European Monetary Integration I.

Dana Viktorová

© Viktorová, 2004 2

History of European Monetary Integration

Bretton Woods System (1944 – 1971) central parities against USD, GBP, gold pegged exchange rates (± 1,0 %). independent monetary policy

Triffin’s motion of the European Reserve Fund (1959)

1st step towards single monetary policy

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History of European Monetary Integration

European Commission’s Action Program (1962) suggestions for monetary integration pegged exchange rates European reserve currency adoption

Committee of Central Banks Governors (1964)

support the adoption of pegged exchange rates

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Werner’s Report (1970-1974)

defining the attributes of the economic and monetary union irrevocable convertibility of central parities (pegged exchange

rates) centralized system of monetary authorities macroeconomic policy cooperation as precondition for

successful economic integration steps to take - free movement of goods, services, capital and

labour sequencing in monetary union creation, time horizon – 1980

1st stage (1971-1973) – stabilization of margins of

exchange rates not supported by France

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European Exchange Rate Arrangement

Snake in Tunnel (1972 - 1973) fluctuation band around USD (± 1,125 %) compared with

(± 2,25 %) of the IMF members worm in snake in tunnel – B + NL (± 0,5 %) speculative pressures, oil shock, economic divergence challenges for the philosophy of monetary integration

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six OCA criteria

1. labour mobility (Mundell)

2. production diversification (Kenen)

3. openness (McKinnon)

4. fiscal transfers

5. homogenous preferences

6. commonality of destiny OCA index

Optimum Currency Areas

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Optimum Currency Areas

EC/EU as an OCA ? NOT, only USA EU countries have different structures,

different goals

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European Monetary System (1979 - 1999)

solution to the end of Bretton Woods System to eliminate competitive devaluations different inflation rates giving up a monetary autonomy, but possible to leave

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EMS - Three Key Elements

Exchange Rate Mechanism mutual unlimited support – FX market

interventions very short (45D), short (3M) and mid-

term (2-5Y) loans European Monetary and Cooperation

Fund (1973) stable but adjustable ER some limitations divergence indicator

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EMS - Three Key Elements

parity grid – bilateral central parities to the

ECU narrow fluctuation band (± 2,25 % or

± 6,0 %) unanimous agreement on realignments

ECU as reserve currency, unit of account weighted average of the EMS

currencies

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European Monetary System

frequent realignments, speculative attacks on weak

currencies, high inflation countries Bundesbank hegemony, shadowing adverse circumstances in 1990

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European Monetary System

financial crisis in 1993 first sign of impossible trinity pegged ER full capital mobility MP pursuing domestic aims pegged ER ? MP autonomy

surrender

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European Single Market European Single Act (1986) capital/financial liberalization and integration elimination of the FX restrictions globalisation European single market is not viable with floating ER (floating

ER are perturbative)

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Delors’ Report (1989)

steps to be take towards monetary union features:

full capital mobility liberalization financial markets integration irrevocable fixing of central parities elimination of fluctuation band

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Three Stages Towards EMU

stage one ERM participation capital mobility liberalization

stage two establishment of ESCB

stage three irrevocable fixing of central parities shift of monetary competencies to

central European institution

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Maastricht Treaty - The Treaty on European Union

Treaty establishing the European Community

(amended) agreed in 1991, signed in 1992 important step in the European integration process creation of the European Monetary Union (EMU) based on Delors’ Report

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Maastricht Treaty

commitment to launch single currency before 1999 introduces five criteria for admission to the

monetary union mentioned conditions on fiscal policy economic definition of the EMU EMU advantages/disadvantages UK + DK negotiated opt-out arrangements

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Timetable for EMU stage one (1990-1993)

I.) full liberalization of capital

movements closer cooperation between MSs on

economic, fiscal and monetary issues Maastricht Treaty ratification II.) freezing of ECU basket

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Timetable for EMU stage two (1994-1998)

I.) preparatory phase for the monetary

union constitution of EMI (forerunner of the

ECB) granting the central bank

independence ban on financing the public deficits monitoring of fiscal and monetary

policies II.) constitution of ECB

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Timetable for EMU stage three (1999-2001)

completion of the monetary union irrevocable fixing of the central

parities responsibility for single monetary

policy transferred to ESCB, ECB single currency adoption

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Maastricht Criteria

Monetary criteria inflation rate (± 1,5 %) long-term interest rate (± 2,0 %) exchange rate stability (ERM)

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Maastricht Criteria

Fiscal criteria budget deficits (3 %) government debt (60 %) relationship between Maastricht fiscal criteria

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Relationship between Maastricht Fiscal

Criteria

PY

Dg

PY

D)(

D is public debt

Y is the GDP

P is the price level

is inflation

g is the growth rate

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Maastricht Criteria Fulfillment, 1997

(12M to 3/2000 for Greece)

Inflation Rate

LT

Interest Rate

ERM

Government Deficit

Public Debt

MC Fulfillment

Austria NO Belgium NO Denmark NO Finland NO France YES Germany NO Greece 1997 NO Greece 2000 NO Ireland NO Italy NO Luxembourg YES Netherlands NO Portugal NO Spain NO Sweden NO United Kingdom

NO

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Convergence report

Maastricht criteria fulfilment guarantee of sound economy financial manoeuvring, criteria

softening precedent for NMS credibility ??

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European Monetary Union

transfer of responsibility for monetary policy to

supranational institution launch of the euro (1999) 11 countries (1999) + Greece (2001) euro area, Eurosystem 2nd largest economic area euro introduction as a economic shock for the

euro area decrease of IR in some countries

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European Monetary Union

6Y of euro area small increase of price level,

inflationary pressures coordination of fiscal policy exceed of M3 threshold (4,5 %) euro devaluation against US dollar

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Euro Area Inflation Rate

0.5

1

1.5

2

2.5

3

3.5

Jan.99 Jan.00 Jan.01 Jan.02 Jan.03

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The euro/dollar exchange rate

0.8

0.9

1

1.1

1.2

Jan.99 Jul.99 Jan.00 Jul.00 Jan.01 Jul.01 Jan.02 Jul.02 Jan.03 Jul.03