The European Monetary Union

1. The European Monetary Union FURTHER READING: McNamara, Kathleen R. 2008. A rivalry in the making? The Euro and international monetary power. International Political Economy 15 (3):439-459.

2. Plan • Eurozone • Solving Addressing an old problem • International Reserve Currency

3. What does the Euro have in common with the IMF? ? Both answers to the quest for the elusive ideal balance between stability in international transactions and domestic autonomy

4. Imbalances are a fact of global life • These days, foreign exchange markets conduct between $1 trillion and $1.5 trillion worth of business… PER…??? • Per year? • Per month? • Per day? • Per hour? •  Exchange rate volatility •  Exchange rate misalignments

5. How do governments deal with these imbalances? Avoid them?  Capital controls! Fixed exchange rate?  Sacrifice monetary policy! OR: Floating exchange rate • Trade-off: exchange rate stability – or – domestic price stability with monetary policy autonomy

6. The Euro represents an ultimate* commitment • *unless they really figure out a way to kick out Greece • (I doubt it) • The Euro solution to the TRILEMMA… 

7. Fixed Exchange Rate The Trilemma Open Capital Flows Sovereign Monetary Policy

8. The Eurozone

9. http://en.wikipedia.org/wiki/Eurozone#Enlargement

10. Strong currency Domestic economic autonomy XR stability Weak currency

11. Sectoral XR preferences summary Exporters in other countries – keep them out of our elections! Imperialist colonial powers? Get them out of our countries! ??? Financial services

12. Membership • Some countries, the Eurozone doesn’t want (yet/ever?) • Must do the 2 year European Exchange Rate Mechanism • Some countries don’t want the Eurozone (yet/ever?) • Opt out – Denmark, UK, Sweden (de facto) • Why? • A real commitment • To understand • how it’s a strong commitment • and why some countries want it, • let’s go back…

13. A puzzle:Why were countries able to maintain fixed exchange rates with high capital mobility in the late 19th century? Fixed exchange rates + Open capital flows Degree of global capital mobility Fixed exchange rates + Capital controls Floating exchange rates + Open capital flows 1870 Interwar period 1971-3 1944

14. Why?

15. Answer: Democracy Growing #’s of democracies Few democracies Fixed exchange rates + Open capital flows Degree of global capital mobility Fixed exchange rates + Capital controls Floating exchange rates + Open capital flows 1870 Interwar period 1971-3 1944

16. Keynes 1919 quote: • “The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery on his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprise of any quarter of the world. He could secure forthwith, if he wished it, cheap and comfortable means of transport to any country or climate without passport or other formality…. He regarded this state of affairs as normal, certain, and permanent.”

17. The international collective action problem: • How can we allow for the free flow of goods, service, and capital without: • Imbalances leading to beggar-thy-neighbor policies

18. One solution: • IMF to the rescue! • Soften the blow of adjustment • Moral hazard? • Conditionality? • Bretton Woods just falls apart… • The IMF never really worked as intended

19. Maybe not an impossible mission? • 1979: The European Monetary System • Fixed but adjustable • The Bundesbank (Germany) used monetary policy to keep inflation low, and other countries engaged in foreign exchange market intervention to fix their currencies to the German mark

20. French-German fight in 1981-3 • Mitterand – socialist president – believed German monetary policy was strangling • Expansionist monetary policy (e.g., lowered interest rates) • French inflation began to rise • Called on Germany to lower their interest rates • 18 month stand-off… the French backed down

21. 1988-2002: Monetary Union • 1988: Planning begins • Gradually moved towards fixing their currency XR’s (1999 – “permanently” fixed) • Jan 2002: The Euro! • Why union? • High degree of economic openness across Europe  • Sacrificed monetary autonomy for XR stability

22. Realignment (against DM) details • UK: 1990/10-1992/9; 1 realignment • Ireland: 1979/3-1993/8; 9 realignments • Netherlands : 1979/3-1993/8; 3 realignments • Belgium: 1979/3-1993/8; (Luxembourg not considered separately); 8 realignments • France: 1979/3-1993/8; 7 realignments • Spain: 1989/6- 1993/8; 4 realignments • Italy: 1979/3-1992/9; 10 realignments • Portugal: 1992/4-1993/8; 3 realignments • Denmark: 1979/3-1993/8; 9 realignments • Size of individual devaluation: smallest 1% (Belgian franc, 1/1987) to largest 10.6% (French franc, 6/1982) • Overall, non-trivial currency depreciation (1979-1993): Italian lira lost 63%; the French franc 45.2%; Irish pound 41.4%

23. Consequences of XR volatility? • Uncertainty may hurt international transactions CONCLUSION? • Global “political will” to fix exchange rates was lacking in 1970s • But stronger political will to fix exchange rates within Europe • Narrower group of countries make a deep commitment – sacrifice for cooperation @regional level!

24. Thank youWE ARE GLOBAL GEORGETOWN!