Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

The European Monetary Union (EMU)|some brief notes

by Ronald Rutherford Sat Jun 2nd, 2007 at 04:18:53 PM EST

Sorry if this is not completely polished, but I wanted to see if there was anything I may be missing or some other areas of research I should look at...

Explain and discuss the principles of monetary unions in the light of European experience.

The first step in creating a monetary union is the setup of a currency bloc which is defined as when the currencies of all the countries are united by fixed exchange rates. This is hard to do at first so `Snakes' are usually set up that maintain the exchange rates within bands usually defined as a percent change.  In addition member countries attempt to follow compatible macroeconomic policies through policy coordination. This was used by most Western European countries during the 1970's.
Eventually a single currency can replace the individual ones, and this arrangement becomes a monetary union. This system though must have coordinated monetary and fiscal policies encompassing all members. And in the system one state usually assumes the leadership role and as the key currency within the system (trading currency). For the EU experience it was the German State (especially in monetary policy) that members attempted to follow and the Deutschemark was the key currency during the process.


The European Monetary System (EMS) was setup during the 1980's to arrange for co-operation between members through Exchange Rate Mechanism. ERM attempted to stabilize the cross exchange rates of a wider group of countries and again tied to the Deutschemark.

But some setbacks came when Britain abandoned fixed exchange rages with its partners in 1992.

Hierarchy of the three types of coordination: 1. exchange of information 2. acceptance of mutually consistent policies and 3. joint action. This is versus coordination with no implied significant modification of national policies and thus little more that `consultation'.

In 1971, the Snake (other EEC (European Economic Community) countries) in the Tunnel (USA exchange rate) and Belgium/Netherlands being the worm inside the snake.
In 1979, the European Monetary System was established to provide a `zone of monetary stability'. The ERM consisted of two parts: 1. bilateral exchange-rate bands (parities) 2. individual currency band against the ECU. The grid in #1 required mutual agreement to make changes and thus Finance Ministers of the currencies participating in the ERM decided these issues.

The ECU was a weighted basket of the 12 member currencies, and from this was an `indicator of divergence'.  The idea was that it would single out the currency that was diverging from the average agreed parities before bilateral action was required, which in essence was an alarm bell to tell which country needed to take action.
The EMS also established the European Monetary Cooperation Fund (EMCF) where members deposited 20% of their gold dollar reserves in exchange for ECUs that were to be used for exchange market interventions instead of the US dollar. And like any other bank members could draw upon the funds to defend their exchange-rate parities and manage transitory BoP problems.

Results of EMS: Exchange Rate Stability, Anti-Inflation Zone.

Two main components of a Monetary Union; an exchange-rate union and complete capital market integration. More specifically the former means that the countries agree to no margin of fluctuation and thus by all intents and purposes creates a single currency. Complete market integration means that all obstacles to free movement of financial capital are removed and that financial capital is treated equally in all member states.

Implicit requirements: members harmonize their monetary policies, single union central bank, and central bank needs to be invested with a pool of reserves of third-country currencies (US dollars, Japanese Yen...).


A History of the Road to European Monetary Union:

The Rome Treaty of 1957 created the European Economic Community (No Monetary Union) and a priority was the creation of a customs union. The CU involved the adoption of a common tariff policy for third party countries and removal of trade barriers between members.

Hague Summit in 1969 the 6 agreed in principle to establish complete economic and monetary union commencing 1971 and expected completed by 1980. This set up the Werner Report (1972) which the main result was the snake in the tunnel which failed by 1978. This was because of the wide differences in how the economy was handled in each country as a result of the oil crisis and external supply shocks to the system of embargoes. Single European Act (1986) was aimed to create a single market by 1992. Delors report (1989) broadly outlined a proposal for achieving EMU which was initiated by the EEC in 1988 and was to commence in three stages:

  1. Greater cooperation and coordination in fiscal and monetary policies as well as removal of financial integration which was the creation of a `Single Market project'. (90-93)
  2. Phase II was the readying of the eventual permanent fixing of exchange rates and the amendment of the Treaty of Rome which resulted in the signing of the Maastricht Treaty. Established the European Monetary Institute which was to assist progress on economic convergence (European System of Central Banks) and make preparations for the final phase (Statute of the E Central Bank, European System of Central Banks). (1994)
  3. Creation of a single monetary policy set by the ECB. 1999

Some acronyms used:
European Union (EU), European Monetary Union (EMU), Exchange Rate Mechanism (ERM), European Currency Unit (ECU), European Monetary Fund (EMF).

Display:
Why have a single currency when you can have a common currency?

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sat Jun 2nd, 2007 at 05:08:28 PM EST
That's the second time you say that today and I don't know what the difference is. Can you explain?

Can the last politician to go out the revolving door please turn the lights off?
by Migeru (migeru at eurotrib dot com) on Sat Jun 2nd, 2007 at 05:09:49 PM EST
[ Parent ]
Common currency is when you have a common currency and keep your own.

Single currency is when you get rid of your own.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Jun 2nd, 2007 at 05:27:30 PM EST
[ Parent ]
Are you thinking that this is this somehow related to "dollarization" of a country?

Rutherfordian ------------------------------ RDRutherford
by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Sat Jun 2nd, 2007 at 05:34:45 PM EST
[ Parent ]
I'm interested in generic clearing mechanisms and "fungibility".

I'm interested in what forms of value (as opposed to the "anti-value" issued by banks) are capable of crossing borders and what forms of value are naturally bound domestically.

I'm interested in how Mahathir put two fingers up to the global financial system - imposing restrictions on the movement of capital out of Malaysia - and thereby saving his currency form the "locusts".

And much more.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Jun 2nd, 2007 at 06:23:26 PM EST
[ Parent ]
Well I did just happen to have the following PDF on my reading list...
http://www.uta.edu/faculty/crowder/papers/Chapter18.pdf

It has on page 13 (of PDF) a section on Currency Substitution.

Rutherfordian ------------------------------ RDRutherford

by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Sat Jun 2nd, 2007 at 08:33:40 PM EST
[ Parent ]
The ECU was a common currency, but the problems with "a common currency keeping your own" include 1) the inconvenience and expense of currency exchange; 2) the inefficiency of periodic exchange rate revisions compared to freely floating currencies; 3) the fact that commitments by central banks to keep their exchange rates within certain bands with freely floating currencies makes them predictable and therefore vulnerable in the currency markets.

I suppose one could have the Euro circulating alongside freely-floating national currencies. The value of the Euro could be constructed as a currency index. The system wouldn't be vulnerable to attack on the financial markets, but I think people across Europe would still find it inconvenient to convert back and forth.

Can the last politician to go out the revolving door please turn the lights off?

by Migeru (migeru at eurotrib dot com) on Sun Jun 3rd, 2007 at 02:15:44 AM EST
[ Parent ]
A plague on the Euro, and all deficit-based currencies.

I'm interested in the concept of a new Euro as a "European energy unit": in energy grids across the Baltic and North Seas and across the Mediterranean, both of which already have the initial elements in place.

National currencies?

Simply base them upon property rental values, as John Law envisaged three hundred years ago.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Jun 3rd, 2007 at 04:15:03 AM EST
[ Parent ]
I think the problem with a scheme such as that, is why tie your economic growth based on one segment of the economy. Just as the Gold Standard tied the inflation rate to amount of gold mined and on the market.

As an economy is in transition then GDP per dollar of energy consumption has decreased over time-including in the USA.

But, keep working this through...

Rutherfordian ------------------------------ RDRutherford

by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Sun Jun 3rd, 2007 at 07:36:52 PM EST
[ Parent ]
Transaction costs.
by nanne (zwaerdenmaecker@gmail.com) on Sun Jun 3rd, 2007 at 07:19:27 AM EST
[ Parent ]
But some setbacks came when Britain abandoned fixed exchange rages with its partners in 1992.

No love may have been lost there, but the fact is that Britain was forced out by Soros.

Nice article, by the way.

Can the last politician to go out the revolving door please turn the lights off?

by Migeru (migeru at eurotrib dot com) on Sat Jun 2nd, 2007 at 05:12:52 PM EST
Thanks.
I know I was tempted to go down my road to how I love...
I mean despise Soros.

Rutherfordian ------------------------------ RDRutherford
by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Sat Jun 2nd, 2007 at 05:37:10 PM EST
[ Parent ]
Britain was forced out of the system because it came in at an unsustainable exchange rate out of stupid pride reasons and was not willing to make the efforts necessary to adjust.

Germany came in the euro at a too high rate for stupid pride reasons but was willing (and, this being the euro and not the EMU, forced,  barring a much bigger European crisis) to make the efforts to readjust its competitivity.

You may consider that Britain made the correct economic choice to devalue rather than to restrain wages and growth, in which case Soros whould not be "blamed" but congratulated, but either way, he was only the bringer of information, not the cause of the crisis.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Jun 3rd, 2007 at 04:05:20 AM EST
[ Parent ]
Um. Not entirely accurate. On the timescale in question, there was no way that any policy changes were going to head off what Soros did.

Now we know, but we didn't then, that the capital flows private speculators can bring to bear are on the same order of size as those of central banks.

by Metatone (metatone [a|t] gmail (dot) com) on Sun Jun 3rd, 2007 at 06:24:52 AM EST
[ Parent ]
private capital flows have an influence when there is a widespread perception that the currency is mispriced, and thus that efforts (by the Central Bank) to defend the existing rate will ultimately fail - and thus that it is a good bet to bet against them.

But that can only happen when there is such a mispricing, which comes from an uncontestable price differential, which has built up over time, as rates of inflation between countries diverge.

Soros was only the canary, or the nudge, that the pound was overpriced. Private speculators cannot overwhelm a centrla bank unless there is a real underlying reason to do so.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Jun 3rd, 2007 at 07:36:18 AM EST
[ Parent ]
Um. no, it's not. There was a quantitative change in the environmental conditions. But if you're determined to rewrite history on this matter there's not much point in continuing the discussion.

I don't dispute that they picked the wrong price to defend. But, that's not what you said. You said they were not prepared to make the efforts to adjust, where other countries did.

I think you'll find little evidence to support that assertion over the timescale (12-18 months) that we are talking about. UK fiscal policies were tightened and recession was created. Some countries devalued and re-entered the ERM (e.g. Italy) where others did their adjusting inside the shelter of the Euro (Germany), which is a much different exchange rate issue.

by Metatone (metatone [a|t] gmail (dot) com) on Sun Jun 3rd, 2007 at 08:08:27 AM EST
[ Parent ]
Metatone, nice succinct explanation of what others did during the time frame.
Strange that Jerome is not concerned about the major contractions in the economy of the UK but sees the slightest hiccup in the housing markets in the USA and makes a big deal about it.

I wonder how much he would have felt if his job was lost because of the contraction in the economy due to Soros (et al).

I wonder how Jerome feels about the other canaries like Vulture Capitalists.


Rutherfordian ------------------------------ RDRutherford

by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Sun Jun 3rd, 2007 at 07:54:38 PM EST
[ Parent ]


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]