The Ems The Emu And The Transition To A Common Currency

When central banks are about to relinquish control over their exchange rate and enter into a currency union, the reptutational costs to devaluation are very low. As with any finite-horizon game, the endpoint affects the earlier expectations of private agents, here causing them to demand higher interest rates and higher wages from countries whose currencies are relatively weak. In looking at the countries within the EMS, we find that Italian long-term interest rates as well as price and wages levels relative to Germany show evidence of growing gaps We also find that the real appreciation of the lira appears to be predominantly due to increases in relative Italian government spending, and not to relatively rapid Italian productivity growth. Taken together, this evidence suggests that convergence within the EMS may have peaked. Furthermore, moving forward the date of currency union may in the short run increase both the growth of the gaps and the need for exchange-rate realignment.

This Report from CEPR and the Paolo Baffi Centre for Monetary and Financial Economics focuses on the key issues involved in Stage II of Europe's transition to economic and monetary union. These issues include the degree of prior economic convergence required for EMU to succeed; whether the risk of currency realignments during the transition, the abolition of exchange controls, or continued economic integration may destabilize the Exchange Rate Mechanism of the EMS and possibly jeopardize the convergence that has occurred already; the functions of the proposed European Monetary Institute in Stage II; and the proposed constitution and responsibilities of the European System of Central Banks during Stage III. Based on a conference held in Milan in September 1991, organized by CEPR and the Paolo Baffi Centre, this Report includes an extended essay by Edward Balls on the issues discussed at the conference and non-technical, accessible summaries of the individual papers for the non-specialist. CEPR books are not available through Brookings in the UK and Europe.

Evaluations of European monetary integration using model simulations have given conflicting results, and the paper attempts to elucidate the reasons for the differences. Several features stand out: how to model realignments; how monetary policy is set for individual countries or for Europe; and how large are risk premium shocks in exchange markets. We quantify the effects of different assumptions relating to these features using MULTIMOD.

EC monetary integration was reinforced in the 1980s when macroeconomic convergence and a dominant role of the German Bundesbank created the basis for relatively stable exchange rates and increasing EC trade volumes. Reduced capital controls and rising capital mobility as well as German unification caused shifts and shocks which undermined EMS stability in a critical period - the transition to EMU in accord with the Maastricht Treaty which called for further increasing monetary integration. The analysis focuses on these issues, the EMS crisis of 1992/93, the topic of optimum currency areas and the problem of fiscal policies/regional stabilization in Europe, the US and Canada. This book gives an assessment of the EMS developments and shows how financial market liberalization as well as the EC 1992 project affect the process of economic and monetary union.

Monetary Integration in Western Europe: EMU, EMS and Beyond discusses the origins of the Economic Monetary Union, (the European Monetary System is the forerunner of the EMU), and the integration of the European Community starting from the Treaty of Rome. The Treaty provides most of the elements necessary for a monetary union. The Community attempts to formulate a systematic, coherent approach to monetary integration as contained in the Barre Report. The Barre Report proposes that progress in two areas, coordinating economic policies and instituting a system of mutual financial assistance, is essential. In the Hague Summit, the heads of state want to enlarge and closely integrate the members of the Community. A commission under Luxembourg Prime Minister and Finance Minister, Pierre Werner prepares the plan for the EMU. On March 22, 1971, the Six member states approve the adoption of the EMU in several stages, and formally launch the EMU project. The Six have as goals to promote exchange rate stability within the Community, to coordinate economic polies through consultation procedures, to settle structural differences through Community policies, and to liberalize the movement of goods, services, and the factors of production. Economists, sociologists, professors in economics, and policy makers involved in international economics, particularly with the EU, will find the book valuable.