The effects of the COVID-19 pandemic on real convergence of the European Monetary Union

Aursulesei, Tudor-Mugurel Article The effects of the COVID-19 pandemic on real convergence of the European Monetary Union CES Working Papers Provided in Cooperation with: Centre for European Studies, Alexandru Ioan Cuza University Suggested Citation: Aursulesei, Tudor-Mugurel (2023) : The effects of the COVID-19 pandemic on real convergence of the European Monetary Union, CES Working Papers, ISSN 2067-7693, Alexandru Ioan Cuza University of Iasi, Centre for European Studies, Iasi, Vol. 15, Iss. 1, pp. 15-33 This Version is available at: https://hdl.handle.net/10419/286689 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ CES Working Papers – Volume XV, Issue 1 15 This work is licensed under a Creative Commons Attribution License The effects of the COVID-19 pandemic on real convergence of the European Monetary Union Tudor-Mugurel AURSULESEI* Abstract The COVID-19 pandemic has placed the European Monetary Union (EMU) in front of a new economic reality. All the health restrictions enforced at the EU level had repercussions on the real convergence of the Eurozone. In the present article, we aimed to observe how real convergence in the Euro area was affected by the analysis of the main economic indicators extracted from the scientific literature. Furthermore, we created an aggregate index of real convergence to determine how it was affected during the pandemic period. We put all this analysis in the context of the effects arising as a result of the pandemic and the various measures implemented at the union level for economic recovery. In the proposed article, we conclude that following the pandemic period, EMU member states abandoned the real convergence criterion. The main policy recommendation emerges from this conclusion: the need for coordination at the EMU level regarding all economic and financial policies adopted. Keywords: pandemic crisis, economic crisis, real convergence, euro zone Introduction One of the biggest and most complicated contemporary events, which had a significant impact on the world, was the COVID-19 pandemic. What we call today the global pandemic COVID-19 is the result of the global spread of the SARS-CoV-2 virus and the end of 2019, the beginning of 2020. One of the main areas where the pandemic made its presence feel was the economy. Our analysis focuses on the European Monetary Union, which faced new economic challenges generated by the various social distancing or isolation measures adopted at the EMU level or individually by each of the 19 member states (Ahmad et al., 2019). Through this study we aim to analyse the effects of the COVID-19 pandemic on the EMU. We explore the various fiscal and monetary policy measures adopted at the union level to mitigate the effects of the crisis as well as the impact on real convergence. As the pandemic spread worldwide and an increasing number of restrictions began to appear in society, its effects began to become more pronounced (Goniewicz, 2020). Social distancing measures * Tudor-Mugurel AURSULESEI is postdoctoral researcher and associate professor at Alexandru Ioan Cuza University of Iasi, Romania, e-mail: aursulesei.tudor.mugur[email protected]. CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY The effects of the COVID-19 pandemic on real convergence of the European Monetary Union 16 and the limitations of various economic activities have brought about effects, such as the interruption of supply chains or the closure of some economic sectors. The labour market was also affected, thus generating a new type of shock in the EMU. In response, governments and monetary authorities have taken swift and innovative measures to support the business environment, jobs and financial stability (Marti, 2021). Although the consequences are complex and still unfolding, this scientific analysis aims to provide a deeper understanding of how the pandemic has shaped and continues to shape the Eurozone economy, thereby contributing to the foundation of more informed decision-making and more effective policies in the future. The purpose of this scientific article is to analyse how real convergence in the European Monetary Union was influenced during the Covid-19 crisis. Furthermore, we aim to observe the effects of the crisis on the economy and the measures have been implemented to reduce the negative effects. As a novelty, the proposed study, in addition to the separate analysis of each indicator of real convergence and the effects produced on the economy, aims to create an aggregate index of real convergence and put it in the context of the pandemic crisis. To create the aggregate index of real convergence, we use data on the most important indicators of real convergence: GDP per capita, unemployment rate, trade openness and price index (Aursulesei, 2023). 1. Real convergence - literature review This section aims to clarify the meaning of real economic convergence. Real convergence implies a reduction in structural disparities that can influence competitiveness and competition in respective economies. These criteria complement the provisions of the Maastricht Treaty, which stipulate nominal convergence criteria. Although it is not a mandatory requirement for joining the euro zone, it is desired that they are met, because they reflect the real situation of national economies. The purpose of real convergence is to promote economic development so that the states wishing to join the union reach the economic level of member states. In addition, after joining the European Monetary Union, the aim is to synchronize the economic cycles of the member states because significant differences in growth can lead to major imbalances within the union. The theory of optimal monetary areas suggests that, as long as the economic cycles of the member countries do not synchronize with those of their partners, the abandonment of autonomous monetary policy may have negative economic effects (Bojeșteanu and Manu, 2011, p. 31). Thus, a crucial condition for joining a monetary union is that business cycles are aligned between member countries (Mongelli, 2002, pp. 31-33). If there is no synchronization of economic cycles within the CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY Tudor-Mugurel AURSULESEI 17 monetary union, common monetary policy may affect member states differently, increasing the risk of misunderstandings between states when making monetary policy. Each state will want to promote its own economic agenda, which may not coincide with the vision of other states on the subject (Artis, 2003, pp. 10-12). However, the scientific literature in the field of the theory of optimal monetary areas offers solutions for protecting national economies in the event of the occurrence of asymmetric shocks as a result of the abandonment of autonomous monetary policy. These protection criteria, the criteria of real convergence, include aspects such as the mobility of production factors (Mundell, 1961, p. 660), international economic openness (McKinnon, 1963, p. 723), diversification of national production (Kenen, 1969, p. 57), financial integration (Ingram, 1973, pp. 6-8), inflation similar to that of other member states (Fleming, 1971, p. 480), wage flexibility and political commitment (Dyson, 2000, pp. 203-209). The scientific literature emphasizes that the countries that adapt best to abandoning their own monetary policy in favour of the common one are those whose incomes and prices are closely correlated with the other states in the union (Alesina, et al., 2002, p. 9). However, it has been observed that the Euro area is not characterized by similar developments in the economic cycles of member states (Acedo Montoya and De Haan, 2009, p. 2012). If we follow the evolution of the EMU from its establishment to the present, we can see that there are gaps between states in terms of the onset of economic or financial crises, as well as the time of recovery from the crises. We can mention here the different crises that different member states went through, such as: Greece, Ireland, Portugal or Italy; crises that were less felt by other members (Aursulesei, 2021). The recent crises experienced in the euro area, whether they were of a financial nature or specific to the area itself, have shown that the member states of the monetary union have not registered a real sustainable convergence, because the politician at the national level will always put his own interest first, leaving the "common good" of the union on the back burner. For political decision makers, it is more important to adopt measures that will please the national electorate, even if these decisions can affect the steps taken up to that point in the path of economic convergence (Dăianu, et al., 2017, p. 50). The effects felt by the member states following various crises, as well as the lack of decisionmaking unity, can be observed by analysing real convergence. In order to deepen the problem of real convergence at the EMU level, we have identified in the specialized literature 4 indicators that are the most representative in the study of real convergence: trade openness (Mundell, 1961; McKinnon, 1963; Kindleberger, 1971); unemployment rate (Mundell, 1961; Davies, 2011; Sensier et al., 2016); CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY The effects of the COVID-19 pandemic on real convergence of the European Monetary Union 18 GDP per capita (Davies, 2011; Kaitila, 2013) and price index (Mundell, 1961; Fleming, 1971; Williamson, 1974). 2. Measures adopted at the level of the European Monetary Union in the context of the COVID-19 pandemic During the COVID-19 pandemic, the member states of the European Monetary Union adopted a series of measures to be able to protect the national economy from the harmful effects of the crisis. There was no full synchronization of all the measures adopted. Some measures were taken at the European institution level, but many decisions were made at the national level. Thus, from the start, we cannot discuss a priority in terms of economic convergence as a result of the implementation of these measures. Following the analysis of the economic measures implemented at the European level during the COVID-19 crisis, we extracted a series of decisions that had a more significant influence on economies. The first measure taken at the European Monetary Union level was the emergency procurement program in the context of the pandemic (PEPP) of the European Central Bank. In March 2020, the European Central Bank launched this program with the aim of maintaining market stability and keeping under control favourable financing conditions for both governments and the population. More specifically, bonds, both sovereign and corporate, were purchased through this program to reduce borrowing costs, while simultaneously encouraging lending (Grund, 2020). States have also taken several fiscal measures at the national level. Thus, each state decided to adopt some fiscal incentive packages to stimulate the economy. The adopted packages had a diverse component, such as: measures to support companies affected by the various restrictions, compensation for employees affected by the sanitary measures adopted, or various other types of social aid to support the population affected by the various restrictions. Another joint measure was the creation of the European Union Recovery and Resilience Fund. This financial package agreed in July 2020 had a value of 750 billion euros (Vanhercke, 2023). The purpose of the fund was to support reforms and investments in the European Union, especially in states affected by the pandemic. This package aims to strengthen resilience and accelerate economic recovery. These funds were accompanied in the euro area by loans granted through the European Stability Mechanism. Thus, the member states of the European Monetary Union were able to obtain emergency loans of up to 2% of GDP to finance various expenses associated with the COVID-19 crisis. Moreover, to support member states, the European Commission and European Council applied temporary measures that allowed member states to exceed certain budget deficits and public debt CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY Tudor-Mugurel AURSULESEI 19 limits. Thus, derogation from the fiscal discipline of the union and the Stability and Growth Pact appeared (Corti, 2023). Countries that have been affected more by the pandemic have received increased aid from the European Commission. The main criteria in this discrimination were the vulnerability of the health system and degree of economic development. These are only part of the measures adopted at the European level with the aim of reducing the negative effects of the COVID-19 pandemic on the economy. From the study of the measures adopted both at the level of the entire euro zone, but also at the individual level of each state, we expect to observe an influence on real convergence as well. For this reason, the main hypothesis from which we start in this article emerges: all the measures adopted at the Eurozone level as a result of the pandemic crisis have led to a decrease in the real convergence between the member states. In what follows, we propose to analyse the evolution of real convergence in the European Monetary Union during this pandemic crisis. 2.1. The economic effects of the COVID-19 pandemic The Covid-19 pandemic has had a significant impact on the entire world map. This epidemic spread rapidly worldwide and had effects not only on the sanitary level, but also on the social or economic level. In the present research we have chosen to focus on the economic effects of the pandemic on the economy of the European Monetary Union. Looking back at all the measures implemented by the member states, but also by the institutions of the European Union, we can delineate several effects that were also felt in the economy (Aursulesei, 2023). One such economic effect is the occurrence of an economic recession. The health crisis has created an unprecedented situation in recent history, namely the closure of key sectors of the economy. The most affected sectors were by far that of: tourism, hotels, restaurants or the organization of events. Considering that among the members of the European Monetary Union, we find that states have the tourism industry as their main activity sector, their receipts to the state budget have decreased significantly (Pavaluc et al., 2020). Furthermore, the limitations imposed on businesses in affected areas have led to supply chain problems. The closure of factories has led to delays in the delivery and supply chains, thus affecting the production of goods and services. This pronounced decrease in the demand for tourism services and events during the pandemic was also reflected in the economic statistics of the union which triggered a period of economic recession (Ahmad et al., 2019). At the level of the European Union, there was also talk of an increase in unemployment as a CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY The effects of the COVID-19 pandemic on real convergence of the European Monetary Union 20 result of the decisions implemented during the pandemic. Because of the isolation measures and various restrictions imposed, people were laid off during this period. The most affected were temporary workers and those in closed sectors of the economy. Many states have resorted to the term technical unemployment, a form of unemployment that did not necessarily mean a different dismissal of employees, but rather a suspension of employment contracts during the period when the restrictions imposed by governments were in force (Akbulaev et al., 2020). The social distancing measures imposed by governments have led to an increase in government spending (Tiliuță and Diaconu, 2020). States had to allocate significant amounts of money to support the health system, to grant various social aids to people affected by the government measures implemented, or to support companies affected by the situation in society. Support for companies came through the allocation of various grants and loans to overcome the crisis situation or through the implementation of various fiscal policies to stimulate business (Marti and Puertas, 2021). All of these budget allocations led to an increase in the budget deficit and public debt. The states had to turn to different lines of financing to be able to cover these unforeseen expenses. It is true that among all these negative effects, we can also identify effects with a beneficial character to society. First, the most important benefit of this crisis period was the forced acceleration of digitization (Cone et al., 2022). Both the state and private companies had to accelerate efforts to implement new technologies in the economy, in order to be able to maintain that important social distance during such a pandemic (Pinzaru et al., 2020). Another effect that we could pass to the category of positive effects, but equal to that of negative effects, is the change in consumer preferences. Starting from the emergence of new technologies in the economy, consumers have learned that there are new work opportunities, new methods of satisfying needs or new typologies of products and services (Goniewicz et al., 2020). All these changes are also reflected on different economic indicators. Finally, we must emphasize that governmental measures, as well as the economic effects of the pandemic, were different from one state to another. Even if we are discussing a union in our case, the measures were not necessarily coordinated at the level of the entire community block. There are several common measures, but many of them have been taken individually at the state level (Casquilho-Martins et al., 2022). Starting from this non-unitary policy at the European level, it is opportune to analyse how the economic convergence of the EMU has been affected. Has it been brought to the front or has it been abandoned to meet the monetary needs of each member state? CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY Tudor-Mugurel AURSULESEI 21 3. Methodology To design the methodology of this article, we selected a total of 19 member states of the European Monetary Union (we excluded Croatia, which only joined the euro zone on January 1, 2023). In the analysis of these states, we selected statistical data from the Eurostat database, for the period 2011-2022. The reason why we started our analysis from the year 2011 is not to interfere with the data due to the financial crisis of the year 2007. We consider that the year 2011 marks for most member states the end of the world financial crisis and the start of a period of economic growth. In the selection of the relevant indicators for our analysis, we selected from the scientific literature the 4 indicators most used in the study of real convergence. Thus, in our research, we used the following indicators: GDP per capita, unemployment rate, trade openness and price index. Table 1. Real convergence indicators Indicator Indicator’s description Indicator’s relevance References GDP per capita Current prices, euro per capita. Gross Domestic Product (GDP) per capita shows a country's GDP divided by its total population. Real convergence aims at economic development, the states that want to join to reach the economic level of the Member States. The amplitude of Member States' business cycles is being monitored, as major differences in growth between them can lead to major discrepancies and the imbalance of the Union. Other indicators (excluding nominal convergence indicators) are targeted at real convergence, in particular macroeconomic indicators: price level, GDP per capita, unemployment level, level of imports and exports. Davies (2011); Kaitila (2013). Unemployment rate Percentage of population in the labor force; aged 15 to 74 years (16 to 74 years in Estonia and Italy) unemployed during the reference week, had actively sought work during the past four weeks and were available to begin working immediately or within two weeks. Mundell (1961); Davies (2011); Sensier et al. (2016). Price index Index 2015=100 The Harmonized Index of Consumer Prices (HICP) gives comparable measures of inflation for the countries and country groups. It measures the change over time of the prices of consumer goods and services acquired by households. Mundell (1961); Fleming (1971); Williamson (1974). Trade openness Exports plus imports as percent of GDP Mundell (1961); McKinnon (1963); Kindleberger (1971). Source: Developed by authors based on the research in May 2023 CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY The effects of the COVID-19 pandemic on real convergence of the European Monetary Union 22 We considered it appropriate in the analysis to also use an index of real convergence, starting from the 4 selected indicators. For each variable that is a component of the real convergence index, the yearly EU average is computed. For each country, the difference between the value of a variable and its EU average, for each year, was calculated. These differences were further considered when calculating the aggregated index of the real convergence. To create this index, we started with the methodology proposed by Nardo et al. (2008). The aggregate index of true convergence is a weighted average of the loading scores of the principal components extracted by applying Panel Principal Components analysis. In other words, we calculate the weights for each indicator using the squared loadings in the variance explained by each component. 𝐼𝑖= 1 𝑣∑𝑥𝑖𝑗 𝑣 𝑗=1 𝑤𝑗 𝑤𝑗=∑[ 𝐸𝑥𝑝𝑙𝑎𝑖𝑛𝑒𝑑 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑚(𝑙𝑜𝑎𝑑𝑖𝑛𝑔𝑗,𝑚)2 ∑𝐸𝑥𝑝𝑙𝑎𝑖𝑛𝑒𝑑 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑙 𝑀 𝑙=1 ∑(𝑙𝑜𝑎𝑑𝑖𝑛𝑔𝑛,𝑚)2 𝑣 𝑛=1 ] 𝑀 𝑚=1 Where: M - is the number of selected components and the load j,mis the loading score of variable j for component m and is zero when the variable does not contribute to the formation of the component. The criterion considered for selecting the number of components, M, is that its eigenvalues are greater than 1. After calculating the weights, we obtained the following results, which we use in the calculation of the aggregate index of real convergence for each member state of the European Monetary Union. Table 2. Variables’ weights for the real convergence index Variable Weights GDP per capita 0.4349 Unemployment rate 0.1170 Price index 0.0163 Trade openness 0.4316 Source: Developed by authors based on the research in May 2023 CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY Tudor-Mugurel AURSULESEI 29 For better relevance regarding the evolution of real convergence at the level of the Eurozone, we calculated the standard deviation of the aggregate index of real convergence between states, for each year of the analysed period. The higher the value of the standard deviation, the greater the disparities between the states, so we are moving away from a convergence of the economies of the member states. As we can see from table number 4, the general trend at the level of the euro zone is rather an increase in the disparity between economies. Only the period 2016-2018 and the year 2022 bring an increase in real convergence at the level of the euro zone. We can see that the moment of the pandemic crisis is on a trend of increasing disparity, so the measures adopted by each individual member state have led to an increase in them. There has not been full coordination among members to limit the effects of the pandemic in a way that does not affect the real convergence of national economies. Conclusions Following the analysis undertaken, we reached a series of conclusions, which can create an overview of what the influence of the COVID-19 pandemic meant on the economy of the European Monetary Union. These conclusions can be the basis of future scientific research and at the same time can be a benchmark for political decision-makers both at the central European level and at the national level of the member states or in the process of accession. First of all, we could observe that the COVID-19 pandemic had a multitude of effects on the economy at the level of the European Monetary Union. Starting from the closure of economic sectors to rethinking the way of doing business. The effects were felt by all member states of the euro area. It is true that some felt these effects more strongly, others that had an economy much more anchored in reality faced a smaller shock. Following the analysis of the main representative indicators for real convergence, we could observe that trade openness (where we included both imports and exports as a percentage of GDP) and GDP per capita had the most drastic decreases during the peak period of the pandemic. The effects of the pandemic were also seen in the analysis of the unemployment rate. We could observe how in the year 2020, unemployment had an upward trend. However, we were faced with an interesting situation. The increase in the unemployment rate in 2020 was not of the caliber we expected. On the other hand, we could observe that the price index was not affected by the crisis, registering only a small decrease in the growth trend. Following the creation of the aggregate index of real convergence, starting from the scientific CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY The effects of the COVID-19 pandemic on real convergence of the European Monetary Union 30 literature, we were able to draw several conclusions. First of all, GDP per capita and economic openness have the greatest weight in the composition of the index. Calculating the value of the index in the analysed period for the average of the European Monetary Union, we could see how there is a tendency towards a real convergence of the member states most of the time. However, in 2020, the value of the aggregate real convergence index registered a noticeable decrease. Regarding real convergence, we could observe that at the level of the euro zone, there is a trend of increasing disparity. Even during the pandemic crisis, the implemented measures failed to stop this trend, but rather accentuated it. A final conclusion concerns the measures adopted both at the central level by the European Monetary Union and at the level of each member state. I could see that there was some unity in the implementation of the measures. The European Monetary Union and the European Union tried to create as many levers of support as possible for the European states. We can deduce that the measures helped to keep the unemployment rate under control, but also the short period (of only one year) of the decrease in the value of the real convergence indicators. This scientific article provides new research opportunities for us. We propose to continue the study through an analysis of the economic effects of the COVID-19 crisis of each member state. Moreover, we want to see if we could group the member states into different clusters in terms of the intensity of the effects felt and at the same time if we can identify a series of adopted measures that had a greater influence in the economic recovery. Acknowledgement: This study was supported by the Erasmus+ programme of the European Union under the Jean Monnet Chair, ‘Doing Resilient Business on the European Market’ (DO RE BIZ) [project number ERASMUS-JMO-2022-HEI-TCH-RSCH-101085838]. References Acedo Montoya, L., De Haan, J. (2009), Regional business cycle synchronization in Europe?, International Economics and Economic Policy, 29, no. 4, pp. 2996-3014. Ahmad, T., Haroon, Baig, M., and Hui, J. (2020). Coronavirus Disease 2019 (COVID-19) Pandemic and Economic Impact, Pakistan journal of medical sciences, 36(COVID19-S4), pp. S73–S78. https://doi.org/10.12669/pjms.36.COVID19-S4.2638. CES Working Papers | 2023 - volume XV(1) | wwww.ceswp.uaic.ro | ISSN: 2067 - 7693 | CC BY Tudor-Mugurel AURSULESEI 31 Akbulaev, N. and Mammadov, I. and Aliyev, V. (2020), Economic Impact of COVID-19, SYLWAN, 164(5). http://dx.doi.org/10.2139/ssrn.3649813 Alesina, A., Barro, R. J., and Tenreyro, S. 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