EMU: The First Experiment

Abstract

From the very outset, the European Common Market lacked the credibility that stems from having the attributes of an optimal currency zone. The EEC was devoid of these classical features of labour market mobility, fiscal transfer mechanisms and the synchronisation of national business cycles that characterise an optimal currency zone. Furthermore, economic divergences between the core and peripheral regions continued to generate centrifugal forces that threatened the internal cohesion of the EEC. Although the EEC failed to conform to the conditions necessary to establish an optimal currency area, the problem of asymmetrical shocks and the question of which countries would incur the main burden of adjustment in the event of monetary union, were to inform earlier experiments towards EMU. This chapter will examine the first experiment known as the “snake in the tunnel” and some of the theoretical problems associated with a system of fixed exchange rates.