EU Convergence Criteria and European Central Bank Functions

Convergence Criteria (Maastricht Criteria)

Price Stability (Inflation)

Price stability — Inflation: The inflation rate of a given Member State must not exceed by more than 1.5 percentage points the average inflation rate of the three best-performing Member States in terms of price stability during the year preceding the examination of the situation in that Member State.

Government Finances: Deficit and Debt

Public deficit: When drawing up its annual recommendation to the Council of Finance Ministers, the Commission examines compliance with budgetary discipline based on two criteria.

• Annual government deficit: The ratio of annual deficit to GDP must not exceed 3% at the end of the preceding fiscal year. If this is not the case, the ratio must have declined substantially and continuously and reached a level close to 3% (interpretation in trend terms according to Article 104(2)), or, alternatively, must remain close to 3% while representing only an exceptional and temporary excess.
• Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year (Stability and Growth Pact, 1997). If this is not the case, the ratio must have sufficiently diminished and be approaching the reference value at a satisfactory pace (interpretation in trend terms according to Article 104(2)).

Exchange Rate Mechanism (ERM) Participation

Exchange rates — Participation in the European Exchange Rate Mechanism (ERM): The national currency must not experience severe tensions during the two years before the examination. In addition, it must not have devalued its currency on its own initiative during the same period.

Long-Term Interest Rates

Long-term interest rates: For the one year before the examination, the average nominal interest rate on long-term government debt must not exceed by more than 2 percentage points the mean interest rate of the three Member States with the lowest inflation (the three best-performing Member States in terms of price stability).

European System of Central Banks (ESCB)

The European System of Central Banks and the Eurosystem have core responsibilities for monetary policy in the EU. The basic tasks of the Eurosystem are to:

• Define and implement monetary policy for participating Member States;
• Conduct foreign exchange operations;
• Promote the smooth operation of payment systems;
• Hold and manage the official foreign reserves of the participating EU Member States.

In addition, the ESCB carries out other tasks such as advisory functions, the collection and compilation of statistics, the issuance of banknotes, contributions to prudential supervision and financial stability, and the promotion of international cooperation. The main objective of the ESCB is to maintain price stability while supporting the general economic policies of the Union.

How Interest Rates Affect the Economy

When interest rates fall, consumption and investment tend to rise, so production increases; this can push inflation up and accelerate economic growth. However, if the inflation rate increases too much, central banks raise interest rates. Higher interest rates reduce demand and investment, which helps bring inflation down. Interest rates are also raised to attract foreign capital.