European Monetary Integration
The subject of European Monetary Union(EMU) is an important and controversial issue facing the members of the European Union, as the date for monetary union quickly approac hes. While politicians and diplomats meet to go forward with the formal arrangements for a single European currency, at the grass roots level there is still considerable anxiety on the part of average EU citizens. Will convergence bring economic prosperit y, or will the measures required for entry into the EMU further depress the already stagnant job market in much of Europe? These and other difficult questions will have to be addressed as plans for one of the world’s largest regional trading blocs moves ahead
Introduction to the European Monetary System (EMS)
The Exchange Rate Mechanism (ERM)
The European Currency Unit (ECU)
Cooperative Central Banking
Basket of Currencies for the ECU
Institutions involved in European Monetary Integration
History and Timetable of European Monetary Union
Introduction to the European Monetary System
The purpose of the European Monetary System (EMS), which was established in 1979, is to stabilize exchange rates between the currencies of member states in the European Union.
In the past years, the EMS has helped to strengthen cooperation among the countries of Europe in the area of monetary policy. It has also had a disciplinary effect on the monetary and financial policies of the EU member states.
All members of the EU are in the EMS, and most of them are in the Exchange Rate Mechanism (ERM) as well.
The ERM fixes the central rates for each currency.
Since 2 August 1993, currency market rates have been allowed to fluctuate up to a maximum of 15 percent either side of the central rate. If greater fluctuations are imminent, the national central banks are obliged to buy or sell the cu rrencies affected and thus stabilize the exchange rates. If the economic trend so requires, the central rates can be adjusted by means of a unanimous decision of the EU finance ministers and central bank governors. Obviously, the EMS binds only the ex change rates of the participating countries. The rates with other currencies, such as the dollar or the yen, fluctuate freely on the currency markets.
Within the EMS there is a European Currency Unit (ECU) which serves as a link and unit of account between member currencies. The ECU is not a currency in itself, however, but a „basket“ of the currencies of 12 of t he presently 15 EU states which contains, for instance, 62 German Pfennigs, 1.33 French Francs and 152 Italian Lira. These amounts are no longer adjusted. Under the Treaty on European Union, the composition of the ECU basket was frozen.
In December 1991 a treaty was concluded in Maastricht by the then 12 EG states pursuant to which a European Economic and Monetary Union is to be completed by 1999 at the latest. Before they can participate in the final stage, states must fulfill strict criteria (stable prices and exchange rates, low interest rates, sound public finances). Participants in the Monetary Union have undertaken to transfer their monetary sovereignty to a politically independent European Central Bank, the foremost objective of which will be to maintain price stability. At the EU summit in Madrid in December 1995, it was resolved that the new European currency be called the „Euro“. The new Eurocash is to replace the nati onal currencies in the year 2002.
European Monetary Union will have numerous advantages. German exporters will no longer be at a disadvantage vis-á-vis their European competitors in the European internal market and in the markets of non-EU states as a result of devaluation of their compet itors’ currencies. Companies will have a reliable basis on which to plan; tourists will not have to exchange currency, which means their holidays will be cheaper; the European currency can become a more important world reserve currency than is presently t he case; and competition intensified by greater transparency in prices will improve the efficiency of the European economies. This will make it possible to safeguard present jobs and create new ones.
Exchange Rate Mechanism (ERM)
The Exchange Rate Mechanism, which forms the core of the EMS, provides a means for stabilizing exchange rates between member states of the ERM.
Each ERM currency has a specified fixed central rate of exchange relative to the ECU basket. Bilateral central rates as well as the current upper and lower fluctuation limits are derived from the ECU central rates. The fluctuation limits also serve as man datory intervention limits. Central banks can however – if they so wish – intervene before bilateral rates reach their intervention points.
When the EMS was established in 1979, all then member states of the EU except the UK joined the ERM. Spain joined the ERM in 1989 and Portugal in 1992; Greece is not yet a member. The UK joined in 1990 but was forced to withdraw from the ERM, along with I taly, in autumn 1992.
The fluctuation margins were ± 2.25 per cent except for the Italian lira, UK pound, Spanish peseta and Portuguese escudo, which were assigned margins of 6 per cent around their central rates. In 1990 the Italian lira was assigned the narrow margins. Following the currency crisis of August 1993, the margins for all ERM currencies were widened to ± 15 per cent. Now, the only exchange rate with margins of ± 2.25
per cent is that between the Deutschemark and the Dutch guilder as per bilateral a greement.
A change of a central rate in the ERM requires preparation of the matter in the EU’s Monetary Committee and negotiations with the finance ministers of the EMS member states and with the EU Commission. The last change in the parity grid took place in March 1995 when the Spanish peseta was devalued by 7 per cent and the Portuguese escudo by 3.5 per cent.
European Currency Unit ECU
Use of the ECU began in 1979. The ECU basket included a specified amount of each EU member currency. The amounts were based on the respective strengths of the economies involved. The composition of the ECU basket was frozen in March 1993 so that the curre ncies of new members, including Finland, are not included. This is, however, of no significance because a central rate for a currency can be defined against both the ECU and each of the other currencies, even though that currency is not included in the ECU basket.
The ECU basket, ie the official ECU, is not a freely traded currency. It is instead a payment and accounting unit for payment transactions between central banks. The ECU will be removed from use when the euro is launched on 1 January 1999.
In addition to the official ECU there is the private ECU created by commercial banks, which is freely exchanged in the various markets. Private ECUs are used on the basis of contracts in which the parties agree that payment is to be made in ECUs.
The values of the official and private ECUs can differ from each other although they generally change in the same direction. The official ECU is the weighted average of the currencies included in the ECU basket whereas the value of t he private ECU is determined by market supply and demand like any other commercially used currency.
Cooperative central bank financing facilities
The cooperative central bank financing facilities are administered by the European Monetary Institute (EMI). There are three of these:
Very Short-Term Financing (VSTF)
Short-Term Monetary Support (STMS)
Medium-Term Financial Assistance (MTFA).
Very Short-Term Financing is the ERM central banks’ mutual intervention financing facility, through which a central bank can automatically obtain loans for supportive selling when the rate approaches a fluctuation limit. The loans are granted by the centr al bank whose currency is approaching its ‘strong’ limit. Loans for interventions well within the fluctuation margins are always subject to approval of the lending central bank.
Short-Term Monetary Support is designed for financing temporary balance of payments deficits; any EMS member state can apply for this type of support.
Medium-Term Financial Assistance can be granted to an EMS state for 2-5 years in case of serious balance of payments problems.
ECU basket weights in September, 1996.
Because of the roundings the sum of the weights does not add up to 100.0.
European Monetary Union(EMU)
The Institutions that make it happen
The following are links to informative articles published on the official European Union Web server : Europa. Most of the formal Institutions of the EU are involved with EMU in one form or another, but the European Commision is in charge of the majority of policy formation on monetary affairs for the Union. The European Parliament
is the directly-elected democratic expression of the political will of the peoples of the European Union, the largest multinational Parliament in the world.
The Committee on Economic and Monetary Affairs and Industrial Policy
Council of the European Union
is usually known as the Council of Ministers, and has no equivalent anywhere in the world. Here, the Member States legislate for the Union, set its political objectives, coordinate their national policies and resolve differences between themselves and with other institutions.
European Commission – Bulletin of the EU
identifies three distinct functions: initiating proposals for legislation, guardian of the Treaties, and the manager and executor of Union policies and of international trade relationships.
Economic and Monetary Policy
• The Union’s Policies
• The Road to Economic and Monetary Union
• Single Currency – Commissions Green Paper
• On the Political Agenda – Next Steps to Integration
• Directorate General II of the European Commision – Economic and Financial Affairs – Official ECU Exchange Rates
• Directorate General XV
• Commission Adopts Single Market Action Plan for Amsterdam European Council
• Communication on the Impact and Effectiveness of the Single Market
Court of Justice
provides the judicial safeguards necessary to ensure that the law is observed in the interpretation and application of the Treaties and, generally in all of the activities of the Union.
Court of Auditors
is the taxpayers’ representative, responsible for checking that the European Union spends its money according to its budgetary rules and regulations and for the purposes for which it is intended.
European Investment Bank
is the European Union’s financing institution, it provides loans for capital investment promoting the Union’s balanced economic development and integration.
Economic and Social Committee (in French)
follows a purely consultative role, but its opinions derive their authority from a membership which is drawn from a broad
cross-section of the Union’s social and economic life.
Committee of the Regions
is the European Union’s youngest institution whose birth reflects Member States’ strong desire not only to respect regional and local identities and prerogatives but also to involve them in the development and implementation of EU policie
– The success of the common market calls for convergence of the Member States’ monetary policies, and an internal market in the full sense of the term includes monetary union.
– Monetary integration is a factor for economic cohesion and solidarity between the Member States; for a united Europe, it is an asset in relations with the outside world.
1. First period (1957-1969): absence of a European monetary project
The Rome Treaty laid down only minor provisions for monetary cooperation. The six founding Member States of the Community were participants in the Bretton Woods international monetary system, which was characterised by fixed exchange rates and possibilities of adjustment. The creation of a parallel system was unnecessary.
2. Second period (1969-1979): the first efforts towards integration
The demise of the Bretton Woods system, confirmed by the ending of the dollar’s convertibility into gold on 15 August 1971, was followed by a general floating of the currencies. With the oil crisis of the early 70s, the European currencies came under even greater pressure. In the face of such general monetary instability, the cause of serious economic and social difficulties, the Member States sought to put in place a framework which could provide a minimum of stability, at least at European level, and which could lead to monetary union.
a. Back in 1969, when the international monetary system was threatening to collapse, the Heads of State and Government had already decided at the Hague Summit that the Community should progressively transform itself into an economic and monetary union.
b. In October 1970, the Werner report (drawn up by the then Prime Minister of Luxembourg) proposed:
for the first stage, a reduction of the fluctuation margins between the currencies of the Member States;
for the second stage, the achievement of a complete freedom of capital movements with integration of the financial markets, and particularly of the banking systems;
for the final stage, an irrevocable fixing of exchange rates between the currencies.
c. In 1972 the „snake in the tunnel“ narrowed the fluctuation margins between the Community currencies (the snake) in relation to those operating between these currencies and the dollar (the tunnel). To ensure the proper operation of this mechanism, the Member States created in 1973 the European Monetary Cooperation Fund (EMCF) which was authorised to receive part of the national monetary reserves.
d. The results of this mechanism were disappointing. The disruptions provoked by the rise in oil prices caused the economic policies of the Member States in the 70s to react in diverse ways. This led to frequent and sharp fluctuations in exchange rates. There were entrances and exits from the exchange stability mechanism and the snake, originally designed as an agreement of Community scope, was reduced to a zone of monetary stability around the German mark.
e. By the end of 1977, only half of the nine Member States (Germany, Belgium, the Netherlands, Luxembourg and Denmark) remained within the mechanism, the others having allowed their currencies to float freely. The Werner Plan was abandoned the same year.
3. Third period (from 1979): the successful resumption of the integration process
a. Instigated by the German Chancellor Helmut Schmidt and the French President Valéry Giscard d’Estaing, the Brussels Summit of December 1978 decided to set up a European Monetary System (EMS). It aimed to create a zone of monetary stability in Europe by reducing fluctuations between the currencies of the participating countries. It was put into operation in March 1979 (* 5.2.0).
b. The establishment of the internal market led the Community to revive the objective of monetary union. The Hannover European Council (June 1988) pointed out that ‘in adopting the Single Act, the Member States of the Community confirmed the objective of progressive realisation of economic and monetary union’. It entrusted to a committee chaired by Jacques Delors, Commission President, and comprising Frans Andriessen, Commission Vice-President, the Governors of the Central Banks of the twelve Member States and three independent experts, ‘the task of studying and proposing concrete stages leading towards this union’.
c. In April 1989 the report of the Delors Committee envisaged the achievement of EMU in three stages: the objective set for the first stage, between June 1990 and January 1992, was to step up cooperation between central banks; the second stage included the establishment of a European System of Central Banks (ESCB) and the progressive transfer of decision-making on monetary policy to supranational institutions; in the third stage, the national currencies would have their convergence rates irrevocably fixed and would be replaced by the European single currency.
The Madrid European Council of June 1989 adopted the Delors Plan as a basis for its work and decided to implement the first of these stages from 1 July 1990, when capital movements in the
be liberalised completely. In December the European Council decided to convene an intergovernmental conference to prepare the amendments to the Rome Treaty in view of EMU.
d. Approved by the European Council of December 1991, the amendments proposed by the intergovernmental conference were incorporated in the Treaty on European Union signed at Maastricht on 7 February 1992. (For the achievement of EMU: * 5.3.0 and 5.4.0) The Treaty’s EMU project was based on the general outlines of the Delors Plan but differed from it on some significant points. In particular the second stage did not begin until 1 January 1994 and did not include the transfer of responsibilities for monetary policy to a supranational body but simply the strengthening of cooperation between central banks, replacing the former Committee of Governors with the European Monetary Institute which would be responsible, with the Commission, for the technical preparation of EMU. Establishment of the ESCB was deferred to the third stage.
e. In December 1995 the European Council in Madrid named the single currency the euro, and set 1 January 1999 as the date for the start of the third stage. It also adopted the scenario for introduction of the euro (* 5.3.0).
f. The European Council in Amsterdam in June 1997 adopted the Stability and growth pact, designed to ensure budgetary discipline during the third stage (* 5.3.0).
g. The same European Council adopted the principles and fundamental elements of a new exchange-rate mechanism to regulate relationships between the euro and the currencies of those Union Member States which would not be taking part in monetary union (* 5.2.0).
h. In accordance with the Treaty of Maastricht (* 5.3.0) the European Council in Brussels decided on 2 May 1988, following the recommendation of the Commission and the Economic and Financial Affairs Council („Ecofin“) and Parliament’s opinion, that 11 countries — Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain — would take part in the third stage of EMU.
i. On the 1st January 1999 the 11 countries chosen joined the European Monetary Union. Greece has subsequently applied for membership and was admitted. It will officially join the EMU on 1 January 2001.
General aspects of European Monetary Integration
The Monetary, Economic and Statistics Department (MESD) plays an important role in fulfilling the tasks of the European Monetary Institute (EMI). In particular, my Department is responsible for economic and statistical aspects of preparatory work for Stage Three. However, I will adopt a slightly different focus, and concentrate on topics related to the remaining work of the Department.
More specifically, the aim of my remarks is, first, to give some historical background information on the process of European monetary integration, and then to consider three general economic aspects of European monetary integration in which MESD plays an active part. These are policy co-ordination in Stage Two, the issue of convergence and the EMI’s role in the process and, finally, consideration of some of the economic issues raised by the plan for EMU. I shall conclude with a personal view of prospects for EMU.
History and timetable of EMU