the european monetary system and the crea;on of the euro€¦ · george alogoskouﬁs,...

GeorgeAlogoskoufis,Interna'onalFinance,2016

TheEuropeanMonetarySystemandtheCrea;onof

theEuroProf.GeorgeAlogoskoufis

FletcherSchool,TuAsUniversity


TheCrea;onoftheEuropeanMonetarySystem(EMS)

• TheEuropeanMonetarySystem(EMS)wascreatedin1978inordertoensurerela;velystableexchangeratesintheEuropeanCommunity(EECnowEU).

• Thisstabilitywasaprerequisitefortheeffec;vefunc;oningoftheCommuni;es’othermechanisms,suchasthefreeintra-Communitytrade,theCommonAgriculturalPolicy(CAP),regionalandstructuralpolicyand,morerecently,theSingleMarketProgramme.

• Theini;a;vebelongedtotheFrench-GermanaxisandarrangementswereagreedintwoEuropeanCouncilsinBremeninJuly1978andinBrusselsinDecemberofthesameyear.

2


TheStructureoftheEuropeanMonetarySystem

• EuropeanCurrencyUnit(ECU)

• ExchangeRateMechanism(ERM)

• FinancingFacili;es

• ExchangeRateRealignments

3


TheECUandBilateralExchangeRates

• ThefirstelementoftheEMSwastheEuropeanCurrencyUnit,theECU,definedasaweightedaverageoftheCommuni;es’sna;onalcurrencies.

• Foreachna;onalcurrencyacentralratewassetagainsttheECU.

• Foranytwocurrencies,thera;ooftheircentralratesagainsttheECUprovidedtheircentralbilateralexchangerate,andtotalofbilateralcentralratesdefinedtheparitygridofthesystem.

4


TheExchangeRateMechanism

• ThesecondelementofthesystemwastheExchangeRateMechanism(ERM).

• Forcurrenciespar;cipa;ngintheERM,na;onalcentralbanksundertooktomaintainmarketratesagainstanyothercurrencyinthesystemwithinpredeterminedlimitsrela;vetothebilateralcentralrates.Theselimits,un;l1993,were±2.25%.Forsomecurrencies,widerlimitswereallowed,i.earangeof±6%.

5


ExchangeMarketInterven;ons

• Exchangemarketinterven;onshadtotakeplacewhenabilateralratereachedthebandlimit,andinvolvedbothofthecentralbanksconcerned.Thesewerecalledmarginalinterven;ons.Withregardtomarginalinterven;ons,thecentralbankofthestrongestcurrencyundertooktoprovidethecentralbankoftheweakercurrencywithunlimitedcredit,aAerthela`erhadusedallofitsforeignexchangereservesinthatcurrency.

• Intra-marginalinterven;onsalsotookplace,bythecentralbankoftheweakercurrency.Thesewerenotcompulsory,andrequiredtheapprovalofthecentralbankwhosecurrencywasusedintheinterven;ons.

• Thewasalsoadivergenceindicator,whichdidnotplayanessen;alrole.

6


FinancingFacili;es• ThethirdelementoftheEMSwerethefinancingfacili;es,whichweredividedintothreetypes:

• 1.TheVeryShortTermFinancingFacility,2.TheShortTermMonetarySupportand3.TheMediumTermFinancialAssistance.

• Themanagementofthefirsttwobelongedtothejurisdic;onofCentralBanks,whilethethirdwasunderthejurisdic;onoftheCouncilofMinisters.

• TheShortTermMonetarySupportprovidedshort-termcreditsforfinancingdeficitsinthebalanceofpayments,whiletheVeryShortTermFinancingFacilitywasaimedatfinancinginterven;onswithintheExchangeRateMechanism.

7


ExchangeRateRealignments• ThefourthandfinalelementoftheEMSweretheperiodicrealignmentsofbilateralcentralpari;es.

• Ini;allythedecisiontoreadingthecentralpari;eswasunilateral,butlater,aAer1981,collec;vedecisionswererequiredwithintheCommunity’sMonetaryCommi`eeandtheECOFINCouncil.

• AAer1981,realignmentsdidnotcoverthefullinfla;ondifferen;albetweenthecurrencybeingdevaluedandtheothercurrencies.

8


HowtheEMSWorked?• TheEMSreducedfluctua;onsinnominalandrealexchangeratesinEurope,thuscontribu;ngtoexchangeratestability.

• However,despiteitssymmetricaldesign,theEMSoperatedasymmetrically.

• AsymmetriescamefromthefactthatGermanmonetarypolicywassystema;callymorerestric;vethaninothereconomiespar;cipa;nginthesystem,andbythefactthattheDMwasaninterna;onalcurrencytoamuchgreaterextentthantheothercurrenciesoftheEuropeanUnion.

9


ABroadDMZone• Themorerestric;vemonetarypolicyoftheGermanBundesbankledtotheneedforintra-marginalinterven;onsbyothercentralbanks.Thus,monetarypolicybecamemorerestric;veinallthecountriesthatpar;cipatedinthesystem.Otherwise,thepressureonweakercurrencieswasstrongandresultedintheneedforrealignment(devalua;on)oftheirexchangerates.

• Becauseofcollec;vedecisionsforrealignments,devalua;onsincountrieswithloosemonetarypolicyandhighinfla;on,wasneverequaltothecumula;veinfla;ondifferen;albetweentheeconomywiththeweakcurrencyandGermany.Thus,Germanywasbecomingmoreandmorecompe;;ve.Between1986and1992,realignmentsvirtuallyceased.

• TheEMSbecameinabroadDMzone,wheremonetarypolicywasdeterminedessen;allybythepolicyofBundesbank.Therestofthesystem"borrowed"thean;-infla;onaryreputa;onoftheBundesbank,andthustherestofthecountriesendedupwithlowinfla;on.

• Atthesame;me,Germanywasgainingincompe;;veness,asithadlowerinfla;onthantherestandanyrealignmentsdidnotfullycoverthisinfla;ondifferen;al.Consequently,allcamewithsomethingoutofthesystem,withGermanyprobablywithmoreasitwasgainingincompe;;venessandwasthefocusofthesystem.

10


ThePathTowardstheEuro• Theini;a;veforthecrea;onofthesinglecurrencybelongedtoFrance,whichearlyin1988,withamemorandumoftheMinisterofFinancetohisEECcolleaguesproposedthemarchtowardsthesinglecurrency.ItalyagreedimmediatelyandGermanyhadnoop;onbuttoagreeaswell.

• TheEuropeanCouncilinHanoverinJune1988setupaneight-membercommièe,chairedbyJacquesDelors,thenPresidentoftheEuropeanCommission,whichwouldstudythemaèr.TheCommièe,inApril1989,submièdareporttotheCouncilofFinanceMinisters(ECOFIN)proposingathreestageprocessforcrea;ngasinglecurrency.

11


TheThreeStagesTowardsMonetaryUnion

• Thefirststageenvisagedcapitalaccountliberaliza;onforthecountriespar;cipa;ngintheEMS,un;lJuly1990.Nocountrywouldbeallowedtomaintaincapitalcontrols.

• Thesecondstage,whichbeganonJanuary1,1994,aimedatthegreatestpossibleconvergenceoffiscalandmonetarypoliciesofEUmemberstates,asenvisagedintheMaastrichtTreatyof1992,inordertoachievefiscalconvergenceandpricestability,whichweredeemednecessaryandsufficientcondi;onsformonetaryintegra;on.

• Thethirdstagewasthemonetaryunionitself,whichwouldtransferallmonetarypolicydecisionstoanindependentEuropeanCentralBank.

12


TheMaastrichtTreatyandtheEuro

• Inlate1991,aAeranintergovernmentalconference(IGC),allEECmemberstatessignedinMaastrichtinHollandtheTreatyonEuropeanUnion.

• Underthistreaty,theEECwasrenamedEuropeanUnion,andinaddi;ontotheSingleMarketprogram,EECmembersagreedonadetailed;metableandcondi;onsforadop;ngthesinglecurrency.

• Thedeadlinesfortheintroduc;onofthenewcurrencywereadoptedbytheMadridEuropeanCouncilinDecember1995.ThisCouncilalsodecidedthatthe"euro"wouldbethenameforthesinglecurrency.

13


TheTimetablefortheAdop;onoftheEuro

• The;metables;pulatedthatun;lJanuary1,1994theEUwouldcompletethesinglemarketandallna;onalparliamentswillhavera;fiedtheMaastrichtTreaty.

• Italsoprovidedfortheprohibi;onofmonetaryfinancingofbudgetdeficits,theliAingofallrestric;onsonthemovementofcapitalandprepara;onforpar;cipa;onintheExchangeRateMechanismoftheEuropeanMonetarySystemforthecountriesthatwerenotpartofit,aswellasthepoli;calindependenceofcentralbanks.

• Whenthesecondi;onsweresa;sfied,thesecondstageofEconomicandMonetaryUnion(EMU)wouldbegin.

14


TheConvergenceCriteria• TheMaastrichtTreatyontheEuropeanUnionalsoprovidedfortheadop;onoftargetsfor1.reducingbudgetdeficitsbelow3%ofGDP,2.reducingpublicdebtbelow60%ofGDPand3.reducinginfla;onandnominalinterestratesclosetotheaverageofthethreecountrieswiththelowestinfla;onrates.

• Achievingtheseobjec;veswasconsideredasaprerequisiteforacountrytopar;cipateinthethirdstageofEMU.

• TheEuropeanCommissionandtheEuropeanCentralBankwouldjudge,insocalledConvergenceReports,whetheracountrydidordidnotsa;sfythesecriteria.

15


PressuresontheExchangeRateMechanism

• Thesecondasymmetryofthesystemresultedfromtheinterna;onalposi;onoftheGermanmark,whichwasaninterna;onalreservecurrency,unlikeothercurrenciesintheEMS.ThismeantthattherewerepressuresintheERM,whenthereweredisturbancesininterna;onalfinancialmarketsaffec;ngtheexchangerateofthedollarortheyen.

• ThesedisturbancescausedgreaterchangesindemandandsupplyforDMsinrela;ontootherEuropeancurrencies,resul;nginsignificantpressureonthebilateralexchangeratesofeuropeancurrenciesagainsttheDM.

• TheERMfacedconsiderablepressuresinsuchperiods,suchas1981-1983,orin1986.Thesepressuresleadtorealignmentsofcentralpari;es.

16


The1992-93Crisis• Thecompleteaboli;onofcapitalcontrolssincetheearly1990smadetheERMextremelyvulnerable,asdemonstratedbythespecula;vea`acksofSeptember1992andAugust1993.

• Aseriesofadverseshocksbrokedownthedefensemechanismsofthesystem,suchasthemechanismforcoordina;ngmacroeconomicpoliciesandtherealignmentofexchangerates.

• InSeptember1992,thecredibilityoftheERMwastested,andthesystemcouldnotstandthepressures.BoththeItalianliraandtheBri;shpoundceasedtopar;cipateintheERM.

• AAerayearofrealignmentsandperiodiccrisesun;llateJuly1993,andfollowingfurtherpressureontheexchangeratesofweakercurrencies,theECOFINdecidedtoextendthefluctua;onmarginsto±15%,inordertodefusepressures.

17


FactorsthatContributedtothe1992-93Crisis

• Firstly,Germanunifica'on,whichtransformedGermanyfromanetcreditortonetborrowerintheglobaleconomy.

• Second,USmonetarypolicy.In1992,duetotheelec;onsandtherecessionintheUS,monetarypolicywasmorerelaxed,andthedollarenteredintoadeprecia;onpathagainsttheDM,thatincreasedpressuresontheERM.

• Thirdly,thepoli'calcrisisinItaly.Thistookplaceata;mewhentherewasalargeincreaseinthefiscaldeficitandpublicdebt,whichcausedacrisisofconfidenceandspecula;vepressuresontheItalianlira.

• Fourth,thenega'veresultofthereferenduminDenmarkonthera;fica;onoftheMaastrichtTreaty,theprospectoftheFrenchreferendumandtheambiguousaDtudeofpoli'ciansinGreatBritain,causedgeneralcrisisofconfidenceinthesystemandintheprocessofEconomicandMonetaryUnion.

18


FF/DMExchangeRate

19

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.0001957.01

1957.11

1958.09

1959.07

1960.05

1961.03

1962.01

1962.11

1963.09

1964.07

1965.05

1966.03

1967.01

1967.11

1968.09

1969.07

1970.05

1971.03

1972.01

1972.11

1973.09

1974.07

1975.05

1976.03

1977.01

1977.11

1978.09

1979.07

1980.05

1981.03

1982.01

1982.11

1983.09

1984.07

1985.05

1986.03

1987.01

1987.11

1988.09

1989.07

1990.05

1991.03

1992.01

1992.11

1993.09

1994.07

1995.05

1996.03

1997.01

1997.11

1998.09

FFDMExchangeRate


ITL/DMExchangeRate

20

0.00

200.00

400.00

600.00

800.00

1000.00

1200.00

1400.001957.01

1957.11

1958.09

1959.07

1960.05

1961.03

1962.01

1962.11

1963.09

1964.07

1965.05

1966.03

1967.01

1967.11

1968.09

1969.07

1970.05

1971.03

1972.01

1972.11

1973.09

1974.07

1975.05

1976.03

1977.01

1977.11

1978.09

1979.07

1980.05

1981.03

1982.01

1982.11

1983.09

1984.07

1985.05

1986.03

1987.01

1987.11

1988.09

1989.07

1990.05

1991.03

1992.01

1992.11

1993.09

1994.07

1995.05

1996.03

1997.01

1997.11

1998.09

ITLDMExchangeRate


£/DMExchangeRate

21

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

0.400

0.450

0.5001957.01

1957.11

1958.09

1959.07

1960.05

1961.03

1962.01

1962.11

1963.09

1964.07

1965.05

1966.03

1967.01

1967.11

1968.09

1969.07

1970.05

1971.03

1972.01

1972.11

1973.09

1974.07

1975.05

1976.03

1977.01

1977.11

1978.09

1979.07

1980.05

1981.03

1982.01

1982.11

1983.09

1984.07

1985.05

1986.03

1987.01

1987.11

1988.09

1989.07

1990.05

1991.03

1992.01

1992.11

1993.09

1994.07

1995.05

1996.03

1997.01

1997.11

1998.09

£DMExchangeRate


$/DMExchangeRate

22

0.000

0.100

0.200

0.300

0.400

0.500

0.600

0.700

0.8001957.01

1957.11

1958.09

1959.07

1960.05

1961.03

1962.01

1962.11

1963.09

1964.07

1965.05

1966.03

1967.01

1967.11

1968.09

1969.07

1970.05

1971.03

1972.01

1972.11

1973.09

1974.07

1975.05

1976.03

1977.01

1977.11

1978.09

1979.07

1980.05

1981.03

1982.01

1982.11

1983.09

1984.07

1985.05

1986.03

1987.01

1987.11

1988.09

1989.07

1990.05

1991.03

1992.01

1992.11

1993.09

1994.07

1995.05

1996.03

1997.01

1997.11

1998.09

$DMExchangeRate


Infla;oninFranceandGermany

23

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%1956.01

1957.04

1958.07

1959.10

1961.01

1962.04

1963.07

1964.10

1966.01

1967.04

1968.07

1969.10

1971.01

1972.04

1973.07

1974.10

1976.01

1977.04

1978.07

1979.10

1981.01

1982.04

1983.07

1984.10

1986.01

1987.04

1988.07

1989.10

1991.01

1992.04

1993.07

1994.10

1996.01

1997.04

1998.07

1999.10

2001.01

2002.04

2003.07

2004.10

2006.01

2007.04

2008.07

2009.10

2011.01

2012.04

2013.07

2014.10

2016.01

France Germany


Infla;oninItalyandGermany

24

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%1956.01

1957.04

1958.07

1959.10

1961.01

1962.04

1963.07

1964.10

1966.01

1967.04

1968.07

1969.10

1971.01

1972.04

1973.07

1974.10

1976.01

1977.04

1978.07

1979.10

1981.01

1982.04

1983.07

1984.10

1986.01

1987.04

1988.07

1989.10

1991.01

1992.04

1993.07

1994.10

1996.01

1997.04

1998.07

1999.10

2001.01

2002.04

2003.07

2004.10

2006.01

2007.04

2008.07

2009.10

2011.01

2012.04

2013.07

2014.10

2016.01

Italy Germany


Infla;onintheUKandGermany

25

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%1956.01

1957.04

1958.07

1959.10

1961.01

1962.04

1963.07

1964.10

1966.01

1967.04

1968.07

1969.10

1971.01

1972.04

1973.07

1974.10

1976.01

1977.04

1978.07

1979.10

1981.01

1982.04

1983.07

1984.10

1986.01

1987.04

1988.07

1989.10

1991.01

1992.04

1993.07

1994.10

1996.01

1997.04

1998.07

1999.10

2001.01

2002.04

2003.07

2004.10

2006.01

2007.04

2008.07

2009.10

2011.01

2012.04

2013.07

2014.10

2016.01

UK Germany


Infla;onintheUSAandGermany

26

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%1956.01

1957.04

1958.07

1959.10

1961.01

1962.04

1963.07

1964.10

1966.01

1967.04

1968.07

1969.10

1971.01

1972.04

1973.07

1974.10

1976.01

1977.04

1978.07

1979.10

1981.01

1982.04

1983.07

1984.10

1986.01

1987.04

1988.07

1989.10

1991.01

1992.04

1993.07

1994.10

1996.01

1997.04

1998.07

1999.10

2001.01

2002.04

2003.07

2004.10

2006.01

2007.04

2008.07

2009.10

2011.01

2012.04

2013.07

2014.10

2016.01

USA Germany


TheFinalStageofEMU• ThethirdstagebeganonJanuary1,1999byirrevocablyfixingthebilateralexchangeratesofthecurrenciesofthepar;cipa;ngcountriesandthesinglecurrency.,theEuro.

• InMay1998itwasdecidedwhichcountrieswillpar;cipateinthethirdstageofEMU.Theselec;onofthe11countrieswasbasedonthefivefiscalandmonetaryconvergencecriteriaoftheMaastrichtTreaty.

• ThethirdphasewascompletedonJanuary1,2001withtheintroduc;onoftheeuroinaccoun;ngform.

• FromJanuary1,2002theeurobecamelegaltender,withtheintroduc;onofcashineverydaytransac;ons.Onthisday,thecircula;onofbanknotesandcoinsandthegradual(withintwomonths)withdrawalofna;onalcurrenciesbeganthroughouttheEuroArea.

27


TheEuropeanCentralBankandtheStabilityandGrowthPact

• FromJanuary1,2001intheEuroAreaeconomythereisasinglemonetarypolicyforallcountries,decideduponandimplementedbytheEuropeanCentralBank,whichaimstoensurepricestability.

• Acentralpillarofmacroeconomicpolicycoordina;onistheStabilityandGrowthPact(SGP).ThepactrequiresalleconomiesintheEurozoneandtheEUtomaintainfiscaldeficitsbelow3%ofGDP,pursuingbudgetarybalanceoverthemediumtermandtoensurethatpublicdebtdoesnotexceed60%ofGDP,orthatittendstowardsthisobjec;ve.

28


TheImplementa;onoftheStabilityandGrowthPact

• TheStabilityandGrowthPact(SGP)providesforremedialac;onforthoseeconomiesthatdonotmeettheirfiscaltargets.ThePactwasrevisedin2005,aAerseveraleconomies,includingGermanyandFrance,failedtocorrecttheirexcessivedeficits.

• TherevisedPactwasmoreflexibleregardingthe;meavailableforthecorrec;onofexcessivedeficits,butatthesame;memoredemandingintermsofachievingfiscalbalance.

• Countrieswererequiredtotendtowardsfiscalbalance(zerobudgetdeficits)duringsocalled"good;mes”,byreducingtheirdeficitsbyatleast0.5%ofGDPannually.

• AAerthecrisisof2008,theEuropeanCommissionproposedandtheECOFINCouncildecidedtoapplythepactinamoreflexibleway.

29


GovernmentDeficitsintheEuroArea

30

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

DeficitofGeneralGovernment(%ofGDP)


GovernmentDebtintheEuroArea

31

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

DebtofGeneralGovernment(%ofGDP)

the european monetary system and the crea;on of the euro€¦ · george alogoskouﬁs,...

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