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Single Currency Topics What is “international money”? European Monetary System (EMS) The Economics of Currency in the 1980’s and 1990’s EMU Treaty of Maastricht The Process 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 What is International Money? (cont’d) The effects of changing exchange rates – – “Correct” policy measures affecting exchange rates – – The relative value of your currency rises (appreciation) The relative value of your currency falls (depreciation) Rate of interest Level of prices “Incorrect” policy measures affecting ex. Rates – Exchange controls 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 European Monetary System (cont’d-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 European Monetary System (cont’d-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 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) The Economics of Currency (cont’d-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 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” EMU (cont’d-1) European Central Bank – Core of European System of Central Banks, which includes ECB and national banks EMU as economic centerpiece of Maastricht Treaty 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” TEU (cont’d-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 The French Vote (Sept. 20, 1992) Poll of 1,531 Persons Source: Le Point Oui Political Party Non 24% PC (Communist) 76% 82% PS (Socialist) 18% 68% Generation Ecologie 32% 50% Verts (Greens) 50% 64% UDF (Liberal Right) 36% 42% RPR (Gaullist Right) 58% 13% FN (Extreme Right) 87% The French Debate Arguments against Maastricht – Relinquish control to Euro-technocrats and to an authority independent of political control – Lose control of financial and budget policy – Prime example cited: single currency and ECB Single currency imposes severe restrictions on the economy and on economic policy Relinquish national sovereignty and the democracy that historically went with sovereignty The French Debate (cont’d-1) Arguments against (cont’d) – – – 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 The French Debate (cont’d-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) The French Debate (cont’d-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.” The French Debate (cont’d-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. The French Debate (cont’d-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 l’Europe en general et de la France en particulier, 1992, p. 67] 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) Process (cont’d -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 Process (cont’d-2) Convergence criteria (cont’d) – – – – 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 Process (cont’d-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