Transcript The European Monetary Union (EMU) The road to EMU • EMU is the latest step on the road towards greater integration in Europe. •

The European Monetary
Union (EMU)
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.
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.
The road to EMU
• The first attempt by the EC to deal with
the exchange rate turbulence that
followed both of these events, the socalled “snake,” rapidly collapsed to an
arrangement involving only a few of the
Member States.
Upper limit
Lower limit
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
"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
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.
The road to EMU
3. It established the institutional framework for
the conduct of monetary policy under EMU.
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.
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 coordinating monetary policy and
preparation for the single currency.
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.
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.
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.
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.
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.
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.
Click on this logo to take
you to a brochure which
explains the operations
of the ECB.
(C) The ECB
The Euro and the UK
The Chancellor’s 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?
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?
The 5 tests
• 5. In summary, will joining EMU promote
higher growth, stability and a lasting increase
in jobs?
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.
Business and the Euro
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.
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.
Impact
• Transparent price differences – it is more
obvious if different euro zone countries
charge different prices for the same goods
and services.
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.
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.
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.
Strategic issues
Raising finance:
• Firms may have more choice since bond and
equity markets may be more attractive in
euros.
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
Pricing points
• 499DM = €255.30
• Lower price - €249.99?
• Higher price - €259.99?
• FrF999 = €152.30
Practical issues
• Firms based in, or who deal with the eurozone
need to make practical changes.
Readings
• The UK and the Euro
• EMU INFORMATION HM Treasury
• Euro case study: Siemens