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EURO System

EURO System

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Published by: Kripansh Grover on Oct 16, 2011
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EURO SYSTEM

PRESENTED BY: Arindam Mallick 10 Shaunak Vats 50

A Brief History of European Economic Integration
• The original goal behind the integration of Europe was to prevent the devastating wars of the first half of the twentieth century from ever happening again…

Dresden, Germany, 1945.

European Economic Integration
• Political end by (mainly) economic means
• European Coal and Steel Community 1951; European Economic Community 1957 (Treaty of Rome) • Customs Union (1968): Free trade area + common external tariff • Single (or Internal) Market (launched 1986, “completed” in1992): breakdown of all tariff and non-tariff barriers to trade and business • Single currency (approved1993 Maastricht Treaty, euro launched 1999, notes and coins 2002): eliminated exchange rate transaction costs and risk

asymmetric. • 1999. • 1993-99: ERM-1 with wide bands (±15%). • 1982-93: ERM-1 centered on the DM.: ERM-2.25%) and symmetric. on the way to euro area. 6 . shunning realignments.The Four Incarnations of the EMS • 1979-82: ERM-1 with narrow bands of fluctuation (±2.

25% Bilateral band among European currencies ±1% .Snake in the Tunnel Fluctuation band against the dollar ±2.

. the ECU was the reserve asset of the EMS (used for settlement of accounts between Central Banks) and its unit of account. including the dollar. Creation of a “cocktail” currency. : ECU (European Currency Unit) consisted of weighted values of EC currencies based on their GDP and trade. Just as the dollar was at the center of the BW system and was its de facto numéraire and reserve asset (the dollar was “as good as gold”).Exchange Rate Mechanism: • • ERM was the institutional mechanism for stability between EC currencies while floating them against all others.

365 1.360 1.340 1.ERM – A Semi-Pegged System 1.355 1.330 Banks intervene Exchange rate vs.380 1.345 1.335 1.370 1. ECU .375 1.350 1.

ECU Components .

8M .Precursors of the ERM Crisis West East DM 350MM 1DM = 1.

George Soros .

1992 3.776 September 16.1992 Black Wednesday .116 2.GBP/DEM X-Rate.

12% .15% • Spent £27B of foreign reserves in propping up (buying) the pound .UK Treasury Response • Raising interest rates to 10% .

£3.4 BILLION Estimated total cost of Black Wednesday [1997] £800 MILLION Estimated Black Wednesday trading losses [1997] .

00% 0.Currency Devaluation by Country 0% Britain -10% -20% -30% Spain Italy Annualized GDP Growth.50% 2.00% 1.50% 0.00% 2.50% 1. 1992-2005 3.00% France Italy Germany Eurozone UK .

loses 1997 election. Prime Minister John Major succeeded by Tony Blair • UK leaves ERM • Italy and Spain widen ERM bands • ECU replaced by euro in 1998 • ERM-II established in 1999 .Aftermath • Conservative Party blamed for crisis.

What is EMU? .

What does EMU stand for? • Does EMU stand for: • European Monetary Union? • Or: • Economic and Monetary Union? .

EMU vs. the euro area • EMU is a Treaty objective shared by all 27 EU Member States • The euro is a reality for 17 Member States (“the euro area”) • What about the “E” in EMU? .

services. capital and people (27) 3) Enhanced policy coordination – countries retain sovereignty over other economic policies but commit to coordinate more closely at the European level (27/16) . with free movement of goods.What are the three parts of EMU? 1) The euro – countries give up their own currency when they join the euro area. The ECB sets interest rates for the euro area (16) 2) The single market – all countries participate in the single market.

What was the start date of Economic and Monetary Union? a) Jan 1980 The first major monetary policy initiative (1970 Werner Plan) called for EMU by Jan 1980.1. EMU officially started on Jan 1. b) Jan 1999 Correct. . but adverse economic conditions doomed the initiative. Conversion rates were irrevocably fixed and legislation related to introduction of the euro came into force. c) Jan 2002 Circulation of euro banknotes began. 1999.

crossed by two parallel lines to ‘certify’ the stability of the euro.Designing the Euro Sign “Inspiration for the € symbol itself came from the Greek epsilon (Є)– a reference to the cradle of European civilization – and the first letter of the word Europe.” – European Commission .

2. b) 16 Number of countries in 2010 c) 17 Correct. 17 EU member states are part of the euro area . As of 2011. How many countries are currently in the euro area? a) 27 Number of current EU member states.

2011 .EUROZONE • • • • • • • • • 17 Member States Use EURO•asLuxembourg their currency Belgium • Malta Germany • The Netherlands Ireland • Austria Greece • Portugal Spain • Slovenia France • Slovakia Italy • Finland Cyprus Estonia.

Spain. Luxembourg. France. Ireland. the Netherlands. Portugal. Malta Slovakia 2001 2007 2008 2009 • .1999 Belgium. Austria. Finland Greece Slovenia Cyprus.

and most of Eastern Europe remain outside of euro • To join would need popular support and low budget deficits • Britain and Sweden unlikely to join unless economy tanks • Eastern European countries perhaps more likely to join as they meet criteria . Sweden. Denmark.The “Outs” • Britain.

A fine distinction: EMS vs. mutual support. ECU • The UK and Sweden do not want ERM membership 28 . ERM • EMS = European Monetary System – all EU members are part of it • ERM = Exchange Rate Mechanism – Grid of agreed bilateral exchange rates. joint realignment decisions.

economic.What were the set of rules set out for entry into the European Monetary Union? a) Copenhagen Criteria The political. The 1992 Maastricht Treaty set out 5 criteria that countries needed to meet prior to joining the EMU. . b) Stability and Growth Pact Pact enacted in 1997 to ensure that fiscal discipline would be maintained and enforced in the EMU. and legislative requirements that countries must meet to join the EU. c) Convergence Criteria Correct.

Government finance: • Annual government deficit: Ratio of the annual government deficit to GDP must not exceed 3% at the end of the preceding fiscal year.5 percentage points higher than the average of the 3 best performing (lowest inflation) member states of the EU. Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the 3 lowest inflation member states. Exchange rate: Applicant countries should have joined the exchangerate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devalued its currency during the period. • Government debt: Ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. .The so-called “Maastricht Criteria” Inflation rates: No more than 1.

• Harmonize social policy within the EU • Centralize EU foreign and defense policy . • Macroeconomic convergence criteria for admission to EMU.How the European Single Currency Evolved – Maastricht Treaty (1991) • Blueprint for the transition process from the EMS fixed exchange rate system to EMU.

. Independent of political authorities.Who sets interest rates in the EMU? a) The European Council Determines membership in the eurozone. d) The European Parliament Not important here. goal is low inflation. c) The European Central Bank Correct. . ECB controls interest rates for euro. b) Member States Manage national fiscal policies within EU limits.

The European Central Bank • Established under the Amsterdam Treaty (1998) • Modeled after the German Bundesbank • Headquartered in Frankfurt • Current president Jean-Claude Trichet • The ECB has the exclusive right to authorise issuance of banknotes • The primary objective of the ECB is to maintain price stability within the Eurozone. or in other words to keep inflation low!! .

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Economic policy in EMU .

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. What is the current dollar-euro exchange rate? a) 86 cents January 2002 b) $1.36 Correct. c) $1.5.59 July 2008 .

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. • EU should have strict rules limiting size of budget deficits. • Governments need to coordinate all tools of economic policy – fiscal.A Single Currency . excha nge rate – to achieve these goals.Competing Models Technocratic • Priority of monetary integration should be to maintain low inflation. Politicized • Priority of monetary integration should be to promote growth and employment. monetary. • Authority over monetary policy should be invested in a political independent central bank directed to keep inflation low.

And the winner is…. Outcomes of negotiations for the Maastricht Treaty favored the technocratic German view: • Politically independent ECB tasked with keeping inflation low • Convergence criteria • Only Britain and Denmark allowed not to participate • Deadline for creation of single currency .

Transition to Monetary Union Rough Seas or Smooth Sailing? .

touches their daily lives) react by objecting to technocratic. elitedriven nature of integration process • Ratification problems: – the Danish “no” – the French “petit oui” – German constitutional woes .e.The backlash begins… • 1992/93 marks end of public’s “permissive consensus” • European project finally starts to hit home for citizens (i.

2009: Happy 10th Birthday.g. lower inflation) • But now the euro area is confronted by a very dire economic situation . euro! • The euro has helped to bring Europeans together • It has fostered greater economic integration (reinforcing the Single Market) • It has contributed to macroeconomic stability (e.

Was It Really Happy? .

8 3.2 11.5 2009 -4.1 1.5 Real GDP growth Inflation Unemployment rate (percentage of labor force) .0 0.3 7.The Euro Area Economic Situation: Not Good! Real annual % change unless otherwise stated 2008 0.9 2010 -0.4 9.

Why is the euro area so affected? • US and euro area economies are closely connected • Many European banks bought securities tied to US subprime loans • German exports have fallen sharply • Spanish and Irish housing bubbles have burst • Euro area economy is less flexible. I don’t think we’re in growth Kansas anymore” • Exposure to Eastern Europe . has lower productivity “Toto.

a coordinated fiscal stimulus .Europe’s response to the crisis The ECB reduces interest rates to historically low levels (1.25%) and begun “quantitative easing” Oct 08: euro area governments adopt concerted action plan to support their financial systems Dec 08: EU governments adopt European Economic Recovery Plan .

The financial crisis: Other ways Europe should respond? Speed up economic reforms (Lisbon Strategy) http://ec.eu/growthandjobs/index_en.htm Make the single market work better (especially for Services) .europa.

but difficult to coordinate fiscal response of 16 Member States • Break-up of EMU? .EMU and the financial crisis • Crisis exposes persistent divergences in the euro area • “One size fits all monetary policy” problematic • Countries need to use fiscal stimulus. just as in US.

how will it cope? • Will the crisis lead to further divergence in EMU.Conclusions • The launch of the euro was a tremendous achievement for the EU • But EMU is still a work in progress (especially for the “E” part) • The euro area is in its first recession. or will it encourage countries to speed up reforms? • Can you have a monetary union without a complete economic union and/or Political union? .

Designing the Currency .

Designing the Currency .

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