1 / 18

Chapter 16

Chapter 16. Chapter 16 The European Monetary System. The EMS: Past and Present. EMS originally a solution to the end of the Bretton Woods System. Over the years it became a kind of DM area, with the Bundesbank very much in command.

mahsa
Download Presentation

Chapter 16

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 16

  2. Chapter 16 The European Monetary System

  3. The EMS: Past and Present • EMS originally a solution to the end of the Bretton Woods System. • Over the years it became a kind of DM area, with the Bundesbank very much in command. • This, and the speculative crisis of 1993, made the monetary union option attractive. • Now the EMS is mostly the entry point for future monetary union members.

  4. A fine distinction: EMS vs. ERM • EMS = European Monetary System • all EU members are part of it • ERM = Exchange Rate Mechanism • Grid of agreed bilateral exchange rates, mutual support, joint realignment decisions, ECU • The UK and Sweden do not want ERM membership • All the others will adopt ERM and Euro sooner or later

  5. Preview: The Four Incarnations of the EMS • 1979-82: ERM-1 with narrow bands of fluctuation (±2.25%) and symmetric. • 1982-93: ERM-1 centered on the DM, shunning realignments. • 1993-99: ERM-1 with wide bands (±15%). • 1999- : ERM-2, asymmetric, on the way to euro area.

  6. The ECU A basket of all EU currencies.

  7. The ERM: Interpretation and Assessment • Improving on the Snake to stabilise intra-European exchange rates: • mutual support • realignment unanimity rule. • Respecting the EU equalitarian approach: • no centre currency • bilateral interventions by strong and weak currency central banks. • No role for the US dollar: Europe on its own.

  8. The ERM: Interpretation and Assessment • Is monetary policy independence lost? • The Impossible trinity: • widespread capital controls to preserve at least the ability to have different inflation rates. Fixed Exchange Rate Monetary union EMS Monetary Independence Full Capital Mobility Free float

  9. Agreeing to disagree • Plan A: Dedicatemonetary policy to exchange rate pegs. This requiressimilarinflation rates, otherwisehighinflationcountrieswill lose competitiveness • Plan B: Accept different inflation rates and adjustexchange rates as frequently as needed to avoidcompetitiveness problems and trade imbalances

  10. Evolution: From Symmetry to DM Zone • Plan B was chosen first: • different inflation rates: long run monetary policy independence • frequent realignments.

  11. EMS before the Euro (DM/FrF in ERM)

  12. Evolution: From Symmetry to DM Zone • Realignments and inflation in between with real appreciation

  13. Evolution: From Symmetry to DM Zone • Realignments • barely compensated accumulated inflation differences • were easy to guess by markets • put weak currency/high inflation countries on the spot: • Continuing current account deficits • Speculative attacks. • The symmetry was broken de facto. • The Bundesbank became the example to follow. • What shadowing the Bundesbank required: • giving up much what was left of monetary policy independence • aiming at a low German-style inflation rate • avoiding realignments to gain credibility.

  14. Black Wednesday • In politics and economics, Black Wednesday refers to the events of 16 September 1992 when the British Government was forced to withdraw the pound sterling from ERM after they were unable to keep it above its agreed lower limit. George Soros, the most high profile of the currency market investors, made over US$1 billion profit by short selling sterling.

  15. Breakdown of the DM zone • Bad design: • full capital mobility established in 1990: ERM in contradiction with impossible trinity • Bad luck: • German unification: a big shock that called for very tight monetary policy • the Danish referendum on the Maastricht Treaty. • A wave of speculative attacks in 1992-3 • The ERM should be made even more cohesive – monetary union is the way to go

  16. ERM-2 • ERM-1 ceased to exist on 1 January 1999 with the launch of the Euro. • ERM-2 was created to: • host currencies of existing EU members who cannot/don’t want to join euro area: • Denmark and the UK have a derogation, but Denmark has adopted the new ERM • Sweden has no derogation but has declined to adopt the new ERM

  17. How Does ERM-2 Differ From ERM-1?

  18. Current ERM II membership

More Related