Single Currency

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Single Currency
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Topics

• What is international money?
• European Monetary System (EMS)
• The Economics of Currency in the 1980s and
  1990s
• EMU
• Treaty of Maastricht
• The Process

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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

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What is International Money? (contd)

• 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

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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

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European Monetary System (contd-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

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European Monetary System (contd-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

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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)

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The Economics of Currency (contd-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

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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

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EMU (contd-1)

• European Central Bank
• Core of European System of Central Banks, which
  includes ECB and national banks
• EMU as economic centerpiece of Maastricht Treaty

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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

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TEU (contd-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

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

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The French Debate (contd-1)

• Arguments against (contd)
• 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

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The French Debate (contd-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)

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The French Debate (contd-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.

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The French Debate (contd-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.

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The French Debate (contd-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
  lEurope en general et de la France en
  particulier, 1992, p. 67

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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)

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Process (contd -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

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Process (contd-2)

• Convergence criteria (contd)
• 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

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Process (contd-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