Fairfield Institute of Management and Technology

EUROPEAN MONETARY SYSTEM AND ROLE OF

EURO IN INTERNATIONAL MONETARY SYSTEM
INTERNATIONAL BUSINESS MANAGEMENT
(Sub code :306)

Submitted to: Submitted by:

MR. DR. SHALINI ASIF HUSSAIN

Enroll no: - 00651401717

BBA-G- 6th Sem

Section - D
 EUROPEAN MONETARY
SYSTEM AND ROLE OF
EURO IN INTERNATIONAL
MONETARY SYSTEM

TABLE OF CONTENTS

Content Page No.

Title……………………………………………………………………2

Introduction……….………………………………………………….4

Objective………………………………………………………………8

Conclusion…………………………………………………………….9

Bibliography…………………………………………………………..10

INTRODUCTION
What is European Monetary System
The foundation of the European Monetary Union, in my opinion, was one of the most

important steps on the way of European integration. Because now every citizen of those 12

countries which entered the EMU has really something common with all the others – the
euro.

It’s really difficult to say, if Europeans are very much interested in the European agreements,

principles, institutions but I can surely say that everybody of them has heard something about

the EMU and ECB.

The aim of my report is to highlight the main stages of European monetary integration

with the focus on European Monetary System and European Monetary Union. EMS appeared
in

1979 as an agreement between central banks of most countries of the EC by which they
linked

their currencies to prevent large fluctuations relative one another. In the early 1990s the

European Monetary system was strained by the differing economic policies and conditions of

its members, especially the newly reunified Germany, and Britain permanently withdrew
from

the system. EMU was established according to the Maastricht Treaty and meant that national

currencies of the EU members were abolished and replaced by a single European currency.

Besides EMU replaced the national, mutually independent central banks by a single European

one (European Central Bank) that is in charge for all member countries. So it seems now, that

the declaration in the preamble to the Treaty of Rome proclaiming the intention to create “an

ever closer union…” (Hansen, 2001: 503, 5) speedily comes into life.

The main theses and points of my paper will be the following:

1. The launch of the EMU in the 1970s was abandoned because of the economic instability
(unequal inflation rates between EEC members) but nevertheless that project

contributed a lot to the understanding of the preconditions for the future European

Monetary Union.

2. A new attempt at establishing monetary stability was launched in March 1979 with the

European Monetary System replacing the “snake”.

3. Exchange Rate Mechanism was a main instrument for fulfilment the objectives of the

EMS

4. The main reason for the ERM (fixed exchange rate system) weakness was its operating

without coordination of monetary policy

5. The efficiencies and benefits from a single market (economic union) will only be

maximized when the costs and risks of currency exchange are eliminated (monetary

union).

6. ERM 2 is an asymmetric system centred around the euro

7. If comparing the costs and benefits of the EMU, it must be decided whether greater

income and price stability is worth the loss of an autonomous monetary and exchange

rate policies

While writing this paper I worked with different sources of information: textbooks,

monographs, articles. But nevertheless, the complete understanding and research of the topic

wouldn’t be possible without Internet resources as they are very helpful while looking for
new

and updated information. The only problem was a fair evaluation of costs and benefits of the

EU. Only very few economists try to sum up now the results of the EMU introduction as
really
very little time has passed. But nevertheless I tried to do my best and reflect the topic as full
and

interesting as possible.

The role of the euro as an international monetary system

How important will the euro become, though, as an investment currency in the global money
and capital markets? At present, the US dollar is the predominant international investment
currency. In 1997 the share of dollar-denominated instruments of the bonds outstanding in the
international bond markets amounted to 46%, followed by Japanese yen-denominated debt
(11%) and debt denominated in Deutsche Mark (10%). All the euro area currencies together
accounted for approximately 24% of the international bond market.

Several arguments seem to indicate that the euro may become a more attractive currency for
bond issuers than all the currencies which it replaced taken together. In fact, the euro was the
most popular currency for bonds issued in the international markets in the first month after its
introduction, accounting for approximately 55% of the volume of new bond issues, compared
with 40% for the US dollar. However, the high figures for euro-denominated bond issuance
in January 1999 may, to a certain extent, reflect a particularly high level of initial interest in
euro-denominated instruments during the new currency's first month of existence. We may
therefore experience a drop in the euro's market share of new bond issues from the high level
experienced last month.

As I mentioned in my introduction, a key element in determining the longer-term

attractiveness of the euro as an investment currency will be the emergence of efficient, large
and integrated financial markets in the euro area. The introduction of the euro will remove
currency risk, increase cross-border competition and provide an incentive for the
harmonisation of market practices, thereby generally reducing transaction costs.

The conditions for financial market integration in the euro area seem to be best at the short
end of the yield curve. In fact, the conduct of a single monetary policy by the Eurosystem
gave market agents an incentive to start large-scale cross-border trade right from the outset,
thereby creating an almost fully integrated money market in the euro area. The integration of
the previous national money markets was made possible thanks to the TARGET system,
which connects the national real-time gross settlement systems in the euro area. It thereby
facilitates banks' cross-border dealing and accessing of funds in euro. The existence of an
integrated money market implies that arbitrage should eliminate any cross-border differences
in interest rates.

At the longer end of the yield curve, cross-border integration is likely to take more time.
Before the introduction of the euro, European bond markets were highly segmented.
Traditionally, this segmentation was a result partly of different currency denominations and
partly of other market-specific conditions, such as differences in national regulations, tax
regimes, practices and market conventions. The introduction of the euro did remove the
foreign currency risks and has been accompanied by an increased harmonisation of market
conventions. As a consequence, the substitutability between bonds traded in different national
markets improved. In fact, the trading of euro area government bonds can already be
considered to be largely integrated.

However, the markets for private bonds, and in particular for mortgage bonds, are still highly
segmented owing to the differing institutional and regulatory frameworks across Member
States. Nevertheless, the tendency towards increased cross-border competition and lower
transaction costs in the national markets may also provide an incentive for increased issuance
volumes of private bonds. We may experience a virtuous circle in which the increased
issuance of bonds denominated in euro will draw the attention of international investors to
euro-denominated assets, thereby making the euro an increasingly attractive currency for
private as well as public bond issuers.

In this context, it is interesting to compare the current sizes of the bond markets in the euro
area and the United States. The market value of the bonds issued in the United States (USD
10,700 billion) is currently twice as large as in the euro area (USD 5,300 billion). While the
market value of government bonds is of a comparable magnitude in the United States and the
euro area, there are large differences in the markets for corporate bonds. The market value of
corporate bonds outstanding in the United States is, at present, almost ten times larger than in
the euro area.

These figures seem to indicate that there is plenty of scope for further securitisation in the
euro area. The introduction of the euro certainly underpins this development. The
establishment of a benchmark for government bonds, increasing economies of scale,
narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and
more competitive underwriting are likely to provide incentives for European corporations to
issue their own securities instead of borrowing from banks.

Moreover, the euro area financial markets now offer a more diversified set of financial
instruments than that which was previously available in any national market in the euro area.
This will give international investors greater scope for portfolio diversification for
investments in euro-denominated assets without their having to incur additional foreign
exchange risk. To the extent that the euro area is a large and rather closed economy, yields on
bonds denominated in euro are likely to become increasingly independent of changes in US
yields compared with the present situation for bonds denominated in the national currencies.
If this is the case, euro area bonds will provide an attractive opportunity for investors who
would like to achieve increased risk diversification in relation to US financial instruments.

Conclusion

In conclusion, I should like to underline once more that it is still too early to make any clear
assessment of the possible role of the euro in the international monetary system. However, I
am convinced that the mandate of the Eurosystem to maintain price stability in the euro area
and its institutional framework, ensuring a high degree of independence, will be a good basis
for developing the international role of the euro. In addition, I am convinced that the
introduction of the euro will contribute to further development of the euro area financial
markets with a view to achieving higher efficiency and international competitiveness. Against
this background, I think there is little doubt that the euro will play a major role as an
international currency.
 OBJECTIVE
 To develop further understanding of the theories and concepts cover in the course,
 To develop a practice of learning new aspects of the subjects and develops a habit of
research related to the subject.
 CONCLUSION

After making this assignment all the concepts related to this topic is now cleared and
provides entro-knowledge regarding this topic.
 BIBLIOGRAPHY

1.Web site:

www.europa.com

www.wikipedia.com

www.scribd.com

2.Search engine:

www.google.com