European Monetary Union

Evolution of the EU

• 1951: European European Steel and Coal Community.

• 1957: European Economic Community, the ‘Common Market’

• 1967: Becomes the EC with a European Parliament.• 1979: ERM is launched.• 1993: The Single Market• 1993: Maastricht Treaty – the EU• 2002: 12 countries adopt the euro• 2004: Expansion of EU to include 25 countries

The Single Market

• The free movement of goods, services, people and capital.

• No barriers to trade.

• The EEC was a customs union.

• EEC established the CAP.

• Single Market measures came into effect in 1993.

Benefits of a Single Market

• TRANSACTION COSTS: A number of non – tariff barriers had built up. It was expected that the removal of these would reduce the cost of trade.

• ECONOMIES OF SCALE: Larger markets should equate to larger economies of scale.

• MORE COMPETITION: This may lead to more efficieny

European Monetary System

• 3 Features: ECU, ERM, EMCF.• ECU: a composite currency• ERM: a ‘parity grid’ system. Fluctuations allowed

(2.25%)If diverges beyond this, central bank intervention.If this continues, can consider realignment.

• EMCF: a forerunner to ECB. Mainly to allow credit facilities to allow member countries to support their exchange rates.

The ERM

• There was initially many reallignments (high French and Italian inflation)

• 1987 – 1992: Growing convergence between members

• By 1990 seen to be a success.

The UK and the ERM

• Initially against joining the ERM because:• UK had a higher ‘endemic’ inflation rate.• UK an oil exporter.• UK set monetary targets which meant

allowing interest rates to fluctuate.• BUT, by the late 1980’s, e/r volatility seen

as bad, inflation down and oil no longer such an important part of BOP.

The UK and the ERM

• Joined ERM in 1990 at DM 2.95

• 6% band for fluctuations.

• BUT economy went into recession and inflation fell.

• Interest rates needed to fall.

• BUT – would push £ to bottom of band.

Progression to EMU

• As the 1990’s progressed, economies of EU were converging.

• Maastricht Treaty criteria:• Monetary Policy• Inflation: no more than 1.5% above the average of 3

lowest 3 countries• Interest and Exchange Rates: No more than 2% above

the average of 3 lowest.• Fiscal Policy: Budget deficit to be no larger than 3%

of GDP and national debt no larger than 60% of GDP.

Progression to EMU

• 11 countries met the Maastricht criteria.

• Exchange rates permanantly fixed in Jan 1999, and the euro came into operation on 1 January 2002.

Advantages of EMU

• Reduced exchange rate costs

• Greater price transparency

• More trade / economies of scale

• Inward investment

• Macro-economic management

• Longer term agenda

Disadvantages of EMU

• Transition costs

• Loss of policy independence

• Structural problems

• Loss of political sovereignty