The European Monetary Union (EMU)

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• The European Monetary Union (EMU)

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The road to EMU

• EMU is the latest step on the road towards
  greater integration in Europe.
• Monetary union in the European Community (EC) was
  proposed as long ago as 1970 in the Werner
  Report, which envisaged it being in place by
  1980.

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The road to EMU

• However, two key developments in the
  international sphere derailed this first attempt
• 1. The breakdown of the Bretton Woods system of
  fixed exchange rates in August 1971, and
• 2. The 1973 oil crisis.

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The road to EMU

• The first attempt by the EC to deal with the
  exchange rate turbulence that followed both of
  these events, the so-called snake, rapidly
  collapsed to an arrangement involving only a few
  of the Member States.

Upper limit
Lower limit
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The road to EMU

• The second attempt, the European Monetary System
  (EMS), created in 1979, proved more durable,
  although it too was accompanied by a number of
  major and minor crises.
• Main elements Exchange Rate Mechanism ECU

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"Britain and Europe"

• ..... let me make clear, from the outset, that
  monetary union is fundamentally a political
  rather than an economic issue. It necessarily
  involves the deliberate pooling of national
  sovereignty over important aspects of public
  policy, in the interest not just of collective
  economic advantage, but of a perceived wider
  political harmony within Europe.
• Governor of the Bank of England, 2000

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The road to EMU

• The Treaty did three things to further monetary
  integration in Europe.
• 1. It set out a timetable for the establishment
  of monetary union.
• 2. It laid down the criteria by which the fitness
  of countries to join in monetary union would be
  determined.

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The road to EMU

• 3. It established the institutional framework for
  the conduct of monetary policy under EMU.

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The three stages of monetary union

• Stage One July 1, 1990.
• The complete elimination of capital controls
  among the Member States and increased cooperation
  between their central banks.

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The three stages

• Stage Two January 1, 1994.
• The real beginning of the transition to EMU with
  the establishment of the European Monetary
  Institute (EMI).
• EMI precursor of the European Central Bank,
  charged with co-ordinating monetary policy and
  preparation for the single currency.

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The three stages

• Stage Three January 1, 1999.
• Eleven countries fixed their exchange rates.
• The national currencies of the eleven were
  replaced by the euro.
• The ECB took over responsibility for monetary
  policy in the euro area.

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The three stages

• Stage Three A
• The initial period of monetary union during which
  the notes and coins of each of the participating
  states continue to circulate as non-decimal
  representations of the euro.

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The three stages

• Stage Three B
• Begins with the introduction of euro notes and
  coins and the withdrawal of national currencies
  on January 1, 2002.
• By July 1, 2002 the old national currencies
  ceased to have legal tender status.

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The convergence criteria

• Essentially all of the EU members satisfied the
  bulk of the criteria for participation in EMU.
• However, Denmark and the United Kingdom did not
  participate in the first round, having negotiated
  derogations, even though they satisfied most of
  the criteria.

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The convergence criteria

• Likewise Sweden did not participate.
• The only country that wished to participate but
  failed to meet the convergence tests was Greece
  (joined in 2001)
• New member states need to meet euro acquis and
  Slovenia, Malta, Cyprus and Slovakia have now
  joined the EMU, too.

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Monetary policy under EMU

• EMU fundamentally changes the way in which
  monetary policy is conducted in the participating
  states.
• Responsibility for monetary policy shifted from
  national central banks to the ECB on January 1,
  1999.

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Click on this logo to take you to a brochure
which explains the operations of the ECB.
(C) The ECB
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The Euro and the UK
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The Chancellors 5 Economic Tests

• 1. Are business cycles and economic structures
  compatible so that we and others could live
  comfortably with euro interest rates on a
  permanent basis?
• 2. If problems emerge is there sufficient
  flexibility to deal with them?

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The 5 tests

• 3. Would joining EMU create better conditions for
  firms making long-term decisions to invest in
  Britain?
• 4. What impact would entry into EMU have on the
  competitive position of the UK's financial
  services industry, particularly the City's
  wholesale markets?

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The 5 tests

• 5. In summary, will joining EMU promote higher
  growth, stability and a lasting increase in jobs?

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Employment and growth

• The fundamental test is how Britain's membership
  of a successful single currency would affect
  prospects for British employment.
• The assessment concludes that membership of EMU
  has the potential to enhance both growth and
  employment prospects.

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Business and the Euro
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Euro Impact

• The euro means big changes for business both
  within these countries and throughout Europe
• Cheaper transaction costs countries in the euro
  zone do not have to change currencies when doing
  business with each other.

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Impact

• Exchange rate certainty sharing a single
  currency means countries in the euro zone are no
  longer affected by currency fluctuations when
  trading with each other.

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Impact

• Transparent price differences it is more
  obvious if different euro zone countries charge
  different prices for the same goods and services.

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Strategic issues

• Increased cross-border competition
• Businesses who want to export into the euro zone
  may be at a disadvantage against competitors
  within the zone who share the same currency as
  the importer.

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Strategic issues

• Cross-border mergers and other joint ventures
• Increased competition might make mergers within
  the euro zone more likely, and
• sharing the single currency may also make them
  easier.

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Strategic issues

• Distribution and purchasing
• May become simpler and cheaper inside the euro
  zone, because businesses there will not have to
  worry about exchange rate risk when trading with
  each other.

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Strategic issues

• Raising finance
• Firms may have more choice since bond and equity
  markets may be more attractive in euros.

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Strategic issues

• Pricing
• Companies may have to decide whether to set new
  pricing points.
• The same price is unlikely to be as attractive
  in euros as in the old national currencies

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Pricing points

• 499DM 255.30
• Lower price - 249.99?
• Higher price - 259.99?
• FrF999 152.30

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Practical issues

• Firms based in, or who deal with the eurozone
  need to make practical changes.

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Readings

• The UK and the Euro
• EMU INFORMATION HM Treasury
• Euro case study Siemens