Transcript The Euro By Rami Elkhoury - UNT College of Arts and Sciences

The Euro
By Rami Elkhoury
How the European Single Currency Evolved
• The Bretton Woods system (which fell apart in 1973) fixed every
member country’s exchange rate against the U.S dollar and as a
result fixed the exchange rate between every pair of nondollar
currency.
• EU countries tried progressively to narrow the extent to which they
let their currencies fluctuate against each other.
• These efforts lead to the birth of the euro on January 1, 1999
• Bretton woods system
– first example of a fully negotiated monetary order intended to govern
monetary relations among independent nation-states. 730 delegates from
all 44 Allied Nations gathered in Bretton woods, New Hampshire and
deliberated upon and signed the Bretton Woods Agreements during the
first three weeks of July 1944.
Why The Euro?
EU members adopted the euro for 4 main reasons:
1.
Unified market: the belief that greater market integration and
economic growth would occur.
2.
Political stability: the belief that a common currency would make
political interests more uniform.
3.
The belief that German influence under the EMS would be
moderated under a European System of Central Banks.
4.
Eliminate the possibility of devaluations/revaluations: with free
flows of financial assets, capital flight and speculation could occur in
an EMS with separate currencies, but would be more difficult with a
single currency.
What is EMS?
• The European Monetary System was originally a
system of fixed exchange rates implemented in 1979
through an exchange rate mechanism (EMR).
• The EMS has since developed into an economic and
monetary union (EMU), a more extensive system of
coordinated economic and monetary policies.
What Has Driven European Monetary
Cooperation?
• Countries that established the EU and EMS had
several goals.
1. To enhance Europe’s power in international affairs:
able to represent more economic and political
power in the world.
2. To make Europe a unified market: Believed with
free trade, free flows of financial assets and fixed
exchange rates, will increase economic growth and
economic well being.
3. To make Europe politically stable and peaceful.
The EMS from 1979–1998
• From 1979–1993, the EMS defined the exchange
rate mechanism to allow most currencies to fluctuate +/2.25% around target exchange rates.
• The exchange rate mechanism allowed larger fluctuations (+/6%) for currencies of Portugal, Spain, Britain (until 1992) and
Italy (until 1990).
– These countries wanted greater flexibility with monetary policy.
– The wider bands were also intended to prevent speculation caused by
differing monetary and fiscal policies.
The EMS from 1979–1998 cont.
To prevent speculation,
• early in the EMS some exchange controls were also enforced
to limit trading of currencies.
– But from 1987–1990 these controls were lifted in order to make the
EU a common market for financial assets.
• a credit system was also developed among EMS members to
lend to countries that needed assets and currencies that were
in high demand in the foreign exchange markets.
The EMS from 1979–1998 cont.
• But because of differences in monetary and fiscal policies
across the EMS, markets participants began buying German
assets (because of high German interest rates) and selling
other EMS assets.
• As a result, Britain left the EMS in 1992 and allowed the
pound to float against other European currencies.
• As a result, exchange rate mechanism was redefined in 1993
to allow for bands of +/-15% of the target value in order
devalue many currencies relative to
the deutschemark.
The EMS from 1979–1998 cont.
• But eventually, each EMS member adopted
similarly restrained fiscal and monetary policies,
and the inflation rates in the EMS eventually
converged (and speculation slowed or stopped)
Inflation Convergence for Six Original EMS
Members, 1978–2006
Source: CPI inflation rates from International Monetary Fund, International Financial Statistics.
20-10
European Economic Monetary Union
• In 1989, a committee headed by Jacques
Delors, president of the European Commission
had a goal, (EMU), economic and monetary
union, which would replace national
currencies by a single EU currency managed
by a sole central bank operating on behalf of
all EU members.
The Maastricht Convergence Criteria
and the Stability and Growth Pact
• The Maastricht Treaty specifies that EU member
countries must satisfy several macroeconomic
convergence before they can be admitted to EMU
1.
2.
3.
4.
The country’s inflation rate in the year before must be no
more than 1.5 percent above the average rate of the 3 EU
member states with lowest inflation.
Must have maintained a stable exchange rate within the
ERM without devaluating on its own initiative
Must have a public-sector deficit no higher than 3 percent
of its GDP
Must have a public debt that is below or approaching a
reference level of 60 percent of its GDP
The Maastricht Convergence Criteria
and the Stability and Growth Pact cont.
• Stability and Growth Pact (SGP)
– Negotiated by European leaders in 1977.
– Sets out “the medium-term budgetary objective
of positions close to balance or in surplus
– Sets out a timetable for the imposition of financial
penalties on countries that fail to correct
situations of excessive deficit and debt promptly
enough
The Maastricht Convergence Criteria
and the Stability and Growth Pact cont.
• Before signing the Maastricht Treaty, low inflation
countries such as Germany wanted assurance that their
EMU partners had learned to prefer an environment of
low inflation and fiscal restraints.
• They feared that the EURO might be a weak currency,
falling prey to the types of policies that fueled other
countries inflation at various points in time.
• By May 1998, 11 EU countries had satisfied the
convergence criteria and would be founders of the
EMU: Australia, Belgiun, Finland, France, Germany,
Ireland, Italy, Luxenbourg, Netherlands, Portugal, and
Spain.
The European System of Central Banks
• Conducts monetary policy for the European
Central Bank in Frankfurt plus the 15 national
central banks.
• Decisions of the ESCB are made by votes from
the president of the ECB and the heads of the
national central banks.
The European System of Central Banks cont.
• The authors of the Maastricht treaty hoped to
create an independent central bank free of
the political influences that might lead to
inflation.
• The ESCB is required to brief the European
Parliament regularly on its activities, but the
European Parliament has no power to alter
the ESCB’s statute.
The Revised Exchange Rate Mechanism
• For EU countries that are not yet members of
EMU, a revised exchange rate mechanism defines
broad exchange rate zones againts the euro and
specifies reciprocal intervention arrangements to
support these target zones.
• It was viewed as necessary to discourage
competitive devaluations against the euro by EU
members outside the euro zone and to give
would-be EMU entrants a way of satisfying the
Maastricht Treaty’s Exchange rate stability
convergence criterion.