The European Monetary Union EMU The road to

The European Monetary Union (EMU)

The road to EMU • EMU is the latest step on the road towards greater integration in Europe. • Monetary union in the European Community (EC) was proposed as long ago as 1970 in the Werner Report, which envisaged it being in place by 1980.

The road to EMU • However, two key developments in the international sphere derailed this first attempt: 1. The breakdown of the Bretton Woods system of fixed exchange rates in August 1971, and 2. The 1973 oil crisis.

The road to EMU • The first attempt by the EC to deal with the exchange rate turbulence that followed both of these events, the socalled “snake, ” rapidly collapsed to an arrangement involving only a few of the Member States. Upper limit Lower limit

The road to EMU • The second attempt, the European Monetary System* (EMS), created in 1979, proved more durable, although it too was accompanied by a number of major and minor crises. • * Main elements: Exchange Rate Mechanism + ECU

"Britain and Europe" • “. . . let me make clear, from the outset, that monetary union is fundamentally a political rather than an economic issue. It necessarily involves the deliberate pooling of national sovereignty over important aspects of public policy, in the interest not just of collective economic advantage, but of a perceived wider political harmony within Europe. ” Governor of the Bank of England, 2000

The road to EMU • The Treaty did three things to further monetary integration in Europe. 1. It set out a timetable for the establishment of monetary union. 2. It laid down the criteria by which the fitness of countries to join in monetary union would be determined.

The road to EMU 3. It established the institutional framework for the conduct of monetary policy under EMU.

The three stages of monetary union Stage One: July 1, 1990. • The complete elimination of capital controls among the Member States and increased cooperation between their central banks.

The three stages Stage Two: January 1, 1994. • The real beginning of the transition to EMU with the establishment of the European Monetary Institute (EMI). • EMI = precursor of the European Central Bank, charged with co-ordinating monetary policy and preparation for the single currency.

The three stages Stage Three: January 1, 1999. • Eleven countries fixed their exchange rates. • The national currencies of the eleven were replaced by the euro. • The ECB took over responsibility for monetary policy in the euro area.

The three stages Stage Three A: • The initial period of monetary union during which the notes and coins of each of the participating states continue to circulate as non-decimal representations of the euro.

The three stages Stage Three B: • Begins with the introduction of euro notes and coins and the withdrawal of national currencies on January 1, 2002. • By July 1, 2002 the old national currencies ceased to have legal tender status.

The convergence criteria • Essentially all of the EU members satisfied the bulk of the criteria for participation in EMU. • However, Denmark and the United Kingdom did not participate in the first round, having negotiated “derogations”, even though they satisfied most of the criteria.

The convergence criteria • Likewise Sweden did not participate. • The only country that wished to participate but failed to meet the convergence tests was Greece (joined in 2001) • New member states need to meet euro acquis and Slovenia, Malta, Cyprus and Slovakia have now joined the EMU, too.

Monetary policy under EMU • EMU fundamentally changes the way in which monetary policy is conducted in the participating states. • Responsibility for monetary policy shifted from national central banks to the ECB on January 1, 1999.

Click on this logo to take you to a brochure which explains the operations of the ECB. (C) The ECB

The Euro and the UK

The Chancellor’s 5 Economic Tests • 1. Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis? • 2. If problems emerge is there sufficient flexibility to deal with them?

The 5 tests • 3. Would joining EMU create better conditions for firms making long-term decisions to invest in Britain? • 4. What impact would entry into EMU have on the competitive position of the UK's financial services industry, particularly the City's wholesale markets?

The 5 tests • 5. In summary, will joining EMU promote higher growth, stability and a lasting increase in jobs?

Employment and growth • The fundamental test is how Britain's membership of a successful single currency would affect prospects for British employment. • The assessment concludes that membership of EMU has the potential to enhance both growth and employment prospects.

Business and the Euro

Euro Impact The euro means big changes for business both within these countries and throughout Europe: • Cheaper transaction costs – countries in the euro zone do not have to change currencies when doing business with each other.

Impact • Exchange rate certainty – sharing a single currency means countries in the euro zone are no longer affected by currency fluctuations when trading with each other.

Impact • Transparent price differences – it is more obvious if different euro zone countries charge different prices for the same goods and services.

Strategic issues Increased cross-border competition: • Businesses who want to export into the euro zone may be at a disadvantage against competitors within the zone who share the same currency as the importer.

Strategic issues Cross-border mergers and other joint ventures: • Increased competition might make mergers within the euro zone more likely, and • sharing the single currency may also make them easier.

Strategic issues Distribution and purchasing: • May become simpler and cheaper inside the euro zone, because businesses there will not have to worry about exchange rate risk when trading with each other.

Strategic issues Raising finance: • Firms may have more choice since bond and equity markets may be more attractive in euros.

Strategic issues Pricing: • Companies may have to decide whether to set new pricing points. • The same price is unlikely to be as ‘attractive’ in euros as in the old national currencies

Pricing points • 499 DM = € 255. 30 • Lower price - € 249. 99? • Higher price - € 259. 99? • Fr. F 999 = € 152. 30

Practical issues • Firms based in, or who deal with the eurozone need to make practical changes.

Readings • The UK and the Euro • EMU INFORMATION HM Treasury • Euro case study: Siemens