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Mr. Massimo M Beber Senior Tutor College Lecturer in Economics Sidney Sussex College Cambridge CB2 3HU

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Presentation on theme: "Mr. Massimo M Beber Senior Tutor College Lecturer in Economics Sidney Sussex College Cambridge CB2 3HU"— Presentation transcript:

1 Mr. Massimo M Beber Senior Tutor College Lecturer in Economics Sidney Sussex College Cambridge CB2 3HU Arts, Humanities and Social Sciences Summer School 2013 One Market, One Money? The Economics and Politics of European Monetary Union ( )


3 Europe – A Phase Chronology 1945-51: “hegemon-led integration” (Marshall Plan, OEEC-OECD, EPU) 1951-1973: “Golden Age regionalism” (ECSC to EEC – customs union, single market in agricuture and coal/steel, first MU blueprint – Werner and MacDougall Reports) 1973-1984 “devil take the hindmost” 1985-1999: “one market, one money” 2008-?? “Make (banking & fiscal union) or Break”

4 Landmarks en route to EMU Jul-50The European Payments Union begins its operation, facilitating clearing of intra-European payments Dec-59With the generalized introduction of "external convertibility", the Bretton Woods system of fixed exchange rates begins to operate. Dec-69At the first European Summit in The Hague, the heads of state and government commission the "Werner Report" on a possible European Monetary Union (George Pompidou and Willi Brandt as French President and German Chancellor respectively). Dec-71The Smithsonian Agreements effectively signal the demise of the international monetary order based on the "dollar standard".The Agreements included (1) a devaluation of the US $ against other currencies; (2) the abolition of the fixed link between dollar and gold, substituted by one with the SDR; (3) wider fluctuation bands (4.5%). Dec-72After 9 months of operation of the "snake in the tunnel", European Summit adopts the goal of economic and monetary union. Dec-78European Council's resolution on "creating a zone of monetary stability in Europe". Mar-79The European Monetary System (EMS) begins to operate on the basis of an agreement between central banks. Britain does not join the Exchange Rate System (ERM) of the EMS, and remains a floating currency. Jul-85Palermo Agreement between Central Bank Governors: the ERM "hardens". Jun-89The Madrid European Council endorses the Delors Report commissioned a year earlier at the Hanover Council. Jun-90Dublin European Council establishes two ICGs (on political as well as economic and monetary union), with the aim of having new treaties ratified by December 1992. Oct-90The UK joins the ERM weeks before Mrs Thatcher's removal from office. Sep-92"Black Wednesday": Britain, Italy and France suspend their membership of the narrow-band ERM Feb-92Following political agreement in Rome (11-12th December 1991), the Maastricht Treaty on Economic and Monetary Union is signed and ratified in all member countries during the rest of the year. Jan-93Stages One of the Convergence to EMU begins, leading through Stage Two to the choice of irrevocable parities and the 1998 Convergence Report, leading to the approval of 11 member countries for initial EMU membership. Jan-99EMU Stage Three launched: national currencies remain in circulation at their irrevocably fixed exchange rate against the euro - effectively, as non-rounded denominations of the same monetary unit. Jan-01Conversion of national currencies into Euro notes and coins.

5 TRADE-OFFS IN THE INTERNATIONAL FINANCIAL ARCHITECTURE Monetary and Macroeconomic Sovereignty Stable Real Exchange Rate Free Mobility of Capital A,D B C’’, C C’ A:the Gold Standard as an “anchor” to the price level B: the Bretton Woods compromise C: the German model, Mrs Thatcher’s monetarist experiment C’, C’’: the Keynesians’ Last Hurrah between autarchy and stagflation D:back to the anchor: EMU, currency boards, dollarisation...


7 AVERAGE EU INCOME PER PERSON AS % OF THAT OF USA Source: High Level Group (2004): Figure 1

8 Benefits (1971) EMU: Costs and Benefits Costs and Benefits of monetary union Trade Integration Costs (2010) Benefits (2010) Costs (1971)


10 ΔE(e 1 ) Δi h Δe 0 Floating Exchange Rates and Volatility If total expected returns are quickly equalised by arbitrage... …any change in the exchange rate expected to prevail in the future will generate an immediate change in today’s interest rate and/or exchange rate: expected depreciation causes either an immediate monetary contraction or immediate depreciation

11 Source: Commission of the European Union (2003) Second Progress Report on Economic and Social Cohesion. Communication from the Commission, Brussels, Commission of the European Union: COMM (2003) 34 Final): Maps Income Disparities and EU Widening

12 Delors I Delors II Berlin Agreement




16 From Intermediation to Securitization

17 Source: Lane (2012) “The European Sovereign Debt Crisis”, p. 52. The Single Capital Market at Work (lending to the private sector)

18 Source: Lane (2012) “The European Sovereign Debt Crisis”, p. 53. The Single Capital Market at Work (external borrowing)

19 while Germany is running a big trade surplus with the rest of the eurozone which Germany's private sector is no longer willing to finance, transfers of one sort or another are inevitable. But no-one should be under any illusions about how difficult this is for politicians to explain to their electorates, even if they understand themselves. In the public's eyes and in the minds of many politicians, a trade surplus just shows that their country is more competitive. What could be wrong with that? Simon Tilford, July 2012 The Single Capital Market Frozen

20 The Lender of Last Resort (LLR) Liquidity: money back today Solvency: money back in full The fire-sale problem “to lend freely on good security at a time of crisis” (Walter Bagehot, Lombard Street)

21 The central bank creates its own IOUs. As a result it does not need equity at all to support its activities. Central banks can live without equity because they cannot default. The only support a central bank needs is the political support of the sovereign that guarantees the legal tender nature of the money issued by the central bank. This political support does not need any equity stake of the sovereign. In fact it is quite ludicrous to believe that governments that can, and sometimes do, default are needed to provide the capital of an institution that cannot default Paul De Grauwe (July 2012) The Politics of Lending of Last Resort

22 Eurozone Sovereign Debt Crisis: Greece Focus on ECB’s liquidity management 2007-9 October 2009 – Greek general election Budget revises deficit from 6 to 12.7% of GDP Earlier years’ budgets (and thus debt) also revised up Rising cost of servicing debt forces first Greek bailout in May 2010

23 Eurozone’s Sovereign Debt Crisis: continued Ireland (November 2010) Portugal (April 2011) Greece again (March 2012) Spain, Cyprus (June 2012)

24 EUROPEAN REDEMPTION (GSP MK II) in November 2011, the GCEE suggested a bridge between short-term stabilisation and long-term governance: The European Redemption Pact, one element of which is the European Redemption Fund. In fact, the European Redemption Pact (henceforth “the Pact”) rests on three pillars, (i) a European Redemption Fund (henceforth “the Fund”), relying on mutualizing part of Eurozone debt; (ii) the Fiscal Compact, in particular a commitment to national debt brakes preferably at the constitutional level; and (iii) the installation of a crisis resolution mechanism, with provisions for the possible involvement of the private sector in future crises. Bofinger, July 2012

25 In contrast to the central banks of the US, the UK and Japan, the ECB is not allowed to finance treasuries in the member states. It cannot therefore act as a lender of last resort for governments. This dividing line between monetary and fiscal policy was drawn by the Maastricht Treaty to ensure price stability and, given the experience with monetisation of fiscal deficits in Europe’s history, should remain in place. But it induces an implicit insolvency risk for investors financing sovereign debt of EZ countries... Peter Bofinger, July 2012 ECB’S COSTLY INDEPENDENCE

26 The trouble with consolidation The “denominator effect” of low growth, low inflation limit the “natural” fall in debt-to-GDP ratios “Adjustment fatigue” leads to protests “Financial repression” within the single market is increasingly difficult – residents cannot be forced to buy government bonds Persistent, significant risk praemia raise the cost of servicing existing debt in the Eurozone’s periphery

27 European Financial Stability Facility Established in 2010 to avoid another “Greece I” bailout (Euro 110bn hard to cobble together) Hopes that it would merely deter bank runs by its existence Yet needed for Ireland and Portugal within months Euro 440bn not enough

28 The Banking Union Proposal A true banking union removes all national differences in the policy and regulatory environments in which banks operate Crisis Prevention – Regulation – Supervision Crisis management: LLR Crisis resolution: bailing in/out


30 Adjustment I: price flexibility

31 Adjustment II: FDI – Perhaps, but...

32 Adjustment III: Migration – really? “either poor countries will become richer, or poor people will move to rich countries. Actually, these two developments can be seen equivalent. Development is about people: either poor people have ways to become richer where they are now, or they can become rich by moving somewhere else. “ (Milanovic 2012)

33 Fiscal transfers? Not really (yet?) we frown upon the transmission of family- acquired wealth to offsprings if two different individuals belong to the same nation [but] we take it as normal that there is a transmission of collectively acquired wealth over generations within the same nation, and if two individuals belong to two different nations, we do not even think, much less question, such acquired differences in wealth, income and global social position. (Milanovic 2012)

34 European policy-makers have been reluctant to accept that the eurozone's decentralised nature makes it an inherently unstable currency union that forces its constituent states and 'their' banks into a pernicious and deadly embrace. On the face of it, all that changed at the June 29 summit, when member- states agreed to consider establishing a banking union. Among the features of such a union would be: a shared supervisory authority; a collective deposit protection scheme for the currency union; and a common resolution framework for dealing with weak banks.... The idea of a banking union is sometimes spoken of as an easier route to 'mutualisation' (or federalisation) than issuing common debt – partly, the reasoning goes, because citizens do not understand what a banking union entails. Philip Whyte, July 2012 CAN THE EU FACE THE TRUTH?

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