Economic and Monetary Union

1
Economic and Monetary Union

• History, Institutions, and Processes

2
Four Levels of Economic Integration

• Preferential trade arrangements
• A free trade area (FTA)..
• Harmonization of external tariffs (to third party
  countries).
• A common market amongst member states which
  combines market integration with absolute factor
  mobility (capital and labor mobility).

3
History of economic integration

• Monetary integration implicitly endorsed by the
  Treaty of Rome
• Werner Plan (1970) came into effect in 1972
• snake fixing exchange rates between the ten
  participants within bands of - 2.25. The
  tunnel involved fixing the parity of the snake
  currencies against the dollar and other world
  currencies.

4
History of economic integration

• EMS comes into existence in 1979. Two features
• European Currency Unit (ECU, based on a weighted
  basket of all the currencies involved).
• Exchange Rate Mechanism (ERM). Fix exchange rates
  between participating countries and between these
  currencies and the ECU, originally within a band
  of - 2.25, and - 6 for weaker currencies such
  as the lira or the sterling. Following the
  sterling crisis of 1992, the bands became - 15.

5
History of economic integration

• The single market program which took off with the
  Single European Act (1987), greatly advanced the
  goal of EMU. Exchange rate fluctuation seemed
  inconsistent with the objectives of the single
  market.
• By the end of the 1980s market integration as a
  rationale for EMU was almost unquestioned.
• Commission communication (1990) a single
  currency is the natural complement of a single
  market, and the Commissions cost-benefit
  analysis of the EMU appeared two months later,
  titled One Market, One Money

6
History of economic integration

• Costs and Benefits of EMU
• --Costs
• Loss of national sovereignty (including much
  national symbolism).
• May promote further political integration/economic
  integration. Constitutes still a further loss of
  national sovereignty and stronger supranational
  institutions.
• Loss of control over monetary policy means (high
  inflation or unemployment).

7
History of economic integration

• --Benefits
• Lower transaction costs between member states.
  (EC-wide savings of 0.3 to 0.4 of the GDP).
• A more efficient market. Reduces the possibility
  for price inequalities of same goods, minimizes
  need for monitoring of price inequalities.
  Promotes market integration.
• Greater economic certainty. Prices and revenues
  are more stable and this improves the quality of
  production, investment and consumption decisions.
• Lower interest rates. Exchange rate stability is
  assured and this leads to lower interest rates
  overall (because no need for risk premiums).

8
History of economic integration

• The Delors Report (April 1989) three stages for
  the development of EMU
• Stage One Increased co-operation between central
  banks with relation to monetary policy, removal
  of obstacles to financial integration, monitoring
  of national economic policies, co-ordination of
  budgetary policy 
• Stage Two Preparatory stage for the final phase
  of EMU, establishment of the ESCB and progressive
  transfer of monetary policy to European
  institutions, narrowing of margins of fluctuation
  within exchange rate mechanism 
• Stage Three Fixing of exchange rates between
  national currencies and their replacement by a
  single European currency, responsibility for
  monetary policy would be transferred to the ESCB.

9
The Maastricht Treaty (1992)

• Three Stages to EMU
• Stage 1 was to consist of the completion of the
  single market, increased coordination and
  cooperation in the economic and monetary fields,
  a strengthening of the EMS, an extended role for
  the ECU, and an enhanced role for the Committee
  of Governors of the EU members central banks.
• It was during this first stage that the
  Maastricht Treaty was signed and the criteria
  for entry into stage 3 were set.

10
The Maastricht Treaty (1992)

• ---The 1992 Crisis
• Throughout 1992 the mark soared as high German
  interest rates attracted funds from the US, and
  other currencies fell to the floor of the ERM
  bands.
• Partly caused by the Danish rejection of the
  Maastricht treaty in late 1992, and speculation
  on French rejection.
• Finnish markka collapsed and Swedish krone
  followed, with huge pressure building up for
  Italian, British, and French currencies.
• On September 16 (Black Wednesday) having spent
  billions of pounds, the UK pulled the pound out
  of the ERM and Italy followed suit. Spain
  devalued the peseta by 5, and French opinion
  polls showing a possible rejection of the TEU
  increased attacks against the franc.

11
The Maastricht Treaty (1992)

• Stage 2 involved the preparations for the single
  currency all members were to be included in the
  narrow band of the ERM (- 2.25), and the
  European Monetary Institute was to be set up to
  promote the coordination necessary for EMU.
• Stage 3 consisted of complete monetary union,
  with the introduction of what is now called the
  euro. A specific agenda was created for this with
  deadlines and convergence criteria to be met.

12
The Maastricht Treaty (1992)

• December 1996, and if the Council of finance
  Ministers (ECOFIN) decided (QMV) critical mass
  of seven states (six with the UK opt-out), had
  met the convergence criteria, then a date would
  be set for introducing the euro in qualified
  states.
• --The Madrid Scenario, 16 December 1995
• Name the single currency the euro and set a date
  of 1st January 1999 for the final stage of EMU.
• Decision on which Member States would participate
  in the euro as early as possible in 1998, based
  on economic data for 1997
• Early creation of ECB and appointment of
  executive board to enable operational status on 1
  January 1999.
• Three year transition period between creation of
  the euro and introduction of notes and coins

13
The Maastricht Treaty (1992)

• The Convergence Criteria
• Price Stability An average inflation rate not
  exceeding by more than 1.5 that of the three
  best-performing Member States (Britain, Denmark,
  and Ireland in 1993).
• Budgetary Discipline A budget deficit of less
  than 3 of GDP and a public debt ratio not
  exceeding 60 of GDP.
• Currency Stability Respect for normal
  fluctuation margins of the ERM without severe
  tensions for at least two years with no
  devaluations.
• Interest Rate Convergence An average nominal
  long-term interest rate not exceeding by more
  than 2 that of the three best performing Member
  States.

14
The Maastricht Treaty (1992)
15
The Institutions of EMU

• The European Monetary Institute (EMI)
  Predecessor to the European Central Bank.
• Established by the TEU to assist member states in
  moving from stage 2 to stage three. Formally
  started on January 1 1994 at the beginning of
  stage 2 in Frankfurt.
• Specify, by the end of 1996, the regulatory,
  organizational, and logistical framework for the
  European system of Central Banks (ESCB), which
  would come into existence o the eve of stage III.
  It consisted of national bank governors.

16
The Institutions of EMU

• The European Central Bank (ECB) and European
  System of Central Banks (ESCB)
• The ECSB, consisting of the ECB and national
  central banks, would replace the EMI at the eve
  of Stage III, and formulate the participating
  states single monetary policy.
• The ESCBs governing body consisted of the ECBs
  executive board (selected by the European
  Council), and governorns of the national central
  banks.

17
The Institutions of EMU

• The Council of Economic and Finance Ministers
  (EcoFin)
• Ecofin had an obvious vested interest in bringing
  about stage 3, as it would gain greater political
  importance in the post-EMU era.
• Consists of all of the Economic and Finance
  ministers of the EU Member States (regardless of
  membership in the Euro-zone).
• The Euro-X committee refers to the meeting of
  the Ministers of the Economy and Finance of the
  Euro-Zone countries only.

18
Ins and Outs

• Ins
• Neither France, nor Germany looked likely in
  early 1997 to come under the 3 ceiling. If one
  or both of them proved unable to participate in
  the EMU the entire project would collapse.
• On January 1, 1999 11 Member States successfully
  joined the Euro-zone
• France, Italy, Germany, Belgium, The Netherlands,
  Luxembourg, Ireland, Portugal, Spain, Austria and
  Finland.

19
Ins and Outs

• Outs
• Denmark and Great Britain decided to make use of
  their opt-outs.
• Sweden fell short of the convergence criteria but
  only because there has been no real attempt on
  the part of the Swedish government to meet them.
• Greece tried to join but fell short of the
  convergence criteria. Admitted officially as of
  January 1, 2001. Was in the euro-zone in time,
  for the January 1st 2002 launch of the euro as a
  real currency.
• Slovenia (2007), Cyprus and Malta (2008),
  Slovakia (2009).