EMU Economic and Monetary Union

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EMU(Economic and Monetary Union)
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Optimal Currency Areas

• Flexible exchange rate often useful for
  states/economies
• Joining EMU implies lossesgains OCA
• Factors determining whether Eurozone is an OCA
• Inflation rates
• Monetary policies
• Exchange rates
• Trade intensities
• Labour market conditions
• Institutional convergence

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Eurozone 2001
Members of the Eurozone, 2001. UK, Denmark and
Sweden outside the zone
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Eurozone 2009

• 16 members
• 8 obliged to join (ERM II)
• UK Sweden still out
• Denmark to hold referendum in 2010?

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What makes a state sovereign?

• Formally, recognition by other states
• Three elements doctrine (G. Jellinek)
• Territory (Borders)
• People
• Legitimate use of force
• Normally Flag, anthem, army, money

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History of Monetary Unions

• Ancient EMUs
• Roman Empire 3rd c. BC 5th c. AD
• Charlemagne Monetary System From 8th c.
• EMU with political union  
• British monetary union England Scotland From
  1707
• US Federal Reserve system From 1913
• Italian monetary union 1861-2002
• German unification 1990-2002
• EMU without political union
• Belgium-Luxembourg union 1923-2002
• West African CFA franc zone From 1948

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History of Monetary Unions II

• Failed when political system collapsed
• German monetary union 1857-WW1
• The Soviet system 1917-1993
• Temporary monetary unions
• Latin MU (B, I, F, CH, Gr) 1865-WW1
• Scandinavian currency union 1873-1920
• Other currency events
• Bretton Woods 1944-1973
• ERM From 1979
• Asian currency crisis 1997

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Bretton Woods

• Dollar backed by gold standard (35/ounce
• Fixed exchange rates (re-alignment possible but
  complicated)
• IMF could intervene to re-balance system
• US monetary policies affected whole world
• Inflation following Vietnam, gold production
• Dollar made inconvertible to gold in 1971
• 1973 the end

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The beginning of European Monetary Policy

• EMU and the foundation of EC
• RIP Bretton Woods fixed rates within EC (CAP)
• Divisions between the six on approach to Monetary
  Union
• Two main strategies
• Locomotive Monetarists (Chicago School),
  supported by Commission EMU leads to economic
  convergence
• Coronation Economists, e.g. Germany economic
  convergence necessary prior to EMU

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EMU First attempts

• Werner plan (1970) proposes EMU in three steps
• snake-in-the-tunnel established (1971),
  collapse of snake (1971), reconstituted (1972)
• Roy Jenkins call for new attempt at EMU (1977)
• taken up by Helmut Schmidt concerned about
  strong Deutschmark
• Giscard in line with Schmidt
• other states support as a means of combating
  inflation
• EMS (ERM) established in 1979

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EMS

• ECU (weighted) basket of currencies
• European Credit Facilities
• European Monetary Co-operation Fund
• Exchange Rate Mechanism (ERM)
• Grid
• Bilateral parities /- 2.5 per cent (6 for Italy)
• Central Bank intervention co-ordination

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EMS in the 1980s

• survived initially because Deutschmark weak
• currency realignments in 1981, 82, 83
• policy changes pressed on French Socialist
  government by Germans
• Britain remained outside of the ERM (until 1990)
• other states supportive of greater cohesion
  within EC, especially following collapse of
  communism

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EMS and Germany

• EMS de facto dominated by Bundesbank/Deutschmark
• Germany biggest and strongest economy in EC
• Deutschmark 2nd reserve currency ( 60 per cent,
  DM 16 per cent, Pound 2 per cent, Franc 2 per
  cent in 1995)
• Bundesbank obsessed with price stability
• EMU already existent but on German terms!

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Delors Report 1989

• Stage I free capital movement and macroeconomic
  co-ordination from July 1990 on
• Stage II Reform of the treaties, establishment
  of European system of central banks, restrict
  fluctuations in exchange rates (ERM)
• Stage III Irrevocable fixing of exchange
  rates, establishment of European Central Bank,
  independent and responsible for price stability

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Monetary Union in the 1990s

• Maastricht timetable set for completion in
  1997/99
• Britain allowed to opt-out
• 1992 Denmark also given an opt-out
• 1992 Britain and Italy forced out of ERM,
  currency crisis in 1993
• widening of narrow bands to 15 

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Monetary Union in the 1990s

• German public scepticism strengthened negotiating
  hand of German government
• Franco-German tensions over conditions for
  sustaining monetary union
• ECU renamed 1995 EURO
• Amsterdam 1997
• Stability and Growth Pact (Germany)
• Agreement by QMV on fines (France)
• 1998 Duisenberg/Trichet ECB at Frankfurt

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Convergence criteria

• Inflation not more than 1.5 percentage points
  above average of lowest three
• Deficit
• Central Government budget deficit no more than 3
  of GDP
• General government debt not more than 60 of GDP
• Currency stability membership in narrow ERM band
  for two years with no devaluations
• Long term Interest rates not more than 2
  percentage points above rates of lowest three

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Convergence criteria problems

• Huge debts in Belgium and Italy
• Germany problems with 3.0 deficit threshold
• Manipulated budgets new taxes (I), sell of state
  properties and industries (France, Portugal), new
  estimation of gold reserves (Germany), false
  information (Greece 2004)
• Only 3 of 12 met all the Copenhagen Criteria (UK
  would have been fourth w/o ERM)
• Ergo a political not an economic decision

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Qualifications for Economic and Monetary Union
(in 1997 figures)
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Long-term interest rates
7.8
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Realisation of EMU

• European Central Bank in Frankfurt
• January 1999 launch of Euro with 11 member
  states participating
• Sweden, Denmark and Britain eligible but outside
• 2001 Greece 12th Euro group member
• January 2002 coins and notes introduced to the
  EURO-zone

Rejected euro in 2000 referendum polls show
support but no new referendum yet
5 tests show UK not ready future referendum in
doubt
Referendum in September 2003 Nos won
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Some Euro Coins
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European Central Bank

• Independence
• Function
• price stability (primary objective)
• mechanism interest rates
• No power to give credits to the public sector to
  finance deficits
• Discussion about presidency (Greenspan
  PSYCHOLOGY) Duisenberg resigned after 5 years,
  now Trichet

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Stability and Growth pact

• Violated by Germany and France from 2003-2005
  (deficit criterion)
• Commission urged EcoFin to censure GF in 2003,
  but EcoFin rejected
• Stability and growth pact watered down
• Formally re-negotiated in 2005
• Operate close to reference values
• peculiar circumstances

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EMU evaluated (1)

• Economic implications
• Spill-over (taxes)
• Reduction of exchange trade costs 30 billion
  (0.5 of present EU-GDP)
• Increased competition
• Even more trade within Eurozone
• Price transparency
• Consumer prices down 50 (1993-99)
• EURO replaced Dollar as second currency in many
  regions
• EU-Dollar parity EURO too strong?

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vs. , Pound Yen
Yesterday 1.29, 0.9 , 116 Yen
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EMU evaluated (2)

• EUROZONE is far apart from being an optimum
  currency area (Robert Mundell 1961)
• 1. labour mobility NOT
• 2. flexible prices and wages NOT
• 3. mechanism for fiscal redistribution (regional)
  NOT
• 4. political will YES

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EMU evaluated (3)

• Political implications
• Different effects of Europeanisation in member
  states
• Spill-over EU towards Common Economic Policy
• Relationship EU/USA
• Flexibility/closer co-operation
• Germany and France under pressure from Growth and
  Stability Pact
• ECB/EcoFin relations somewhat tense

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Conclusion

• Best economic reason for EMU transaction costs
• Alternative explanations
• High degree of linkage between core economies
  (Germany, France, BeNeLux)
• Deal between France Germany (Euro-11, political
  role of EcoFin, domestic and international
  concerns in Germany)
• Commission Central Bankers
• Dominance of monetarist ideas (vs. Keynesian)
  ideas

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Class Questions

• What lessons can be drawn from the experiences of
  the single currency so far?
• Have there been significant changes in the EU
  since the introduction of the EURO?
• What can be said about the future prospect of
  joining the common currency by Denmark, Sweden
  and the UK?