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 % 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