The European Monetary System, The

Maastricht Treaty, Birth oI the Euro and

its Future
Group Members
516 Tulika Gurung
537 Sharon Nunes
552 Bhavana Sonawane
555 Shivangi Tarai
A Brief History of European Economic Integration A Brief History of European Economic Integration
The euro was already envisaged as a goal
back at the start of European integration in
1950s
It was always seen as the ~next logical step
after the single market
The idea gained academic attention through
the work of economist like Robert Mundell
(~Optimal Currency Areas)
Break-up of the gold standard in the 1970s
led to creation of the forerunners of the euro,
European Monetary System (EMS) and
Exchange Rate Mechanism (ERM)
German reunification (1990) and currency
crisis of 1992 as catalysts for push toward
the euro leading to Maastricht Treaty in
1992/93.
A 8r|ef G|ossary of Luronyms
WhaL ls Lhe Lu?
W 1he Luropean unlon ls a sysLem of lnLernaLlonal lnsLlLuLlons
Lhe flrsL of whlch orlglnaLed ln 1937 whlch now represenLs 27
Luropean counLrles Lhrough Lhe followlng bodles
Luropean ar||ament elecLed by clLlzens of member counLrles
Counc|| of the Luropean Un|on appolnLed by governmenLs
of Lhe member counLrles
Luropean Comm|ss|on execuLlve body
Court of Iust|ce lnLerpreLs Lu law
Luropean Centra| 8ank whlch conducLs moneLary pollcy Lhrough a sysLem of
member counLry banks called Lhe Luropean System of Centra| 8anks
204
WhaL ls Lhe LMS?
W 1he Luropean Monetary System was orlglnally a sysLem of flxed
exchange raLes lmplemenLed ln 1979 Lhrough an exchange rate
mechan|sm (L8M)
W 1he LMS has slnce developed lnLo an econom|c and monetary
un|on (LMu) a more exLenslve sysLem of coordlnaLed economlc
and moneLary pollcles
1he LMS has replaced Lhe exchange raLe mechanlsm for mosL members
wlLh a common currency under Lhe economlc and moneLary unlon
203
1he LMS 19791998
W lrom 1979 Lo 1993 Lhe LMS deflned Lhe exchange
raLe mechanlsm Lo allow mosL currencles Lo flucLuaLe +/
223 around LargeL exchange raLes
W 1he exchange raLe mechanlsm allowed larger flucLuaLlons (+/
6) for currencles of orLugal Spaln 8rlLaln (unLll 1992) and
lLaly (unLll 1990)
1hese counLrles wanLed greaLer flexlblllLy wlLh moneLary pollcy
1he wlder bands were also lnLended Lo prevenL speculaLlon caused by
dlfferlng moneLary and flscal pollcles
206
1he LMS 19791998 (conL)
1o prevenL speculaLlon
W early ln Lhe LMS some excbooqe coottols were also enforced
Lo llmlL Lradlng of currencles
8uL from 1987 Lo 1990 Lhese conLrols were llfLed ln order Lo make Lhe
Lu a common markeL for flnanclal asseLs
W A cteJlt system was also developed among LMS members Lo
lend Lo counLrles LhaL needed asseLs and currencles LhaL were
ln hlgh demand ln Lhe forelgn exchange markeLs
207
1he LMS 19791998 (conL)
W 8uL because of dlfferences ln moneLary and flscal pollcles
across Lhe LMS markeL parLlclpanLs began buylng Cerman
asseLs (because of hlgh Cerman lnLeresL raLes) and selllng
oLher LMS asseLs
W As a resulL 8rlLaln lefL Lhe LMS ln 1992 and allowed Lhe
pound Lo floaL agalnsL oLher Luropean currencles
W As a resulL Lhe exchange raLe mechanlsm was redeflned ln
1993 Lo allow for bands of +/13 of Lhe LargeL value ln order
devalue many currencles relaLlve Lo Lhe deuLschemark
208
1he LMS 19791998 (conL)
W 8uL evenLually each LMS member adopLed slmllarly resLralned
flscal and moneLary pollcles and Lhe lnflaLlon raLes ln Lhe LMS
evenLually converged (and speculaLlon slowed or sLopped)
ln effecL LMS members were followlng Lhe resLralned moneLary pollcles
of Cermany whlch has LradlLlonally had low lnflaLlon
under Lhe LMS exchange raLe mechanlsm of flxed bands Cermany was
exporLlng" lLs moneLary pollcy
209
Membershlp of Lhe Lu
W 1o be a member of Lhe Lu a counLry musL
among oLher Lhlngs
1 have low barrlers LhaL llmlL Lrade and flows of
flnanclal asseLs
2 adopL common rules for emlgraLlon and lmmlgraLlon
Lo ease Lhe movemenL of people
3 esLabllsh common workplace safeLy and consumer
proLecLlon rules
4 esLabllsh cerLaln pollLlcal and legal lnsLlLuLlons LhaL
are conslsLenL wlLh Lhe Lu's deflnlLlon of llberal
democracy
2010
Snake ln Lhe Lunnel CommlLmenL Lo
keeplng Luropean raLes wlLhln narrower
band compared wlLh 8reLon Woods SysLem
C
L
x
c
h
a
n
g
e

r
a
L
e
no
lnLervenLlon
CenLral bank
buys domesLlc
currency
no
lnLervenLlon
CenLral bank
sells domesLlc
currency
no
lnLervenLlon
1lme
+430
430
+223
223
Lu8CLAn Cu88LnC? unl1(LCu)
Luropean Currency unlL (LCu) ls a composlLe
currency unlL LhaL conslsLs of flxed amounLs of
Len currencles 1he quanLlLy of each counLry's
currency ln Lhe LCu reflecLs LhaL counLrles
relaLlve economlc sLrengLh ln Lhe Luropean
communlLy 1he LCu funcLlons as a unlL of
accounL as a means of seLLlemenL and a
reserve asseLs for Lhe members of LMS
Weak vers|on
% llxed bllaLeral exchange raLes (rlgldly or wlLhln a band)
% Lach member underLakes moneLary pollcles Lo defend Lhe
raLes
Strong vers|on
% lndlvldual currencles are replaced by a slngle currency
% lndlvldual moneLary auLhorlLles are replaced by a slngle
auLhorlLy
WhaL ls MoneLary unlon?
% 1he Luropean MoneLary lnsLlLuLe (LMl) was a precursor Lo Lhe
Luropean CenLral 8ank (LC8) and was creaLed Lo
% CoordlnaLe moneLary pollcles and ensure prlce sLablllLy
% repare Lhe esLabllshmenL of Lhe Luropean SysLem of CenLral
8anks (LSC8) overseen by Lhe Luropean CenLral 8ank (LC8)
% repare Lhe lnLroducLlon of a slngle currency ln sLage 3
% Lxamlne Lhe achlevemenL of economlc convergence among
Lu sLaLes as esLabllshed by Lhe MaasLrlchL 1reaLy (1992)
1he Maastr|cht 1reaty (1991)
% eflnes Lhree sLages ln Lhe process Lowards moneLary unlon
I|rst Stage (from 1 !uly 1990 Lo 31 ecember 1993) 1he LMS counLrles
abollshed all remalnlng caplLal conLrols (lree movemenL of caplLal) 1he
degree of moneLary cooperaLlon among Lhe LMS cenLral banks were
sLrengLhened 8eallgnmenLs were posslble Member sLaLes underLake
programs LhaL make posslble flxed exchange raLes
Second Stage (from 1 !anuary 1994 Lo 31 ecember 1998) A new
lnsLlLuLlon Lhe Luropean MoneLary lnsLlLuLe (LMl) was creaLed
1he Maastr|cht 1reaty (1991)
% 1h|rd (I|na|) Stage (from 1 !anuary 1999 Lo 31 !une 2002) 1he
exchange raLes were lrrevocably flxed LsLabllshmenL of Lhe
Luropean CenLral 8ank ln charge of Lhe Luropean moneLary pollcy
1he LC8 lssued Lhe euro 1he LranslLlon Lo Lhls flnal sLage was
made condlLlonal on a number of convergence crlLerla"
% 1hlrd SLage was dlvlded lnLo three substages
1 lrom 1 !anuary 1999 unLll 31 ecember 2001 Lhe naLlonal
currencles conLlnued Lo clrculaLe alongslde Lhe euro albelL aL
lrrevocably flxed exchange raLes Commerclal banks used Lhe euro
ln lnLerbank LransacLlons lndlvlduals had Lhe cholce of openlng
euro accounLs noLe LhaL durlng Lhls perlod Lhe euro dld noL exlsL ln
Lhe form of banknoLes and colns All LransacLlons beLween Lhe LC8
and commerclal banks were ln euros new lssues of governmenL
bonds were also ln euros
1he Maastr|cht 1reaty (1991)
2 urlng Lhe perlod 1 !anuary Lo 1 !uly 2002 Lhe euro would replace
Lhe naLlonal currencles whlch would lose Lhelr legalLender sLaLus
3 lrom 1 !uly 2002 on a Lrue moneLary unlon would come Lo
exlsLence ln whlch Lhe euro would be Lhe slngle currency managed
by one cenLral bank LC8
1he MaasLrlchL 1reaLy was flnally raLlfled ln Lhe fall of
1993 and 12 counLrles (excepL uk Sweden and
enmark) began Lo lmplemenL SLage 2 of LMu Lhe
convergence phase ln whlch sLaLes were requlred Lo cuL
Lhelr deflclLs and lower lnflaLlon Lo quallfy for SLage 3
1he Maastr|cht 1reaty (1991)
WhaL ls LMu?
W WhaL ls LMu descrlpLlon
WhaL are Lhe Lhree parLs of LMu?
1) 1he euro counLrles glve up Lhelr own
currency when Lhey [oln Lhe euro area 1he LC8
seLs lnLeresL raLes for Lhe euro area (16)
2) 1he s|ng|e market all counLrles parLlclpaLe ln
Lhe slngle markeL wlLh free movemenL of goods
servlces caplLal and people (27)
3) Lnhanced po||cy coord|nat|on counLrles
reLaln soverelgnLy over oLher economlc pollcles
buL commlL Lo coordlnaLe more closely aL Lhe
Luropean level (27/16)
Membershlp of Lhe
Lconomlc and MoneLary unlon
W 1o be parL of Lhe economlc and moneLary unlon LMS
members musL
1 adhere Lo Lhe L8M exchange raLes were flxed ln speclfled bands
around a LargeL exchange raLe
2 follow resLralned flscal and moneLary pollcles as deLermlned by
Councll of Lhe Luropean unlon and Lhe Luropean CenLral 8ank
3 replace Lhe naLlonal currency wlLh Lhe euro whose clrculaLlon ls
deLermlned by Lhe Luropean SysLem of CenLral 8anks
2021
1he Luro
O an. 1, 1999: The euro became an oIIicial currency;
O 1999-2002: Existing national currencies and the euro operate side by
side at Iixed rates. The euro is not imposed as currency, but inter-
bank transIers can be made in Euros.
O an. 2002:New euro notes and coins circulate;
O uly 2002: Local currencies are completely phased out and no longer
allowed. Only euro transactions (cash or transIer) are possible.
Whlch counLrles are ln Lhe euro area?
W W Luro area Luro area AusLrla 8elglum
Cyprus llnland lrance
Cermany Creece lreland
lLaly Luxembourg MalLa
neLherlands orLugal
Slovakla Slovenla Spaln
W W LU Member States ob||ged to LU Member States ob||ged to
adopt the euro eventua||y adopt the euro eventua||y
8ulgarla Czech 8epubllc
LsLonla Pungary LaLvla
LlLhuanla oland 8omanla
Sweden
W LU Member States w|th an
opt out from adopt|ng the
euro enmark unlLed
klngdom
nCn MLM8L8S Cl Lu8CZCnL
Cf Lhe members of Lhe Luropean unlon Lo
whlch parLlclpaLlon ln Lhls lnnovaLlon was
resLrlcLed enmark Sweden and Lhe uk chose
noL Lo lnLroduce Lhe euro ln place of Lhelr exlsLlng
currencles
1he uk wlLhdrew from Lhe LMS Cne of Lhe
causes of Lhls was Lhe subsLanLlal flow of shorL
Lerm caplLal from Lhe uk where lnLeresL raLes
were relaLlvely low Lo Cermany whlch was
lmplemenLlng a very LlghL moneLary pollcy and
hence had very hlgh lnLeresL raLes
Pow does a counLry [oln Lhe euro?
W A Member SLaLe musL fulflll Lhe convergence
crlLerla" lald down by Lhe MaasLrlchL 1reaLy
% Low lnflaLlon
% Low lnLeresL raLes
% Low governmenL deflclL
% Low governmenL debL
% SLable exchange raLe (L8M ll)
WhaL are Lhe beneflLs of Lhe euro?
WCI1I2LNS benef|t from qreoter price tronsporency
wh|ch shou|d st|mu|ate competition and reduce
prices and from the e/iminotion of currency
exchonqe costs
WIor 8USINLSSLS |t |s eas|er to make |nvestment
dec|s|ons (no exchonqe rote risk)
W1he LCCNCM benef|ts from price stobi/ity and
|ack of exchonqe rote risk
Countr|es that adopt the euro can no
|onger change the|r IN1LkLS1 kA1L or the|r
LkCnANGL kA1L In a monetary un|on you
cannot have an INDLLNDLN1 MCNL1Ak
CLIC
% 8enef|ts
8educLlon ln LransacLlon cosLs
LllmlnaLlon of Lhe exchange raLe rlsk
CreaLer compeLlLlon leadlng Lo greaLer efflclency
CreaLer lnLegraLlon among Lhe Luropean flnanclal markeLs and
greaLer lnvesLmenL efflclency
lnflaLlon dlsclpllne guaranLeed by Lhe lndependence of Lhe
Luropean CenLral 8ank
llscal dlsclpllne as a requlremenL Lo enLer and sLay ln Lhe sysLem
lncrease Lhe urgency of sLrucLural reforms ln Lurope
CosLs and beneflLs of Lhe Luro
@he euro ond the sinq/e morket @he euro ond the sinq/e morket
W 1he euro ellmlnaLes
currency LransacLlons cosLs
W Leads Lo greaLer prlce
Lransparency prlce
convergence
W LllmlnaLes exchange raLe
uncerLalnLy sLlmulaLes
lnvesLmenL
W Luro leads Lo lncreased
Lrade and lnvesLmenL flows
Cne markeL one money"
lAC1C8S AllLC1lnC LxCPAnCL 8A1LS
W lour facLors are ldenLlfled as fundamenLal
deLermlnanLs of Lhe real euro Lo dollar
exchange raLe
W 1he lnLernaLlonal real lnLeresL raLe dlfferenLlal
W 8elaLlve prlces ln Lhe Lraded and nonLraded
goods secLors
W 1he real oll prlce
W 1he relaLlve flscal poslLlon
Lconomlc pollcy maklng Lhe euro
area and Lhe uS
MoneLary pollcy
lederal 8eserve Chalrman
8en S 8ernanke
LC8 resldenL
!eanClaude 1rlcheL
llscal pollcy
1reasury SecreLary
1lmoLhy CelLhner
Lurogroup llnance MlnlsLers
Economic policy co Economic policy coordination more difficult? ordination more difficult?
1he Luro Area Lconomlc SlLuaLlon
noL Cood!
#eal annual change
unless otherwise stated
2008 2009 2010
#eal GDP growth 0.8 -4.0 -0.1
InIlation 3.3 0.4 1.2
Unemployment rate
(percentage oI labor Iorce)
7.5 9.9 11.5
Source Luropean Commlsslon Sprlng lorecasL May 2009
Why ls Lhe euro area so affecLed?
W uS and euro area economles are
closely connecLed
W Many Luropean banks boughL
securlLles Lled Lo uS subprlme loans
W Cerman exporLs have fallen sharply
W Spanlsh and lrlsh houslng bubbles
have bursL
W Luro area economy ls less flexlble
has lower producLlvlLy growLh
W Lxposure Lo LasLern Lurope?
1oLo l don'L Lhlnk we're ln
kansas anymore"
C8LLk C8lSlS
W 8efore one Lo could even Lhlnk of Lhe end of
greaL recesslon of 2008 Creece gave blrLh Lo
anoLher crlsls
W Creece debL crlsls ls acLually an evoluLlon of Lhe
global crlsls
W Creece allowed deflclLs from CenLral bank and
governmenL bonds Lo plle up`
W Creece debL came Lo llghL ln 2009
Cu88Ln1 C8lSlS
W 1he Luropean debL crlsls came lnLo llmellghL wlLh Creece
W 1hls was done by Lhe new governmenL who Look charge
afLer Lhe general elecLlons
W Shocklng role of Coldman Sachs ln Lhe fraud
W new governmenL revealed Lhe facLs whlch acLually
happened ln whlch Lhe prevlous governmenL had overspenL
and also reporLed a debL whlch ballooned Lo 127 of Lhe
C
C8LLCL A1A
W Creece has Lhe hlghesL deflclL of 136 of C
or euro 324bn(as of Aprll 2010)
W 8udgeL deflclL hlghesL ln Lhe world
W ebL Lo C raLlo 113
W ebL C raLlo 2
nd
hlghesL ln Lu
W ebL of euro 216bn (as on [an 2010)
Lurope's response Lo Lhe crlsls
Tle ECB ieduces inieiesi iaies io
lisioiically low levels (i.:%) and begun
"quaniiiaiive easing"
Dec o: EU goveinmenis adopi
Euiopean Economic Recoveiy Plan - a
cooidinaied fiscal siimulus
Oci o: euio aiea goveinmenis adopi
conceiied aciion plan io suppoii ileii
financial sysiems
8AlLCu1 ACkACL
W Creece was ln urgenL requlremenL of funds
and on Aprll 23
rd
lL approached lMl and
Lu8CZCnLS asslsLance ln form of 8allouL
package
W CondlLlon for funds from lMl was LhaL Lhe
economy musL lmplemenL Auster|ty
measures
W Lu lMl agreed Lo 110bn Luros(80bn Luros
from Lu 30bn Luros from lMl)
CCn18CvL8SlLS
W ubllc proLesL ln Creece due Lo lmplemenLaLlon
of ausLerlLy measures
W roLesLs and pressure from oLher Luropean
naLlons malnly Cermany(46 ln Lu)because
Lhe debL load ls hlLLlng Lhe mark of 121 of
C
W owngradlng of Creece bonds Lo [unk sLaLus
8y S
LllLC1S
W SLock markeLs plummeLed
W ShorL Lerm borrowlng raLes had hlL levels of 38
W ?leld premlum wldens owlng Lo lncreased cosL
of borrowlng for Creece
W epreclaLlon of currency
8LSCuL8S
W Cermany Lhe largesL euro member because
of Lhe feellng LhaL lL could lead Lo worsenlng
of slLuaLlon Lo Lhe oLher Lurope naLlons
W lMl by fundlng Lhe ballouL packageLu for
provldlng SLCl AL u8CSLvLPlCLLS(Sv)of
euro 440bn + 60bn(for emergencles)
CCnCLuSlCn
W lallure of Creek flnanclal sysLem wlll beneflL Lhe uS Lreasurles
W Pelp uS Lo correcL lLs own flnanclals
W Creek govL LargeLs publlc debL Lo a llmlL of 60and deflclL Lo 3
W Creece announces lncrease ln Laxes and spendlng cuLs Lo conLrol
deflclL
W Lu8C counLrles wlll fund Creece wlLh Lerms seL by LC8
W lMl can provlde more funds lf aL all requlred