Abstract
Numerous political and economic dilemmas have confronted the European Economic and Monetary Union (EMU) since 1989, when it was resurrected by the Delors Report. Some of these dilemmas have eventually faded away as, for example, the ratification difficulties of the Maastricht Treaty (the Treaty on the European Union), while others continue such as the political challenges facing the Maastricht Treaty, the impact of the Exchange Rate Mechanism (ERM) crises, as well as the implications of the admission of new members. Still other problems loom on the horizon as, for example, the institutional and decision-making reforms needed to provide for the efficient functioning of the EMU, the implications of a multi-speed EMU and the effects of the opt-out and of the non-EMU member nations on monetary integration. These past and continuing dilemmas are the subject of this chapter.
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Notes
Measures affecting sovereignty require a two-thirds majority in both the Bundestag and the Bundesrat.
As mentioned in Chapter 1, under the Maastricht Treaty the Council of Ministers was renamed the Council of the European Union as of November 1, 1993. To avoid confusion, the term Council of Ministers will be used throughout this book.
This draft paper was submitted for approval to the European Council at the December 1993 Summit in Brussels.
“Progress Towards Convergence,” European Monetary Institute (EMI), Frankfurt am Main, November 1995 and “Progress Towards Convergence 1996,” European Monetary Institute (EMI), Frankfurt am Main, November 1996.
“Brussels Says EU Must Act on Jobs of Risk Social Unrest.” Financial Times. November 16, 1993. p. 1.
“EC Must Regain Its Street Credibility.” Financial Times. September 22, 1992, p.2.
Denmark has had the right to opt out of the Treaty since its acceptance on February 7, 1992. This, however, was not well known to the Danish citizens prior to the June 1992 referendum.
The Treaty needs unanimous approval by all national parliaments, otherwise it cannot serve as an amendment to the Treaties of Rome.
As in the case of the U.K. with respect to the Social Charter.
The economically weaker member nations such as Greece, Portugal, Spain, Ireland and Italy have ratified the Treaty without delay as they will be the primary beneficiaries of the single currency and of the ECB.
In early November 1992 Major had achieved a very narrow majority in the House of Commons (319 to 316) in support of restarting the Treaty ratification process and also in order to have another vote in early 1993. Although the government had a majority of 21 votes over all other parties, it could not convince 30 Conservative Euroskeptics and had to rely on the support of 19 out of the 20 Liberal MPs.
“Major Survives Maastricht Vote.” Financial Times, November 5, 1992, p.1.
These rates remained high as long as the Bundesbank kept the Lombard and discount rate high because of worries about inflation.
A minor, yet telling, example is that the head of the Bundesbank is paid approximately one-third more than the Federal Chancellor. A more somber example is the Bundesbank’s record in standing up to the various chancellors over the years. Tight monetary policy precipitated the first German post-World War II recession, contributing to Chancellor Ludwig Erhard’s downfall. In 1969, although the Deutsche Mark was eventually revalued according to the Bundesbank’s proposal, the row between the central bank and the government prior to the decision helped reduce Chancellor Kurt George Kiesinger’s re-election chances. In 1981–82, high interest rates expedited Chancellor Helmut Schmidt’s resignation.
Under Chancellor Kohl’s leadership the German government is doing everything possible to meet the 1999 EMU deadline.
Eichengreen, Barry and Jeffry Frieden, eds. The Political Economy of European Monetary Unification. San Francisco: Westview Press, Inc., 1994, p.52.
A post-EMU fiscal “Stability and Growth Pact” was singed at the December 1996 Dublin European Council Summit. See Chapter VI for more details.
For example, the student and union strikes in France during 1995 and 1996 over austere budget cuts and high rates of unemployment. In Germany, Oscar LaFontaine, the leader of the German Social Democratic Party, challenged Chancellor Kohl on the EMU numerous times. See Chapter VI for more details.
It should be noted that asymmetric shocks will In all probability continue and may even increase as the nations strive to meet the Maastricht convergence, in particular the fiscal criteria. The French strikes during December 1995 were a good example of this possibility.
As a condition to its acquiescence in the Maastricht Treaty, the German Constitutional Court has insisted that the “letter” rather than the “spirit of the law” be observed in applying the convergence criteria.
Only EMU central bank governors can belong to the ECB Governing Council, which is a voting body. All 15 EU central bank governors, however, are members of the ECB General Council, which is a non-voting policy discussion forum.
The Be-ne-lux an economic union includes Belgium, the Netherlands and Luxembourg. It was formed in 1948.
This was also the motivation, for the creation of the “Snake” and the EMS/ERM, following the collapse of the Bretton Woods system.
French President François Mitterand shouldered the cost of ERM participation in the early 1980s when his experimentation with socialism was undermined by the Bundesbank’s resistance to French fiscal expansion within the ERM. Mitterand again bore the costs in the early 1990s when in the midst of a French recession and rising double-digit unemployment the Bundesbank raised interest rates that eventually led to the ERM crisis, its semi-collapse and the widening of the bands to +/−15 percent. This was a partial reason for the Socialist loss of the 1993 parliamentary and 1995 presidential elections. The economic costs to Italy were very large despite its late entrance into the narrow +/−2.25 percent ERM band. Ireland also experienced difficult times owing to the ERM constraints in the 1980s. Spain and Portugal realized that they would have to join the narrow ERM band while Greece wanted to join the ERM soon. All knew that the economic costs would be high.
The Cohesion Fund, aimed at reducing economic disparities between member states, provides Ecu 15 billion (US$18.585 billion) over the 1993–99 period. The regulation establishing the Fund requires an indicative allocation of the resources among the four beneficiary countries: Spain: 52 to 58 percent; Greece: 16 to 20 percent; Portugal: 16 to 20 percent; and Ireland 7 to 10 percent. See Chapter III for (a) more details on the Cohesion Fund, (b) a summary of the differences between the Cohesion and Structural Funds, (c) actual disbursements among member nations, and (d) the assistance function of the Cohesion Fund in 1993.
Germany was favored by immigrants because of the liberal asylum laws and the cultural ties of the ethnic Germans who lived in the former Soviet Union. By October 1992, approximately 50,000 refugees were entering Germany every month — a 71 percent increase over 1991 and more than the number that entered the rest of Europe combined. Thus, in December 1992 the major political parties agreed to a modification of the laws, which went into effect in July 1993.
German officials revised their 1989 reunification cost estimates to DM150 billion (US$98 billion) in late 1992. “Germany: A Survey,” Financial Times, October 26, 1992.
Germany’s budget deficit in 1992 was 2.8 percent, in 1993, 3.5 percent, in 1994, 2.4 percent, and in 1995, 3.5. “Progress Towards Convergence 1996”. European Monetary Institute (EMI), Frankfurt am Main, November 1996, p.20.
Although some reunification aid was received through the EU structural fund for the economic transformation of the eastern region of Germany, the Bonn government still continues to pay for most of the financial cost. Moreover, Germany also shoulders the largest financial responsibility, among the EU nations, associated with aiding the transformation of the Central and Eastern European economies.
The Constitutions of Denmark and Ireland required a referendum, while French President Mitterand wanted to use the referendum to capitalize on the mistaken notion that the Treaty had strong popular support.
There are those who argue that attributing the convergence of interest and inflation rates to the success of the ERM is erroneous, as they were converging anyway.
John Williamson argued that to pursue acceptable employment policies countries must achieve exchange rate equilibria, which occurs when the current account surplus or deficit becomes equivalent to the capital flow. (John Williamson. “Fundamental Equilibrium Exchange Rates,” National Institute of Economic and Social Research Review. December 1991.)
Dornbusch, Rudiger. Two-track EMU, Now! In Britain and EMU. Center for Economic Performance in Association with Financial Markets Group, London School of Economics, 1990.
Sir Alan Walters was Chief Economic Advisor to Prime Minister Margaret Thatcher.
Otmar Emminger, 1986, translated by Peter Kenen, in “Capital Controls, The EMS and EMU,” The Economic Journal, 105, Royal Economic Society, London: Blackwell Publishers, January 1995, pp. 181–92.
The reports issued by the EC Monetary Committee and the Committee of Central Bank governors were released to the public by the EU finance ministers and central bank governors at their meeting in Kolding, Denmark on May 22, 1993.
Kenen, Peter. “Capital Controls, The EMS and EMU,” 1995, p. 185. Abstract taken from the actual reports of the Monetary Committee and Committee of Central Banks.
Kenen, Peter. “Capital Controls, The EMS and EMU,” 1995, p.185.
They predicted that reunification would be self-financing in the short run, as it would boost West German growth and thus raise government revenues.
The boom in West Germany was not expected to be inflationary, as the East could provide low-cost labor which would increase output in the West and simultaneously exert downward pressure on West German wages.
It should be noted that most officials, especially those of the Bundesbank, were aware of the potentially harmful fiscal and inflationary consequences of Chancellor Kohl’s policies but recognized political necessity to proceed with reunification.
The monetary union between the Ost-mark and the Deutsche mark took place three months prior to the official dissolution of East Germany on October 3, 1990, a date also known as “Unification Day.”
East German wages and aggregate productivity (GDP per employee) in the 3rd quarter of 1990 reached 39 and 26 percent of West German levels. However, by the first quarter of 1993, East German wages had risen to 70 percent while productivity reached only 42 percent of the West German levels. Temperton, Paul, ed. The European Currency Crisis. Cambridge: Probus Publishing Company, 1993, p.5.
By 1991 approximately 8 million of the 16 million East Germans were either unemployed or employed part-time.
Although West Germany did experience a short-lived economic boom, particularly in the construction sector, the tax revenue generated was not enough to cover the high transfer payments. Despite the 1991 tax increase, the 1993 government deficit rose to its highest level in ten years. During 1991 and 1992, East German subsidies cost West German taxpayers DM150 billion (approximately US$100 billion) annually.
Initially, the 1992 crisis was surrounded by controversy, as there were calls for the temporary suspension of the Deutsche mark from the ERM parity grid until German monetary policy could get back on track. Although the Germans favored this option, others, especially the French, rejected it because they feared a loss of credibility of their own monetary policy during the German absence. The alternative option was a Deutsche mark revaluation within the ERM. However, even with a 1990 or 1992 revaluation in a low inflationary environment, the Bundesbank would probably still have pursued a tight monetary policy to curtail money supply growth and to establish fiscal and wage restraints. This could have made it easier for the other EU member nations to tolerate high interest rates, but neither option was carried out.
The Delors Report was published in April 1989. The October 1990 Rome European Council Summit meeting set the date of standing Stage II of the EMU for January 1, 1994. This called for the establishment of the EMI and for narrower ERM bilateral exchange rate parities. The Maastricht Treaty which set the timetable for Stage II and Stage III, was agreed upon in December 1991 and signed in February 1992.
Italy needed to devalue the lira by approximately 17.4 percent against the ECU to be price competitive as measured by the ERM average.
When the EMS and the ERM were created in 1979, there was an implied commitment by the Bundesbank to support the franc’s parity against the Deutsche mark as long as the French government more or less followed an inflation-free monetary policy (i.e., shadowed the Bundesbank). Using a play on words concerning the location of the Bundesbank, which serves as the supporting arch of the ERM, this policy became known as the “franc-fort” policy. This policy is the backbone of the ERM, as it symbolizes the 40-year-old Paris-Bonn axis on which integration has to be achieved.
Kenen, Peter. “Capital Controls, The EMS and EMU,” 1995, p. 185.
During the early 1990s, (July 1990 in Denmark; June 1991 in France; July 1991 in Belgium; and the late 1980s — 1990s — apart from 1991 — in the Netherlands) interest rates fell below those of Germany. Although some of this could be attributed to the ERM’s success, the effects of German reunification coupled with slow growth rates and the sharp fall in oil prices in 1986 also played a role.
World Economic and Financial Surveys. “International Capital Markets: Part I: Exchange Rate Management and International Capital Flows,” Washington, DC: International Monetary Fund (IMF) Publication, April 1993, p.8.
For example, according to an April 1993 IMF Study, during 1987-1992, the average spread between the one-year lira yield over the corresponding Deutsche mark instrument was almost 5 percent. It was approximately the same for the dollar. (“International Capital Markets: Part I,” IMF, April 1993).
IMF estimates have set the cost of the convergence plays at US$300 billion.
Other tactics for defending ERM parities include: official intervention; the use of existing stocks of international reserves; borrowing from private capital markets; borrowing from the official sector (i.e., the Very Short-Term Financing Facility (VSTF); defensive increases in interest rates; and capital controls.
The ERM II with its new anchor currency, the Euro, was officially proposed during the Verona, ECOFIN Council meeting in April 1996. It was approved during the 1996 Dublin European Council Summit. The ERM II is a transition mechanism to the final phase of Stage III of EMU
These conclusions were reached by the Group of Ten and the IMF in their “International Capital Markets: Part 1,” 1993.
Bofinger, Peter and Collighon, Stefan, Johnson Christopher and Bertrand de Maigret. The EMS in Transition. A study prepared for the EU Parliament. Paris: Association for the Monetary Union of Europe, July 1993.
Bishop, Graham. “Is There a Rapid Route to an EMU of the Few?” Economic and Market Analysis, London: Solomon Brothers, 1993.
Henning, Randall C., Eduard Hochreiter, and Gary Clyde Hufbauer. Reviving the European Union. Washington, DC: Institute of International Economics and the Austrian National Bank, 1994.
In Henning, Randall C. et al.. Reviving the European Union, 1994.
Article 6.4, EMI Protocal, Maastricht Treaty, 1992.
Article 6.4, EMI Protocal, Maastricht Treaty, 1992.
Article 109(j) of the Maastricht Treaty states that member nations’ currencies must meet the “normal” fluctuation margins of the ERM for at least two years without devaluing against any other member currency. Initially, when the Treaty was approved “normal” fluctuation margins pertained to the +/−2.25 percent currency bands of the ERM. It should be noted that in the aftermath of the ERM crises and the subsequent widening of the currency bands to +/−15 percent, the EU regards +/−15 percent as “normal” during the EMU’s 1997 membership review.
“Pact sets rules for ins and outs of ERM”. Financial Times. December 17, 1996, p.2.
Temperton, Paul, ed. The European Currency Crisis, 1993.
Fratianni, Michele and Jürgen von Hagen. “The Transition to European Monetary Union and the European Monetary Institute.” In Eichengreen, Barry and Jeffry Frieden, eds. The Political Economy of European Monetary Unification. San Francisco: Westview Press, 1994, pp. 129–48. The following section is based on the above-mentioned study.
However, a multi-currency monetary union would require that the various central banks engage in more lender-of-last-resort activities and introduce more regulations than would be needed in a single currency union. The lack of credibility of such a monetary union would tend to hinder financial market integration.
The majority of central banks are shifting away from using reserve requirements as a monetary policy tool and are moving toward open market operations. In Belgium, Denmark, the Netherlands and the U.K., reserve requirements are still used as a monetary policy tool. In nations where reserve requirements are of sizable proportions, central banks pay interest on them. The costs and benefits of using reserve requirements are still debated. Although they are very effective, they are also far-reaching and powerful, and thus could be harmful to the banking systems’ competitiveness.
The central banks of Greece, Spain, Ireland, Italy and Portugal have broad-based regulatory authority in the banking sector, but the central bank of Denmark has no regulatory role at all.
Under the Maastricht Treaty, the ECB performs only an executive and advisory role in relation to deposit protection.
The three scenarios were originally discussed in a 1994 study by Fratianni, Michele and Jürgen Von Hagen in “The Transition to European Monetary Union and the European Monetary Institute”, in Eichengreen, Barry and Jeffry Frieden, eds., The Political Economy of European Monetary Unification. Edited; San Francisco: Westview Press, Inc., 1994. The following section is based on this study.
Stage III is divided into two parts, Phase A and Phase B. During the former, the EU is still composed of 15 currencies and the EMU-eligible members “irrevocably” lock exchange rates, while during the latter phase a single currency, the Euro, is shared by the eligible EMU members. (Schlesinger, Helmut. “Auf dem Weg zur Europäischen Währungsunion: Die Rolle des Europäischen Währunginstituts.” Aüszuge aus Presseartikeln 38.1992, pp. 1–4.)
Although the ECB’s General Council mandates the presence of all 15 central bank governors, this could also be the subject of political conflicts between the EMU core and the peripheral nations. The real power, however, lies with the ECB Governing Council which is the voting body of the ECB, while the 21-member ECB General Council comprised of all 15 member nations, is only a non-voting policy forum.
All three new members are very close to fulfilling the Maastricht convergence criteria. Austria could become an immediate EMU member while Sweden and Finland are closer to joining the EMU than are some of the long-standing member nations. For now, Sweden has elected to remain outside of the ERM.
This compromise was formalized at the December 1992 Edinburgh European Council Summit. The agreement also increased the ratio of the EU budget to the common GDP by 12 percent, beginning 1995.
Austria, Finland and Sweden are net contributors to the common budget as they have above EU average per capita incomes, well-protected agricultural sectors and no serious regional problems.
The convergence criteria requirements automatically create a two-speed EMU. Initially, the Germans took a hard line on these requirements as their preference was not for a multi-speed EMU but for an EMU that integrates only when all members are ready (i.e. when all EU nations meet the criteria). However, propelled by Chancellor Kohl’s rush to meet the 1999 EMU timetable, most Germans recognize the necessity of a multi-speed arrangement. Nevertheless, they fundamentally disapprove of a “Europe à la carte.”
The Delors proposal’s call for the financing of the Cohesion Fund through an increase in contributions to the common budget from 1.2 percent of GDP to 1.32 percent over a five year budget cycle (1994–99) was not approved by the heads of state during the Edinburgh Summit. Instead, the European Council established a one-time-only seven-year budget cycle (1992–99) and limited the increase to 1.27 percent of GDP, beginning in 1999.
Breadshaw, Jeremy. “Constitutional Reform after Maastricht,” European Trends. First Quarter, 1994, pp.58–69.
Meares, Richard. “Britain Vows to Opt to Veto EU Constitutional Changes.” Reuter News. London, January 8, 1995.
The initially German hard line on a multi-speed EMU has given way to Chancellor Kohl’s rush to meet the 1999 EMU timetable. However, the Germans fundamentally disapprove of a “Europe à la carte.”
Murphy, Richard. “Britain Floats Proposal on European Integration.” Reuter News. Bonn, February 20, 1995.
Adopted from a quote of a statement by former German Foreign Minister Hans Dietrich Genscher in “German CDU Pleased about Reform Controversy,” Reuter Community Report. Bonn, September 8, 1994.
“Multispeed Europe Inconceivable EP Says”, Reuter Community Report. Strasbourg, September 28, 1994.
“EU at Crossroads, Veto Should Go, EU Socialists Say,” Lovell, Jeremy in Reuter News. Brussels, January 31, 1995. Former French minister Elisabeth Guigou, leader of the European Parliament Socialist group, proposed more qualified majority voting and an end to the national veto. She envisioned an EU of 27 members, and she proposed that any institutional change should consider a EU of that size.
“European Union: European Christian Democrats Adopt Skin-Deep Consensus.” European Information Service — European Report. April 4, 1995.
Harrop, Jeffrey. The Political Economy of Integration in the European Community. London: Edward Elgar Publishing Limited, 1989, pp.185–93.
There are numerous past examples, such as the difficulties of attaining consensus concerning the “Single Market” environmental and safety standards. The Southern members oppose standards that are too high because they see them as slowing down economic development and foreign investments. The Northern countries argue that too low standards place consumers and the environment at risk and would not only generate internal political pressures from consumer groups and opposition political parties, but would reduce the international competitiveness of industries.
Is Bigger Better?-The Economics of Enlargement. Monitoring European Integration 3. A CEPR Annual Report, London: Center for Economic Policy Research (CEPR), 1992, p.96.
Schaeuble, Wolfgang. “Kohl’s Loyal Lieutenant,” Financial Times. March 21, 1995, p. 14.
“Kohl’s Re-election Bestows Added Clout in Setting the European’s Course.” The Wall Street Journal. October 18, 1994, Section A, p. 14.
The 15 EU Central Bank Governors and the President of the EMI.
Is Bigger Better?-The Economics of Enlargement. CEPR, 1992, p.97.
See Chapter I, Figure 1.4 (in Annex 1–1), for a description of the EU decision-making structure.
Reuters News (AL410reuec-rf). Brussels: EU Parliament-IGC. January 30, 1995.
“Preparing for 1996 and a Larger European Union: Principles and Priorities.” CEPS Report, Brussels. CEPS director Peter Ludlow and former Council Secretary General Niels Ersboell argue that in the 1996–97 the IGC have to deal with the post-Maastricht ratification crisis including the democratic deficit and the lack of transparency. This will start a parting of ways between those that want a deeper EU and those who do not.
“Preparing for 1996 and a Larger European Union: Principles and Priorities.” CEPS Report, Brussels.
This view is shared by European Socialist and the German CDU parliamentary groups.
The Bundesbank Central Bank Council has a maximum of 16.
The U.S. Federal Reserve System is a combination of districting and of alternating voting membership.
The New York Federal Reserve District Bank is a permanent member of the FOMC, owing to its importance as a commercial — investment banking and foreign exchange center, and to the fact that it is the bank that implements the FOMC’s open market operations.
Germany, France, Italy, Spain and the U.K. have two commissioners each.
Britto, Andrew and David Mayes. “Achieving Monetary Union in Europe,” U.K.: National Institute of Economic and Social Research, 1992, pp.79–91.
Is Bigger Better? The Economics of EC Enlargement, CEPR, pp. 103–4.
Article 126 of the Maastricht Treaty requires member state representation within the EU institutional structure, and any change of this article would require unanimous votes.
There is an implied commitment in a special protocol attached to the Maastricht Treaty stating that all member states “shall…respect the will for the Community to enter swiftly into the third stage and therefore no member state shall prevent the entering into the third stage.”
Pinder, John. European Community: The Building of a Union. London: Oxford University Press, 1991, p.59.
Germany has 662 representatives in the Bundestag (Federal Assembly — lower house) and 68 in the Bundesrat (Federal Council — upper house); Italy has 630 seats in the Chamber of Deputies and 315 in the Senate of the Republic; France has 577 seats in the National Assembly and 321 in the Senate; and the U.K. has 651 seats in the House of Commons and over 1,000 in the House of Lords.
The average size of national parliaments (both upper and lower houses) of the EU-15 member nations is approximately 475 seats.
Arrowsmith, John. “Economic and Monetary Union in a Multi-tier Europe.” National Institute for Economic Review, No. 152, May 1995, p.76.
Arrowsmith, John. “Economic and Monetary Union in a Multi-tier Europe,” 1995, p.76.
For the U.K. and/or Denmark to prevent the other nations from proceeding to Stage III of EMU would mean to breach the commitment laid out in a special protocol attached to the Maastricht Treaty, according to which member nations “shall…respect the will for the Community to enter swiftly into the third stage and therefore no member state shall prevent the entering into the third stage.”
Arrowsmith, John. “Economic and Monetary Union in a Multi-tier Europe,” 1995, p.76.
The Governing Council of the ECB is composed of the President and Vice-President of the ECB and the Governors of all the EU central banks. See Chapter V for more detail.
It should be noted that with the dissolution of the Deutsche mark (and the Ecu), the current ERM automatically disintegrates.
The Visegrad Group consists of Hungary, Poland and the Czech and Slovak Republics.
Countries that meet the Maastricht convergence criteria are to irrevocably lock their exchange rates on January 1, 1999.
This could be done within the context of the “ERM II” in which, for example, Spain and Portugal would have a separate agreement to have tighter bi-lateral currency bands. This would be similar to the agreement Germany and the Netherlands had in the aftermath of the 1993 ERM crisis, which restricts their bilateral currency bands to +/−2.25 percent rather than to the +/−15 percent.
This is assuming that Italy continues to have internal difficulties in reducing debt.
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Rehman, S.S. (1997). Political and Economic Dilemmas of the EMU. In: The Path to European Economic and Monetary Union. Springer, Dordrecht. https://doi.org/10.1007/978-94-011-5358-4_2
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