exception of Italy. In addition, this strengthening could be short-lived as it partly 
reflects cyclical factors. 
Table 7.2 
Labour costs 
(percentage change, total economy) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR 
1) Autun 
Source: Nominal compensation per 
employee 
1993 
3.5 
1.6 
4.3 
10.1 
6.5 
2.8 
6.7 
3.7 
5.2 
3.3 
4.6 
9.1 
1.0 
4.4 
4.3 
4.2 1994 
4.4 
3.6 
3.2 
11.9 
3.1 
2.2 
2.3 
3.0 
3.7 
2.4 
3.1 
8.2 
3.5. 
5.4 
3.5 
3.3 1995 
2.5 
3.6 
3.8 
12.7 
3.0 
2.3 
1.1 
5.2 
3.8 
2.0 
3.8 
5.3 
4.7 
3.1 
2.9 
3.5 1996 
(1) 
1.6 
4.1 
2.6 
11.1 
3.9 
2.2 
4.0 
6.2 
3.4 
1.0 
2.9 
5.8 
4.0 
6.6 
3.3 
3.4 Labour productivity growth 
1993 
0.0 
2.5 
0.6 
-3.2 
2.6 
-0.2 
3.0 
1.8 
-1.7 
0.9 
0.8 
0.7 
5.7 
3.2 
3.7 
1.4 1994 
2.9 
5.0 
3.6 
-0.4 
2.7 
2.9 
4.1 
3.7 
1.0 
3.3 
2.9 
0.9 
5.6 
3.6 
3.8 
3.3 1995 
1.5 
1.1 
2.2 
1.1 
1.1 
1.0 
6.1 
3.4 
0.9 
0.2 
2.1 
2.9 
3.1 
1.4 
1.8 
1.9 1996 
(1) 
1.5 
1.5 
2.2 
1.2 
0.8 
1.3 
4.3 
0.5 
1.1 
1.0 
1.7 
2.0 
1.0 
2.3 
1.9 
1.5 Nominal unit labour costs 
1993 
3.5 
-0.8 
3.6 
13.7 
3.7 
2.9 
3.6 
1.9 
7.0 
2.5 
3.7 
8.3 
-4.4 
1.2 
0.5 
2.7 1994 
1.4 
-1.4 
-0.4 
12.3 
0.4 
-0.7 
-1.7 
-0.7 
2.7 
-0.8 
0.2 
7.2 
-2.0 
1.7 
-0.3 
0.0 1995 
1.0 
2.5 
1.5 
11.5 
1.9 
1.4 
-4.6 
1.7 
2.8 
1.8 
1.6 
2.3 
1.5 
1.7 
1.2 
1,5 1996 
0) 
0.1 
2.6 
0.4 
9.8 
3.1 
0.9 
-0.2 
5.7 
2.2 
0.0 
1.2 
3.8 
2.9 
4.1 
1.4 
1.9 
in 1996 economic forecasts. 
Commission services. 
7.4.2 Import prices 
Given the increased degree of international openness of the Community economy, the 
evolution of import prices plays an important role in domestic price formation. Import 
prices in domestic currency are the synthesis of the evolution of several differenc factors: 
the value of the exchange rate, international prices* the geographical composition of 
imports and the price-setting behaviour of foreign suppliers. 
68 
Several elements had helped in keeping the growth in 
import prices very moderate between 1990 and 1992: 
low oil prices, a weak US dollar, progress in trade 
liberalisation, coupled with the completion of the 
internal market. As a result, contributions of import 
prices to final demand inflation were negative in most 
Member States (and to varying degree) over this 
period. 
However, the effects of some of these factors were 
reversed or weakened during the 1993-95 period. 
Oil prices increased at a relatively fast pace in the 
first half of 1994 and again in early 1995, while the 
dollar strengthened somewhat in 1993 and 1994. In 
addition, the curbing impact on prices exerted by the 
single market gradually faded. 
The upward impact of these factors on import prices 
varied strongly country by country, depending on 
developments on the exchange rate front. In 
countries whose currencies remained strong 
(Belgium, Denmark, Germany, France, the 
Netherlands and Austria), increases in import prices 
remained subdued (see Table 7.3), and their 
contributions to final demand inflation were still 
negative in 1993 and marginally positive in 1994-95 
(see Table 7.4). On the other hand, in those countries which experienced marked 
depreciation between 1993 and 1995 (Spain, Italy, Sweden and the United Kingdom), 
import prices increased strongly over the period. However, the knock-on effects on 
domestic inflation were relatively limited, particularly owing to the appropriate economic 
policy response, but also to the weak growth environment prevailing in these countries. 
Most commodity prices have experienced another fall since mid-1996 (see Graph 7.1). On 
the other hand, the dollar has recovered somewhat since mid-1995. European currencies 
which depreciated significantly in early 1995 also strengthened during the course of 1995 
and 1996. Consequently, the rise in import prices should remain moderate throughout the 
Community in 1996. Their contributions to overall inflation are thus expected to narrow 
in Member States whose currencies have appreciated recently, and to remain moderate in 
other Member States (around 0.5%). Table 7.3 
Import price inflation 
(percentage change in the deflator of 
imports of goods and services, in national 
currency; national accounts basis) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR 1993 
-2.6 
-1.1 
-1.5 
9.1 
6.6 
-2.5 
4.4 
12.1 
5.4 
-2.3 
0.8 
8.9 
8.7 
14.5 
8.4 
3.1 1994 
0.9 
0.4 
0.5 
8.3 
6.0 
1.7 
2.8 
5.0 
0.2 
0.6 
0.7 
4.5 
-0.3 
3.3 
1.9 
2.2 1995 
0.5 
1.3 
0.7 
7.1 
4.2 
1.3 
4.2 
11.7 
0.5 
0.2 
0.9 
1.5 
0.4 
5.1 
7.3 
3.8 1996 
0) 
1.6 
2.1 
0.7 
4.0 
0.9 
1.8 
* 0.5 
-0.6 
3.1 
2.0 
1.2 
1.2 
2.3 
-3.1 
2.0 
1.1 
(1) Autumn 1996 economic forecasts. 
Source: Commission services. 
69 
Table 7.4 
Contribution of import prices to the 
change of the final uses deflator. 
(percentage change) 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
rasr 
s 
UK 1993 
-1.0 
-0.3 
-0.2 
1.9 
1.1 
-0.4 
1.5 
2.0 
2.6 
-0.7 
0.2 
2.4 
1.8 
3.0 
1.7 1994 
0.4 
0.1 
0.1 
1.7 
1.0 
0.3 
1.0 
0.8 
0.1 
0.2 
0.2 
1.2 
-0.1 
0.8 
0.4 1995 
0.2 
0.3 
0.1 
1.5 
0.8 
0.2 
1.5 
2.0 
0.2 
0.1 
0.2 
0.4 
0.1 
1.2 
1.6 1996 
0) 
0.6 
0.5 
0.1 
0.9 
0.2 
0.3 
0.2 
-0.1 
1.4 
0.6 
0.3 
0.4 
0.5 
-0.8 
0.4 
(1) Autumn 1996 economic forecasts. 
Source: Commission services. Table 7.5 
Nominal effective exchange rate changes 
relative to 23 industrial countries; 
(annual percentage changes) 
B/L 
DK 
D 
EL 
E 
F 
IRL 
I 
NL 
A 
P 
FIN 
S 
UK 
EUR (2) -10.5 1993 
1.4 
3.1 
4.1 
-7.0 
•11.5 
3.0 
-5.3 
-15.8 
3.7 
3.3 
-6.3 
•13.0 
•18.5 
-7.9 1994 
2.6 
0.8 
2.0 
-4.8 
-5.3 
2.0 
0.7 
-2.5 
1.5 
1.2 
-3.7 
9.0 
-0.3 
1.5 
3.4 1995 
5.4 
5.1 
6.8 
-1.5 
1.2 
4.7 
0.6 
-8.0 
4.8 
4.2 
2.3 
11.4 
0.4 
-3.4 
7.9 1996 
O) 
-1.4 
-0.4 
-1.6 
-0.8 
1.7 
0.8 
1.9 
9.7 
-1.4 
-1.3 
-0.2 
-2.5 
10.1 
0.6 
4.7 
(1) Based on the geometric average of monthly 
exchange rates until 23 October 1996. 
(2) Relative to 9 non-member countries. USA, 
Japan, Mexico, Canada, Switzerland, Norway, 
Australia, New Zealand and Turkey. 
Source: Commission services. 
70 
7.4.3. Effects of indirect tax changes on inflation 
Although during Stage Two the progress in budgetary consolidation has been achieved 
predominantly through a reduction in the share of government expenditure relative to 
GDP, all Member States have also made use of increases in indirect taxes to this end but 
to varying degree. In several countries, increases in 
indirect taxes have contributed importantly to increases in 
inflation, as is suggested in Table 7.6 which shows 
estimates of the direct mechanical impact under the 
assumption of a full pass-through of changes in indirect 
taxes to consumer prices. 
The most important contributions of indirect tax 
increases to inflation have been observed in Belgium 
(1994), France (1995), Italy (1995), Finland (1995-1996) 
and the United Kingdom (1994-95). However, more 
than the direct impact - which is, by definition, a one-off 
effect - what matters is the risk that increases in indirect 
taxes raise inflation expectations and thus trigger a 
wage/price spiral. This does not appear to have been the 
case in any of these countries. After showing a blip 
during the year in which increases in indirect tax 
occurred, inflation came down swiftly to its previous 
pattern within a short delay. Table 7.6. 
Effects of indirect tax changes 
on consumer price inflation 
(percentage points) 
B 
DK 
D 
GR 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 1994 
0.7 
0.4 
0.4 
0.8 
0.3 
0.1 
0.3 
0.3 
0.1 
0.2 
0.2 
0.2 
0.7 
0.3 
0.7 1995 
0.1 
0.4 
0.0 
0.6 
1.0 
1.1 
0.1 
0.8 
0.1 
0.1 
0.5 
0.5 
1.1 
0.4 
0.6 1996 
0.2 
0.4 
-0.2 
0.8 
0.2 
0.1 
0.2 
0.0 
0.0 
0.4 
0.2 
-0.2 
0.7 
0.3 
0.4 
Source: Commission services. 
71 
72 
8. CONCLUDING SUMMARY 
8.1 General assessment 
This report has been prepared in accordance with the procedure and timetable set out 
in Article 109j of the Treaty. 
Substantial progress towards the achievement of a high degree of sustainable 
convergence has been made in all Member States since the beginning of the second 
stage of EMU. This progress gathered greater momentum during 1996, when efforts 
to achieve convergence (especially in the budgetary field) were intensified in many 
Member States. Other necessary preparations for the third stage are also advancing at 
the national level and at Community level, where during the past year agreement has 
been reached on the scenario for the introduction of the single currency, the 
Commission has recently presented proposals for the legal status of the euro and for a 
stability pact to ensure budgetary discipline in the third stage, a consensus is emerging 
on the design of the so-called "ERM II" and a communication campaign has been 
launched. 
The examination in Chapter 2 of this report of the compatibility between national 
legislation and Articles 107 and 108 of the Treaty and the Statute of the ESCB first of 
all set out the requirements that will have to be satisfied by the start of stage three. It 
then identified types of existing provisions, mainly in the statutes of national central 
banks, which do not yet conform. In virtually all Member States there continue to exist 
provisions that will need to be amended. Several Member States are preparing or have 
already brought forward proposals for changes in their legislation. 
Li the next four chapters progress by each Member State in relation to each of the 
convergence criteria has been examined. 
The steady progress made in the European Union as a whole and by individual 
Member States in moving towards or maintaining a high degree of price stability has 
continued in 1996. The assessment of price convergence has been made using the 
recently available interim indices of consumer prices (IICPs), which are more 
comparable than national indices but not yet fully harmonised. The average rate of 
inflation for each Member State has been calculated as the percentage change in the 
average IICP in the latest 12 months relative to the average index in the preceding 
12 months. The reference value has been calculated for the purpose of this report as 
the simple arithmetic average of the average inflation rates in the three best performing 
Member States plus 1.5 percentage points. Calculated in this way and according to the 
latest available information (September 1996), the three best price performers were 
Finland, the Netherlands and Germany, and the reference value was 2.6% (see 
Table 8,1). Ten Member States (Belgium, Denmark, Germany, France, Ireland, 
Luxembourg, the Netherlands, Austria, Finland and Sweden) had average inflation 
rates below this reference value. A box in Chapter 3 shows that the number of Member 
States respecting the price stability criterion is not at present sensitive to the method 
chosen to calculate the reference value. Five Member States still have average inflation 
rates above the reference value in September (Greece, Spain, Italy, Portugal and the 
United Kingdom), but the differentials have tended to narrow in recent years and again 
73 
in 1996. Portugal and the United Kingdom are less than V2 percentage point above the 
reference value. 
Only three Member States (Denmark, Ireland and Luxembourg) are currently not the 
subject of a Council Decision on the existence of an excessive government deficit and 
so respect the criterion on the government budgetary position. The most recent 
decisions under the excessive deficit procedure (Article 104c) were made in June 1996. 
Chapter 4 also reviewed budgetary developments in the Member States during the 
second stage and presented estimates of likely outturns in 1996. Significant progress 
has been made since 1993 by most Member States in reducing government deficits; in 
1996 four countries (Denmark, Ireland, Luxembourg and the Netherlands) are 
expected to achieve a government balance better than the 3% of GDP deficit reference 
Table 8.1 
Performance of the Member States in relation to convergence in 1996 
Reference 
value 
B 
DK 
D 
EL 
E 
F 
IRL 
I 
L 
NL 
A 
P 
FIN 
S 
UK 
EUR Inflation 
Interim 
index of 
consumer 
prices 
0) 
Oct. 1995 
Sep. 1996 
2.6 (3) 
1.6 
2.2 
1.3 
8.4 
3.8 
2.1 
2.1 (5) 
4.7 
1.3 
1.2 
1.7 
3.0 
0.9 
1.6 
3.0 
2.7 General government budgetary position 
Existence 
of 
an excessive 
deficit 
Council 
decisions, 
26.9.1994, 
10.7.1995 and 
27.6.1996 
yes .. 
no 
yes 
yes 
yes, 
yes 
no 
yes 
no 
yes 
yes 
yes 
yes 
yes 
yes Deficit 
(% of 
GDP) 
(2) 
1996 
3.0 
3.3 
1.4 
4.0 
7.9 
4.4 
4.0 
1.6 
6.6 
-0.9 
2.6 
4.3 
4.0 
3.3 
3.9 
4.6 
4.4 Debt 
(%ofGDP) 
(2) 
1996 
60 
130.6 
70.2 
60.8 
110.6 
67.8 
56.4 
74.7 
123.4 
7.8 
78.7 
71.7 
71.1 
61.3 
78.1 
56.3 
73.5 Change 
94/93 95/94 96/95 
-2.0 
-4.1 
2.2 
-1.4 
2.6 
2.8 
-6.6 
6.2 
-0.5 
-3.4 
2.3 
1.4 
2.2 
3.3 
1.9 
2.0 -1.3 
-4.1 
7.7 
1.4 
2.6 
4.4 
-6.3 
-0.6 
0.3 
2.3 
3.9 
2.1 
-0.3 
-0.6 
3.7 
3.2 -3.1 
-1.7 
2.7 
-1.2 
2.1 
3.6 
-6.9 
-1.5 
1.8 
-1.0 
2.7 
-0.6 
2.1 
-0.6 
2.2 
2.2 Exchange 
rates 
ERM 
participation 
October 
1996 
yes 
yes 
yes 
no 
yes 
yes 
yes 
no 
yes 
yes 
yes 
yes 
yes 
no 
no Long-term 
interest rates 
Oct. 1995 
Sep. 1996 
8.7(4) 
6.7 
7.4 
6.3 
15.1 
9.5 
6.6 
7.5 
10.3 
7.0 
6.3 
6.5 
9.4 
7.4 
8.5 
8.0 
7.6 
(1 ) Percentage change in average level of index in latest 12 months over average in previous 12 month period 
(2) Estimates from Commission services' Autumn 1996 Economic Forecasts. 
(3) Definition adopted in this report: arithmetic average of the three best performers in terms of inflation plus 
1.5 percentage points. 
(4) Defmition adopted in this report: arithmetic average of the 12-month average of interest rates of the three best 
performing Member States in terms of price stability plus 2 percentage points. 
(5) Measured on the basis of quarterly data. 
Source: Commission services. 
74 
value; Belgium and Finland are likely to have deficits smaller than 31/2% of GDP. By 
the end of 1996 three Member States (France, Luxembourg and the United Kingdom) 
are expected to have a government gross debt ratio below the 60% of GDP reference 
value. In Germany and Finland, the debt ratio is likely to exceed the reference value of 
60% by the end of 1996, after having been consistently below that value. Several 
Member States have succeeded in reversing the earlier upward trend in the debt ratio, 
with a steady reduction since 1993 in Belgium, Denmark and Ireland and declines 
expected in 1996 also in Greece, Italy, the Netherlands, Portugal and Sweden. 
Since the turbulence in foreign exchange markets that led to the realignment in March 
1995 within the ERM of the Spanish peseta, followed by the Portuguese escudo, 
exchange rate conditions have not been subject to severe tensions and the gap between 
the strongest and weakest currencies within the ERM band has tended to narrow (as 
described in Chapter 5). There are currently eleven currencies participating in the 
ERM. Nine of these (the currencies of Belgium, Denmark, Germany, Spain, France, 
Ireland, Luxembourg, the Netherlands and Portugal) have been members of the ERM 
for well over two years. Austria joined the ERM at the beginning of 1995 and Finland 
in the middle of October 1996. Four Member States (Greece, Italy, Sweden and the 
United Kingdom) are not currently participating in the ERM; the last three of these 
countries have seen a significant appreciation of their currencies during 1996, 
following the weakness of earlier years. 
The fourth criterion, on the durability of convergence as reflected in long-term interest 
rates, has been examined in Chapter 6. The assessment is based on the interest rates on 
comparable 10-year benchmark bonds (not fully comparable for Greece) , using an 
average rate over the latest 12 months. The reference value has been calculated as the 
simple arithmetic average of the long-term interest rates of the three best performing 
Member States in terms of price stability plus 2 percentage points. In September 1996 
the reference value was 8.7%. Eleven Member States (Belgium, Denmark, Germany, 
France, Ireland, Luxembourg, the Netherlands, Austria, Finland, Sweden and the 
United Kingdom) have average interest rates below the reference value. Developments 
in bond markets during 1996, and especially in September, have resulted in a 
significant narrowing in interest rate differentials, especially among the higher-yielding 
countries where the criterion is not yet respected. 
The Treaty also requires that this report should examine developments in several other 
areas relevant to economic integration and convergence. These are dealt with in 
Chapter 7. Financial markets in ECU have tended to decline in importance since the 
severe currency turbulence of 1992 and 1993, but significant amounts of commercial 
transactions are settled in ECU. The spread between the private and public ECU is 
reducing as the certainty of the 1 for 1 convertibility between the ECU and the euro is 
incorporated by the markets. The Single Market project has been having a significant 
impact on economic integration, particularly on the structure of trade between Member 
States, on foreign direct investment flows, on competition conditions and on price 
convergence for certain categories of goods and services. The current account of the 
balance of payments reflects the national savings in each Member State; the European 
Union as a whole and ten Member States are expected to be in surplus in 1996. 
Additional indicators for unit labour costs and import prices confirm the picture given 
75 
in Chapter 3 of a satisfactory and soundly based price performance in most Member 
States. 
Mainly as a consequence of the persistence of budgetary imbalances (although they are 
being reduced) and as illustrated by the existence of excessive government deficits in 
twelve Member States, it is clear that currently a majority of Member States has not 
yet made sufficient progress in the achievement of a high degree of sustainable 
convergence. 
8.2 Summary by Member States 
In this final section of the report performance in relation to the convergence criteria is 
presented on a country-by-country basis in accordance with Article 109j(l) which 
requires an examination of the achievement of a high degree of sustainable 
convergence by reference to the fulfilment by each Member State of the criteria. The 
criteria on inflation and long-term interest rates have been examined using data 
covering the period up to September 1996. The reference value has, in both cases, 
been calculated using the average of the three best performing Member States in terms 
of inflation. As regards the criterion on the government budgetary position, where 
relevant, Commission estimates of budgetary data for 1996 as a whole are presented. 
In Belgium the average inflation rate in the year ending in September 1996 stood at 
1.6% which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 6.7% which is also below the reference value. The 
Council has not yet abrogated its Decision of 26 September 1994 according to which 
an excessive government deficit exists in Belgium. In 1996 the general government 
deficit is expected to be reduced by 0.8 percentage points to 3.3% of GDP; the 
government gross debt ratio is likely to decline from 133.7% of GDP in 1995 to 130.6 
% in 1996. Belgium has been a member of the ERM since its inception; in the latest 
two years the BFR has respected the fluctuation margins of the ERM and has not been 
subject to severe tensions and the BFR bilateral central rate has not been devalued. 
In Denmark the average inflation rate in the year ending in September 1996 stood at 
2.2% which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 7.4% which is also below the reference value. The 
Council decided on 27 June 1996 to abrogate its Decision of 26 September 1994 on 
the existence of an excessive government deficit in Denmark. In 1996 the general 
government deficit is expected to be reduced by 0.2 percentage points to 1.4% of 
GDP; the government gross debt ratio is likely to decline further to 70.2% in 1996 
from 71.9% of GDP in 1995. Denmark has been a member of the ERM since its 
inception; in the latest two years the DKR has respected the fluctuation margins of the 
ERM and has not been subject to severe tensions and the DKR bilateral central rate 
has not been devalued. 
In Germany the average inflation rate in the year- ending in September 1996 stood at 
1.3% which is the third best performance in the EU and is therefore below the 
reference value; during the same period nominal long-term interest rates were, on 
average, 6.3% which is also below the reference value. The Council decided on 
27 June 1996 that an excessive government deficit exists in Germany. In 1996 the 
76 
general government deficit is expected to increase to 4.0% of GDP from 3.5% in 1995; 
the government gross debt ratio which has been below 60% of GDP is likely to 
increase in 1996 reaching 60.8% of GDP. Germany has been a member of the ERM 
since its inception; in the latest two years the DM has respected the fluctuation margins 
of the ERM and has not been subject to severe tensions and the DM bilateral central 
rate has not been devalued. 
In Greece the average inflation rate in the year ending in September 1996 stood at 
8.4%) which is significantly above the reference value; during the same period nominal 
long-term interest rates were, on average, 15.1%, also clearly above the reference 
value. The Council has not yet abrogated its Decision of 26 September 1994 according 
to which an excessive government deficit exists in Greece. In 1996 the general 
government deficit is expected to be reduced by 1.2 percentage points to 7.9% of 
GDP; the government gross debt ratio is likely to decline from 111.8% of GDP in 
1995 to 110.6% in 1996. The DR does not participate in the ERM. 
In Spain the average inflation rate in the year ending in September 1996 stood at 3.8% 
which is above the reference value; during the same period nominal long-term interest 
rates were, on average, 9.5% which is also above the reference value. The Council has 
not yet abrogated its Decision of 26 September 1994 according to which an excessive 
government deficit exists in Spain. In 1996 the general government deficit is expected 
to be reduced by 2.2 percentage points to 4.4% of GDP; the government gross debt 
ratio is likely to increase from 65.7% of GDP in 1995 to 67.8% in 1996. Spain has 
been a member of the ERM since June 1989; in March 1995 the bilateral central rate of 
the peseta was devalued by 7%, at the initiative of Spain; since then the PTA has 
respected the fluctuation margins of the ERM and has not been subject to severe 
tensions. 
In France the average inflation rate in the year ending in September 1996 stood at 
2.1%) which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 6.6% which is also below the reference value. The 
Council has not yet abrogated its Decision of 26 September 1994 according to which 
an excessive government deficit exists in France. In 1996 the general government 
deficit is expected to be reduced by 0.8 percentage points to 4.0% of GDP; the 
government gross debt ratio continues to be below 60% of GDP in 1996. France has 
been a member of the ERM since its inception; in the latest two years the FF has 
respected the fluctuation margins of the ERM and has not been subject to severe 
tensions and the FF bilateral central rate has not been devalued. 
In Ireland the average inflation rate in the year ending in September 1996 stood at 
2.1% which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 7.5% which is also below the reference value. Ireland 
is not the subject of a Council decision on the existence of an excessive government 
deficit. The general government deficit has been below 3% of GDP since 1989 and is 
expected to be reduced further by 0.4 percentage points to 1.6% of GDP in 1996; the 
government gross debt ratio is likely to decline further to 74.7% in 1996 from 81.6% 
of GDP in 1995. Ireland has been a member of the ERM since its inception; in the 
latest two years the ERL has respected the fluctuation margins of the ERM and has not 
77 
been subject to severe tensions and the IRL bilateral central rate has not been 
devalued. 
In Italy the average inflation rate in the year ending in September 1996 stood at 4.7% 
which is clearly above the reference value; during the same period nominal long-term 
interest rates were, on average, 10.3% which is also above the reference value. The 
Council has not yet abrogated its Decision of 26 September 1994 according to which 
an excessive government deficit exists in Italy. In 1996 the general government deficit 
is expected to be reduced by 0.5 percentage points to 6.6% of GDP; the government 
gross debt ratio is likely to decline from 124.9% of GDP in 1995 to 123.4 % in 1996. 
Italy was a member of the ERM from its inception until September 1992 when the 
intervention obligations for the LIT were suspended; since then the LIT has not re­
entered the ERM. 
In Luxembourg the average inflation rate in the year ending in September 1996 stood 
at 1.3% which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 7.0% which is also below the reference value. 
Luxembourg is not the subject of a Council decision on the existence of an excessive 
government deficit. The general government financial position has traditionally been in 
a surplus, expected to amount to 0.9% of GDP in 1996. The government gross debt 
ratio continues to remain significantly below 60% of GDP. Luxembourg has been a 
member of the ERM since its inception; in the latest two years the LFR has respected 
the fluctuation margins of the ERM and has not been subject to severe tensions and the 
LFR bilateral central rate has not been devalued. 
In the Netherlands the average inflation rate in the year ending in September 1996 
stood at 1.2% which is the second best performance in the EU and is therefore below 
the reference value; during the same period nominal long-term interest rates were, on 
average, 6.3% which is also below the reference value. The Council has not yet 
abrogated its Decision of 26 September 1994 according to which an excessive 
government deficit exists in the Netherlands. In 1996 the general government deficit is 
expected to be reduced by 1.4 percentage points to 2.6% of GDP; the government 
gross debt ratio is likely to decline from 19.1% of GDP in 1995 to 78.7 % in 1996. 
The Netherlands have been a member of the ERM since its inception; in the latest two 
years the HFL has respected the fluctuation margins of the ERM and has not been 
subject to severe tensions and the HFL bilateral central rate has not been devalued. 
In Austria the average inflation rate in the year ending in September 1996 stood at 
1.7% which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 6.5% which is also below the reference value. The 
Council has not yet abrogated its Decision of 10 July 1995 according to which an 
excessive government deficit exists in Austria. In 1996 the general government deficit 
is expected to be reduced by 1.6 percentage points to 4.3% of GDP; the government 
gross debt ratio is likely to increase from 69.0% of GDP in 1995 to 71.7 % in 1996. 
Austria has been a member of the ERM since early January 1995; since then the OS 
has respected the fluctuation margins of the ERM and has not been subject to severe 
tensions and the OS bilateral central rate has not been devalued. 
78 
In Portugal the average inflation rate in the year ending in September 1996 stood at 
3.0% which is above the reference value; during the same period nominal long-term 
interest rates were, on average, 9.4% which is. also above the reference value. The 
Council has not yet abrogated its Decision of 26 September 1994 according to which 
an excessive government deficit exists in Portugal. In 1996 the general government 
deficit is expected to be reduced by 1.1 percentage points to 4.0% of GDP; the 
government gross debt ratio is likely to decline from 71.7.% of GDP in 1995 to 71.1% 
in 1996. Portugal has been a member of the ERM since April 1992. In March 1995, 
following the devaluation of the Spanish peseta, the bilateral central rate of the 
Portuguese escudo was devalued by 3.5%. Since then the ESC has respected the 
fluctuation margins of the ERM and has not been subject to severe tensions. 
In Finland the average inflation rate in the year ending in September 1996 stood at 
0.9% which is the best performance in the EU and is therefore below the reference 
value; during the same period nominal long-term interest rates were, on average, 7.4% 
which is also below the reference value. The Council has not yet abrogated its Decision 
of 10 July 1995 according to which an excessive government deficit exists in Finland. 
In 1996 the general government deficit is expected to be reduced by 1.9 percentage 
points to 3.3% of GDP; the government gross debt ratio which has been below 60% of 
GDP is likely to increase in 1996, reaching 61.3% of GDP. Finland has been a member 
of the ERM since mid-October 1996. 
In Sweden the average inflation rate in the year ending in September 1996 stood at 
1.6% which is below the reference value; during the same period nominal long-term 
interest rates were, on average, 8.5% which is below the reference value. The Council 
has not yet abrogated its Decision of 10 July 1995 according to which an excessive 
government deficit exists in Sweden. In 1996 the general government deficit is 
expected to be reduced by 4.2 percentage points to 3.9% of GDP; the government 
gross debt ratio is likely to decline from 78.7% of GDP in 1995 ta 78.1% in 1996. The 
SKR does not participate in the ERM. 
In the United Kingdom the average inflation rate in the year ending in 
September 1996 stood at 3.0% which is above the reference value; during the same 
period nominal long-term interest rates were, on average, 8.0% which is below the 
reference value. The Council has not yet abrogated its Decision of 26 September 1994 
according to which an excessive government deficit exists in the United Kingdom. In 
1996 the general government deficit is expected to be reduced by 1.2 percentage 
points to 4.6% of GDP; the government gross debt ratio continues to be below 60% of 
GDP in 1996. The currency of the United Kingdom entered the ERM in October 1990; 
the participation of the UKL in the ERM was suspended in September 1992 and has 
not been resumed. 
ISSN 0254-1475 
COM(96) 560 final 
DOCUMENTS 
EN 09 10 
Catalogue number : CB-CO-96-569-EN-C 
ISBN 92-78-11424-3 
Office for Official Publications of the European Communities 
L-2985 Luxembourg