Single Currency

Topics

What is “international money”? European Monetary System (EMS) The Economics of Currency in the 1980’s

and 1990’s EMU Treaty of Maastricht The Process

What is International Money?

The idea of exchange rates on either side of Bretton Woods– Bretton Woods (up to 1973): fixed but adjustable

exchange rates – a high degree of stability of currency values

– After Bretton Woods (post-1973): freely fluctuating exchange rates – instability of currency values

The factors affecting exchange rates

What is International Money? (cont’d)

The effects of changing exchange rates– The relative value of your currency rises (appreciation)– The relative value of your currency falls (depreciation)

“Correct” policy measures affecting exchange rates– Rate of interest– Level of prices

“Incorrect” policy measures affecting ex. Rates– Exchange controls

European Monetary System (EMS)

The “Debate” since the late 1960s– The ‘economists’: Germany, Netherlands– The ‘monetarists’: France, Belgium, Luxembourg

The Werner Report 1970 The “snake in the tunnel” of 1972 on

– The “tunnel” is the US dollar– 2.25 per cent bands of fluctuation of intra-EEC exchange

rates, in terms of parity against $– An effective DM zone after 1974

European Monetary System (cont’d-1)

Establishment of EMS and ERM (1979)– “a system of fixed and periodically adjustable exchange

rates between EC currencies, operating within relatively narrow margins of fluctuation.” (Tsoukalis, The New European Economy Revisited p. 143)

– The ECU– “Central rate” and bilateral exchange rates

Allowable margins of fluctuation of 2.25 per cent around bilateral rates, except 6 per cent for Italian lira. Spanish peseta and Portuguese escudo

European Monetary System (cont’d-2)

– Divergence indicator– Britain within EMS, but not ERM

Implications of EMS– Instrument for fight against inflation– German policy sets the standard (strong currency,

anti-inflationary)– Zone of monetary stability

The Economics of Currency

In the1980s– Policy convergence– Control of inflation

Downward convergence of inflation rates

– Intra-ERM exchange rate stability In the 1990s

– 1992 crisis Progressive currency realignments begin Withdrawals from ERM (Britain, Italy)

The Economics of Currency (cont’d-1)

Currency instability and divergent policies Deflationary bias of system The central role of Germany (Bundesbank policy, the

DM)– Preference for high interest rates, even in recession– DM as the “defining” currency of the system

Necessity for a new flexibility– Wider margins of fluctuation

EMU

Origins– Committee for the Study of Economic and

Monetary Union (1988): Delors Report (1989) Central bank governors, member of Commission,

independent experts

Three stages– 1 July 1990: liberalization of capital movements– 1 January 1994: Initiate economic convergence– 1 January 1999: Decision on “in” and “out”

EMU (cont’d-1)

European Central Bank– Core of European System of Central Banks,

which includes ECB and national banks

EMU as economic centerpiece of Maastricht Treaty

Treaty of Maastricht (TEU)

Single currency as centerpiece of a broader debate about European Union

Debate crystallizes around two developments– Referendums in Denmark and in France, 1992– Profound “disconnect” between political leaders

and elites, and their people

Results are deeply troubling for “Europe”

TEU (cont’d-1)

– The Danish “no” (50.7%) June 2 Becomes a “yes” only after opt-out clause (May 1993)

– The French razor-thin “oui” (51%) Sept. 20 Intense public debate precedes the referendum The vote defies the logic of the political parties

The French Vote (Sept. 20, 1992)Poll of 1,531 PersonsSource: Le Point

Oui Political Party Non

24% PC (Communist) 76%

82% PS (Socialist) 18%

68% Generation Ecologie 32%

50% Verts (Greens) 50%

64% UDF (Liberal Right) 36%

42% RPR (Gaullist Right) 58%

13% FN (Extreme Right) 87%

The French Debate

Arguments against Maastricht– Relinquish control to Euro-technocrats and to an

authority independent of political control Prime example cited: single currency and ECB

– Lose control of financial and budget policy Single currency imposes severe restrictions on the

economy and on economic policy

– Relinquish national sovereignty and the democracy that historically went with sovereignty

The French Debate (cont’d-1)

Arguments against (cont’d)– Economics dictates politics, whereas it should be

the opposite– The feeling of “being French” trumps “being

European”– Maastricht is a “sharp turn” (in another direction)

Arguments in favor of Maastricht– Maastricht is the culmination of a long process

that began with the end of World War II

The French Debate (cont’d-2)

Arguments in favor– Single currency is necessary for the functioning of

single market– Single currency can achieve a par with $ and yen;

without it, there is the danger of “feodalite” to Japanese “invasion,” perhaps even American

– Look to the future, not to the past– Multiple gains of efficiency, notably lower

transactions costs (business argument in favor)

The French Debate (cont’d-3)

Argument in favor:“People worry today that the economic and

financial union might lead to the loss of French sovereignty and independence. In fact, at a time when capital moves about in mere seconds, thanks to the computer, from one financial location to another, one notices that speculative movements are completely ignorant of borders.”

The French Debate (cont’d-4)

Argument against:

“The [European] bureaucracy secretes rules, by a law of nature, just as the horse produces dung; increased rule-making generates an extension of its personnel, who for their own part … And thus on and on. As long as those administered do not rise up, this process goes on endlessly.

The French Debate (cont’d-5)

“Even our chocolates … are the target of a directive some 70 pages in length and our national identity is strongly threatened, at the present time, on the matter of cheese.”

[Marie-France Garaud and Philippe Seguin, De l’Europe en general et de la France en particulier, 1992, p. 67]

Process

First Stage: Full freedom of capital movements (achieved by end of 1993)

Second Stage: European Monetary Institute created (precursor to ECB), to strengthen cooperation between national central banks. Prospective members get their economies “in order” – especially by reducing excessive budget deficits (1994-1999)

Process (cont’d -1)

Third Stage: Irrevocable fixed exchange rates between participating currencies. ECB begins operation. European Council decides which countries meet criteria of convergence (1999-2002). “Euro” becomes legal currency.

The five “Convergence Criteria”:– Inflation rate: not higher than 1.5 % above

average of 3 countries with lowest inflation rates

Process (cont’d-2)

Convergence criteria (cont’d)– Budget deficits: not in excess of 3% of GDP– Government debt: not in excess of 60% of GDP– Long-term interest rate: not more than 2% above

rates of 3 countries with lowest inflation rates– No currency devaluation within 2 years preceding

entrance into the union

Process (cont’d-3)

The core criteria– Inflation rates: converge at low end

Low: northern European countries Average: France, UK, Ireland Above average: Mediterranean region

– Government deficit and debt: the signal of intent Stability pact “enshrined” at Amsterdam 1997 Censure (by finance minister colleagues) and heavy

fines for violating 3% rule except for natural disaster German insistence to enforce fiscal discipline