If Lithuania would have had the euro instead of the litas, the painful measures currently taken by the Kubilius government would not have been necessary. Two years ago Lithuania was very close to adoption of the euro, but it became a victim of the strict adherence of the so-called euro convergence criteria by the European Central Bank. Taking a closer look at the history of the creation of the euro, it becomes clear that this strict adherence was not applied to the original member countries when the euro was created in the late 1990s.
The aim of the convergence criteria is to avoid a destabilization of the euro by too early admitting countries whose underlying economic performance is not yet compatible with fixed exchange rates. The euro convergence criteria entail that successful candidates must have:
1. Inflation rates of no more than 1.5 percent above the average of the three countries with the lowest inflation rates in the EU.
2. Long-term interest rates of no more than 2 percent above the average of that of the three lowest inflation countries.
3. Exchange rates that remain within the fluctuation band of +/- 15 percent with the euro without tension and without initiating depreciation for two years. This system is known as the Exchange Rate Mechanism.
4. A state debt of less than 60 percent of GDP.
5. A budget deficit of less than 3 percent of GDP.
Lithuania was denied membership because its inflation rate was 0.1 percent higher than set down in the first criterion. The other criteria were satisfactorily fulfilled.
The convergence criteria were formulated already back in the early 1990s and initially designed for the creation of the euro. This meant that the original member countries also had to fulfill these criteria before the euro was launched in 1999.
The inflation criterion was met by all the original member countries in the year before entry, but once the euro was created, inflation rates skyrocketed in several member countries. This gives doubt to the usefulness of this criterion as convergence prior to entry is no guarantee for convergence afterwards.
Italy failed to meet the third criterion, because it did not take part for two years in the Exchange Rate Mechanism. Lithuania is already successfully taking part in the Exchange Rate Mechanism for more than five years, despite the grave pressures that it has to withstand in order to avoid devaluation.
Seven out of twelve original member countries had state debts that exceeded 60 percent of their GDP. In Austria, Germany and Greece state debt was even increasing in the period before they joined. The OECD reported that these countries had a state debt of respectively 62.6, 64.8 and 100.8 percent in 2008. Belgium, Italy, the Netherlands and Spain had decreasing state debts in the period before they joined, but this decrease was only marginal. Last year these countries had state debts of respectively 92.2, 113, 54.4 and 44.2 percent. These figures exclude the massive economic stimulation programs for countering the current financial crisis which increased state debt even more. The Lithuanian government does not have the luxury of using stimulation programs. They instead have to find more painful ways to counter the crisis, such as a cutting government spending and increasing taxation in order to fulfill the state debt criterion.
Concerning budget deficits things look slightly better when just looking at the numbers. Only Greece and Spain exceeded the 3 percent margin in the year prior to entry. However, it turned out later that several national governments had been manipulating the true level of their budget deficits. By creative accounting, Belgium, France and Italy showed the satisfactory levels of budget deficit. The Lithuanian government, on the other hand is required to strictly fulfill this criterion if they want to see their country becoming a member of the euro. Especially now during the financial crisis it is extremely difficult not to exceed this 3 percent.
Thus, the original member countries ignored the criteria once the euro came into operation. In order to prevent this, the so-called Stability and Growth Pact was agreed upon. According to the pact, member countries of the euro are not allowed to have a state debt of less than 60 percent of GDP and a budget deficit of less than 3 percent of GDP. The pact includes provisions that a country not fulfilling this criterion is subjected to disciplinary actions in the form of fines. In 2004, France and Germany violated the pact for the third year in a row, but ultimately no sanctions were conducted against them.
It can be concluded from the foregoing that the convergence criteria are applied in an arbitrary way. The European Central Bank applies double standards by initially relaxing the requirements for the original member countries, while nowadays they are strictly adhered to delay eastern enlargement. A large majority of the original member countries are now against entry of new members from Central and Eastern Europe. The European Central Bank is thus not as independent as is always proclaimed, because they could not withstand political pressure in the case of Lithuania.Lithuania would have been far better off if it had been able to join the euro two years ago. The impact of the current financial crisis would not have been so painful, because the Kubilius government would have had less painful policy options to counter the crisis. There would have been no fear for devaluation. Far-reaching cuts in government spending and massive tax increases would not have been necessary.