European Monetary Union


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European Monetary Union

  1. 1. Ece DINCASLAN Econonomic and Monetary Union Which factors explain the creation of the EMU? The European economic and monetary union (EMU) is widely viewed as one of the mostimportant developments in recent European integration. The idea of an economic andmonetary union in Europe started well before the Treaties establishing the EuropeanCommunities after the Second World War. The reasons for the creation of EMU have beenwidely discussed; some focus on the request for political integration that would have resultedfrom an EMU, some claim that the EMU was established to promote growth and investment.The project will hence discuss how the creation of EMU was both an economic and politicallydriven process. The European Monetary System (EMS) was the pioneer of Economic and Monetary Union(EMU), which led to the establishment of the Euro. It was a way of creating an area ofcurrency stability throughout the European Community by encouraging countries to co-ordinate their monetary policies. It used an Exchange Rate Mechanism (ERM) to create stableexchange rates in order to improve trade between EU member states and hence help thedevelopment of the single market. Stable money had been a key part of internationaleconomic calculations since World War II. However, by the 1980s, opinion about it was muchmore divided. As a result, not all countries took part in the EMS directly, and there weresharper cleavage in the years to come over the role of the EU in setting monetary policy as theEMS was replaced with the Euro. The EMS was launched in 1979 to help lead to the ultimate goal of EMU that had been setout in the Werner Report (1970). Since World War II, attempts had been made to maintaincurrency stability amongst major currencies through a system of fixed exchange rates calledthe Bretton Woods System. This collapsed in the early 1970s. However, European leaderswere maintain the principle of stable exchange rates rather than moving to the policy offloating exchange rates that was gaining popularity in the USA. This led them to create theEMS. Yet it was not an entirely successful move because, first, it posed many technicaldifficulties in setting the correct rate for all member states, and secondly, some members wereless committed to it than others. Britain didnt join the ERM until 1990 and was forced toleave it in 1992 because it could not keep within the exchange rate limits. The project,however, continued: under the Maastricht Treaty (1992), the EMS became part of the widerproject for EMU that was developed during the 1990s. When the Euro came into being in1999, EMS was effectively wound up, although the ERM remained in operation. The EMS came about because of the high global inflation and economic stagnation thatcharacterized much of the 1970s. Contributing greatly to these problems was the sorryfinancial predicament of the United States during this decade. The dollar, which served as apeg for European currencies, was plagued by a ballooning American deficit, the oil crisis, arapid rise in the demand for gold in world commodity markets, and unemployment and"stagflation" at home. The currency exchange rates of European Community (EC) membersfluctuated wildly against the dollar which the Nixon administration, because of domesticdemands, refused to devalue. As a result the central banks of most western Europeancountries, in an effort to stabilize their own currencies, were unable to continue buying theseinflationary dollars. This led to increased speculation against the dollar, driving its valuedown even further. EC members were increasingly uneasy about this financial morass and
  2. 2. gave birth to the EMS out of fear that these monetary problems would derail plans forEuropean economic integration. In 1978 the European Council, which then was the principal policy making organ of theEC, agreed to establish the EMS. Its purpose was twofold: stabilize the currency exchangerates of participating countries and protect each members currency from the fluctuating dollarand other perceived weaknesses in American fiscal policy. Participating initially wereBelgium, Denmark, France, Ireland, Italy, Luxembourg, the Netherlands, and West Germany.Spain became a full participating member in 1989 as did the United Kingdom in 1990.Portugal and Greece are members but do not participate fully. The EMS had its antecedent inthe Werner Report of 1970 and the so-called "snake system" initiated in 1972. The WernerReport proposed a gradual ten-year move towards an economic union focusing on a singleunit of currency and a single monetary policy. The European currency "snake" was anagreement whereby participating EC members agreed to manage their respective currencyexchange rates so that they fluctuated with each other within a narrow prescribed band or"snake" of plus or minus 2.5 percent. EMS is an "asymmetrical" system that is dominated by the conservative monetarypriorities of Germany and its independent central bank (the Bundesbank). Under the rules ofthe EMS, Germany, because it has Europes strongest economy and most stable currency,basically determines European monetary policies. This asymmetry of the EMS has broughtcharges of German hegemony and has been the source of considerable resentment amongother EC countries. In particular, France has chafed under the restrictions of Germanmonetary dominance. A key moment came in 1983, when the Socialist government ofFrançois Mitterrand was forced to abandon its expansionary economic program in order toremain within the EMS. Since this point, establishing control over German monetary policythrough the creation of supranational monetary institutions has been a central objective of theFrench government.1 By the middle of 1989, the discussion of European monetary union was already wellunderway. The growing political instability in Eastern Europe, however, culminating in thedramatic opening of the Berlin Wall on 9 November, placed the issue of monetary union in awholly new context. Concern about the power and orientation of a united Germany led manyEuropean leaders to espouse a strengthening or deepening of EC institutions; this, it wasbelieved, would serve to permanently bind Germany to the Community, thus preventing amore independent or nationalistic course in the future. October 1989 argued that theconstruction of a federal Europe was "the only satisfactory and acceptable response to theGerman question." 2 The British government under Prime Minister Thatcher argued against EC deepening, andinstead gave priority to widening the Community to incorporate new members. There wasalso the traditional British reluctance to surrender further aspects of national sovereignty tosupranational institutions, since rapid expansion of the Community would favor its evolutioninto a looser confederation of independent states rather than a more unified federal Europe.Another important motivation for Britain, however, was fear of German power. According toThatcher and in direct contrast to the French position, a tightly integrated EC would be moreeasily dominated by Germany than would a broader grouping of sovereign states31 Michael J. Baun, The Maastricht Treaty as High Politics: Germany, France, and European Integration, 6072 The Economist, 21 October 1989, 503 Michael J. Baun, The Maastricht Treaty as High Politics: Germany, France, and European Integration, 624
  3. 3. Britain entered the ERM in 1990 at a rate of 2.95 Deutschmarks to one Pound Sterling.Many feel this rate was too high and caused Britains rapid departure from the system. What’smore; Britain dramatically left the ERM on 16 September 1992 (a day that became known asBlack Wednesday), because it was no longer possible to keep the pound within the bands ofthe ERM. German unification and the end of cold war have considerably altered the dynamics ofEuropean integration. In a new and more unstable postcold war context, it is to be expectedthat considerations of national security and position will once again come to dominateEuropean and EC politics. To be sure, this new balance-of-power game will be played outwithin the context of established European and supranational institutions, thus mitigating itspotential negative consequences. Nevertheless, as a result of its high politics nature, Europeanintegration after the cold war will become increasingly problematic and more highlypoliticized.The Single European Act and the Delors Report (1989) The Single European Act (17.2.1986) enshrined in law some of the major economicpreconditions for ‘fair and loyal’ competition and long-term stability within the internalmarket. It introduced a new article in the EEC Treaty concerning EMU and co-operationbetween Member States in this field, with special reference to the EMS and the developmentof the European Currency Unit (ECU). It also created a European Currency Unit (ECU) to be used as a unit of account. Althoughnot a real currency, the ECU became the basis for the idea of creating a single currency - anidea that was realised with the launch of the Euro in 1999. The debate on EMU was fully re-launched at the Hannover Summit in June 1988, askingan ‘ad hoc Committee’ of the Central Bank Governors of the twelve Member States, chairedby the President of the Commission, Jacques Delors, to propose a new timetable with clear,practical, realistic steps for creating an economic and monetary union. The report on EMU inthe European Community drafted by the Delors Committee was presented to the public inApril 1989. The report’s recommendations were reached unanimously. It favoured theapproach of making substantial steps towards economic convergence, price stability andbudgetary discipline before irrevocably fixing the exchange rates between the currencies in amonetary union. This article has argued that the Maastricht Treaty was essentially a political response bythe EC and its member countries to German unification and the end of the cold war. Inparticular, it represents a bargain between the Communitys two most important countries,Germany and France, each of whom viewed the agreement as a means of securing vitalnational interests. For Germany, the treaty was necessary to assuage the fears of its ECpartners about a more independent united Germany and to convince them of its unflaggingcommitment to the Community and European integration. For France, an agreement onmonetary union was a means of integrating Germany even more firmly into European
  4. 4. institutions and structures and of retaining some degree of leverage and control over itspowerful neighbor. The leaders of both countries also regarded the maintenance of positivebilateral relations as a crucial objective, and the Maastricht Treaty was viewed as a means forpreserving the Franco-German axis of European cooperation in the post-cold war era. In thefinal analysis, the Maastricht Treaty was a mechanism by which German unification andEuropean integration could be reconciled and made compatible. The Way to Go the Maastricht Summit Accepting the ‘Delors report’ as a useful basis for further work on EMU, the MadridEuropean Council decided in June 1989 to begin the process of creating a single currencywith the first stage starting on 1 July 1990. In Strasbourg in December 1989, the EuropeanCouncil agreed to convene an Intergovernmental Conference (IGC) on EMU before the end of1990, in particular to make the necessary changes to the treaty for an economic and monetaryunion. The Maastricht Summit and Its Outcome ‘9/10 December 1991’ One possible explanation of the treaty, focusing on the core agreement on monetary union,a second explanation can be derived from neofunctionalist theories of European integration,which have enjoyed a resurgence of academic interest in recent years; this basically explainsthe agreement on monetary union as an inevitable outgrowth, or spillover effect, of thedynamic of economic integration unleashed by the Communitys single-market project(Europe 1992) in the 1 9 8 0 and it does in fact have important roots in economic andinstitutional developments prior to 1989, must be understood primarily as a political responseby EC countries to German unification and the end of the cold war. In particular, it representsa political bargain between the ECs two most important members, Germany and France, eachof whom viewed the agreement as a means of securing vital national interests. 4 The Maastricht Treaty, therefore, can be understood as an exercise in high politics, with theprimary motivations of the key players being broad considerations of national security andadvantage rather than technical solutions to domestic economic and social problems (lowpolitics). It was signed by the Heads of State or Government in May. However, it only cameinto force on 1 November 1993. This delay was due to difficulties in the ratification process insome Member States, in particular due to the need for a second referendum in Denmark. With the "Treaty of Maastricht", the Member States confirmed their political will to realisean Economic and Monetary Union, although exceptions were made for Denmark and theUnited Kingdom in terms of when they would join it. In parallel, in economic and financialcircles there was a growing conviction that a European Union with a single currency might bemore resistant to economic and monetary crises. The most important feature of the EMS is the exchange rate mechanism (ERM) which, likethe "snake," keeps each members respective currency within a prescribed range offluctuation. The hoped-for range was plus or minus 2.25 percent. Those currencies that werefloated were allowed to fluctuate as much as plus or minus 6 percent but only on a temporary4 Michael J. Baun, The Maastricht Treaty as High Politics: Germany, France, and European Integration, 605-606
  5. 5. basis. In 1993, however, the band of fluctuation was temporarily increased to plus or minus15 percent as a response to currency speculation pressure. In order to stabilize these exchangerates there is an obligatory intervention procedure. Central banks of countries having strongercurrencies are obliged to "intervene" or buy weaker currencies whose value has fallen belowthe prescribed range or band. Likewise, the central banks of countries having the weakercurrencies are obliged to sell their currencies to the central banks of financially strongercountries. A central feature of the EMS is a common unit of currency. Created in 1974 it was initiallycalled the European unit of account but soon became known as the European currency unit(ECU). The unit was backed by pooling specified amounts of member nations currency. Theamount of currency deposited by each member country was related to the economic strengthof that country. In 1990 30 percent of the ECU pool or basket was in deutsche marks, 19percent in French francs, 12 percent in pound sterling, and 10 percent in Italian lira. Thebalance of the basket came from the remaining EMS participants. The ECU represented astable unit of exchange and could be used in commercial transactions. Key concepts here are:excessive deficit procedure, prohibition of privileged access, prohibition on the central banksgranting credit facilities to public authorities and undertakings, broad economic policyguidelines and convergence criteria. In 1995 the European Council, which consists of the heads of state of the ECs 12members, renamed the ECU the "euro." Although the acronym "ECU" made sense as anEnglish term, it had no basis of meaning in any other European language. Germany proposedthe term" euro" be combined with the name of each national currency as a suffix. In this casethe new unit of exchange could be known as the "euromark," "euro-franc," "euro-lira," etc.,but ultimately, the simpler "euro" was selected. The most important part of EMS was the Exchange Rate Mechanism. This committed allmember states governments to keep their currency exchange rates within bands. This meantthat no countrys exchange rate could fluctuate more than 2.25% from a central point. Thiswas designed to help create stable commerce without the fear that sudden changes in thevalues of currencies would dampen trade and encourage the development of trading barriersbetween member states. There are arguments which are support and criticize Economic and Monetary Union;For;  The European Monetary System was important in ensuring currency stability in the European Community at a time when international markets were very volatile.  Without the EMS the completion of the single market project would have been more difficult.Against;  Fixing exchange rates is dangerous because unless the correct rate is set and changed appropriately, a national economy can be forced to pursue policies that are not best suited to domestic conditions simply in order to maintain international stability.  EMS established the principle that one monetary policy can suit all member states. The events of 1992 proved that this was not the case.
  6. 6. To sum up; although concerns about the EMU center around loss of nationalsovereignty for each of the individual participating states and some fear that theparticipating states may not be able to pull out of a national economic crisis without theability to devalue its national currency and encourage exports, there are more benefits tobe a member of EMU. Moreover; the use of the common euro eliminates the currencyexchange fees from the cost of doing business between the European states. Higherproductivity growth, increased labour utilisation, and improved competitiveness in theglobal economy. Companies will be able to quickly compare prices with their competitors,which may encourage competition and may result in lower prices for consumers. Byencouraging stability and efficiency, proponents of the EMU hope that the use of the eurowill stimulate economic growth and may reduce the unemployment rates in theparticipating member states. International investors will likely diversify their portfolioswith euros, encouraging more investment in the European continent. The European stateswant the euro to become one of the premier currencies in the international financialmarket, alongside the dollar and the yen.