CH20Optimum-Currency-Areas-and-the-European-Experi

Chapter20OptimumCurrencyAreasandtheEuropeanExperienceSlide20-2Copyright©2003PearsonEducation,Inc.ChapterOrganizationHowtheEuropeanSingleCurrencyEvolvedTheEuroandEconomicPolicyintheEuroZoneTheTheoryofOptimumCurrencyAreasTheFutureofEMUSummarySlide20-3Copyright©2003PearsonEducation,Inc.IntroductionEuropeanUnioncountrieshaveprogressivelynarrowedthefluctuationsoftheircurrenciesagainsteachother.•ThisculminatedinthebirthoftheeuroonJanuary1,1999.Thischapterfocusesonthefollowingquestions:•HowandwhydidEuropesetupitssinglecurrency?•Willtheeurobegoodfortheeconomiesofitsmembers?•HowwilltheeuroaffectcountriesoutsideoftheEuropeanMonetaryUnion(EMU)?•WhatlessonsdoestheEuropeanexperiencecarryforotherpotentialcurrencyblocks?Slide20-4Copyright©2003PearsonEducation,Inc.IntroductionFigure20-1:MembersoftheEuroZoneasofJanuary1,2001Slide20-5Copyright©2003PearsonEducation,Inc.Table20-1:ABriefGlossaryofEuronymsHowtheEuropeanSingleCurrencyEvolvedSlide20-6Copyright©2003PearsonEducation,Inc.HowtheEuropeanSingleCurrencyEvolvedEuropeanCurrencyReformInitiatives,1969-1978•TheWernerreport(1969)–Itsetoutablueprintforthestage-by-stagerealizationofEconomicandMonetaryUnionbyproposingathree-phaseprogramto:–Eliminateintra-Europeanexchangeratemovements–CentralizeEUmonetarypolicydecisions–LowerremainingtradebarrierswithinEurope•TwomajorreasonsforadoptingtheEuro:–ToenhanceEurope’sroleintheworldmonetarysystem–ToturntheEuropeanUnionintoatrulyunifiedmarketSlide20-7Copyright©2003PearsonEducation,Inc.TheEuropeanMonetarySystem,1979-1998•Germany,theNetherlands,Belgium,Luxemburg,France,Italy,andBritainparticipatedinaninformaljointfloatagainstthedollarknownasthe“snake.”–Mostexchangeratescouldfluctuateupordownbyasmuchas2.25%relativetoanassignedparvalue.–ThesnakeservedasaprologuetothemorecomprehensiveEuropeanMonetarySystem(EMS).•EightoriginalparticipantsintheEMS’sexchangeratemechanismbeganoperatingaformalnetworkofmutuallypeggedexchangeratesinMarch1979.HowtheEuropeanSingleCurrencyEvolvedSlide20-8Copyright©2003PearsonEducation,Inc.•Capitalcontrolsandfrequentrealignmentswereessentialingredientsinmaintainingthesystemuntilthemid-1980s.–Afterthemid-1980s,thesecontrolshavebeenabolishedaspartoftheEU’swider“1992”programofmarketunification.•DuringthecurrencycrisisthatbrokeoutinSeptember1992,BritainandItalyallowedtheircurrenciestofloat.•InAugust1993mostEMScurrencybandswerewidenedto±15%inthefaceofcontinuingspeculativeattacks.HowtheEuropeanSingleCurrencyEvolvedSlide20-9Copyright©2003PearsonEducation,Inc.GermanMonetaryDominanceandtheCredibilityTheoryoftheEMS•Germanyhaslowinflationandanindependentcentralbank.–Italsohasthereputationfortoughanti-inflationpolicies.•CredibilitytheoryoftheEMS–ByfixingtheircurrenciestotheDM,theotherEMScountriesineffectimportedtheGermanBundesbank’scredibilityasaninflationfighter.–InflationratesinEMScountriestendedtoconvergearoundGermany’sgenerallylowinflationrate.HowtheEuropeanSingleCurrencyEvolvedSlide20-10Copyright©2003PearsonEducation,Inc.HowtheEuropeanSingleCurrencyEvolvedFigure20-2:InflationConvergenceWithinSixOriginalEMSMembers,1978-2000Slide20-11Copyright©2003PearsonEducation,Inc.TheEU“1992”Initiative•TheEUcountrieshavetriedtoachievegreaterinternaleconomicunityby:–Fixingmutualexchangerates–Directmeasurestoencouragethefreeflowofgoods,services,andfactorsofproduction•TheprocessofmarketunificationbeganwhentheoriginalEUmembersformedtheircustomsunionin1957.•TheSingleEuropeanActof1986providedforafreemovementofpeople,goods,services,andcapitalandestablishedmanynewpolicies.HowtheEuropeanSingleCurrencyEvolvedSlide20-12Copyright©2003PearsonEducation,Inc.EuropeanEconomicandMonetaryUnionIn1989,theDelorsreportlaidthefoundationsforthesinglecurrency,theeuro.•Economicandmonetaryunion(EMU)–AEuropeanUnioninwhichnationalcurrenciesarereplacedbyasingleEUcurrencymanagedbyasolecentralbankthatoperatesonbehalfofallEUmembers.HowtheEuropeanSingleCurrencyEvolvedSlide20-13Copyright©2003PearsonEducation,Inc.•ThreestagesoftheDelorsplan:–AllEUmembersweretojointheEMSexchangeratemechanism(ERM)–ExchangeratemarginsweretobenarrowedandcertainmacroeconomicpolicydecisionsplacedundermorecentralizedEUcontrol–ReplacementofnationalcurrenciesbyasingleEuropeancurrencyandvestingallmonetarypolicydecisionsinaESCBHowtheEuropeanSingleCurrencyEvolvedSlide20-14Copyright©2003PearsonEducation,Inc.•MaastrichtTreaty(1991)–ItsetoutablueprintforthetransitionprocessfromtheEMSfixedexchangeratesystemtoEMU.–ItspecifiedasetofmacroeconomicconvergencecriteriathatEUcountriesneedtosatisfyforadmissiontoEMU.–ItincludedstepstowardharmonizingsocialpolicywithintheEUandtowardcentralizingforeignanddefensepolicydecision.HowtheEuropeanSingleCurrencyEvolvedSlide20-15Copyright©2003PearsonEducation,Inc.•EUcountriesmovedawayfromtheEMSandtowardthesinglesharedcurrencyforfourreasons:–GreaterdegreeofEuropeanmarketintegration–SameopportunityasGermanytoparticipateinsystem-widemonetarydecisions–Completefreedomofcapitalmovements–PoliticalstabilityofEuropeHowtheEuropeanSingleCurrencyEvolvedSlide20-16Copyright©2003Pearso