Case study of growth of regional financial institutions, Microeconomics

Case Study - EUROPE 

Let us now see how events unfolded over the decades in Europe that led to monetary unification in terms of a single currency and single central bank. At the very beginning Europe undertook steps in this direction by forming a customs union. European attempts at regional integration started soon after the Second World War when there was a common realisation among these countries of the need to rebuild their war-affected economies. Moreover, the United States through the Marshall Plan for the reconstruction of Europe. The US urged the European governments to combine their economic and political resources. At first, Europeans adopted a sectoral approach. The European coal and Steel Community was created, freeing trade in coal and steel. Then efforts were directed towards the creation of a full - fledged customs union, an arrangement under which all trade barriers among these countries would be abolished, and a common external tariff for other countries would be adopted. In 1957, six countries (Belgium, France, Germany, Italy, Luxembourg and the Netherlands) signed the treaty of Rome, establishing the common market in 1958. Monetary cooperation in Western Europe began before the creation of the common market in 1958 but efforts in this direction were stepped up in the later period. The customs union was completed in 1968. in 1973, Britain was admitted to the EEC. The EEC adopted a Common Agricultural Policy (CAP) in 1968, setting uniform prices for farm products and imposing variable levies on imports. Current account convertibility came early (in 1958, coinciding with the launch of the Common Market), capital account liberalisation came late, and was part of a gradual process that did not culminate in the collective removal of capital controls until 1990. 

This was soon followed by a major crisis in 1992. It thus became clear that exchange rate stability required a full-fledged movement toward monetary union. This was combined with the Stability and Growth Pact, which established explicit fiscal rules and convergence criteria. Europe's move towards a common currency area started in the late 1960s when the Bretton Woods system started showing problems and there were currency crises.

In 1969, European leaders met at The Hague and appointed Pierre Werner, Prime Minister and finance minister of Luxemburg to head a committee that would outline concrete steps for eliminating intra-Europe exchange rates, lowering trade barriers and centralising EU monetary policies. The Werner Report was adopted in 1971 . 

In March 1979 was formed the European Monetary System. It was a mutually pegged exchange rate system consisting of eight members originally: France, Germany, Italy, Belgium, Denmark, Ireland, Luxembourg, and The Netherlands. This system worked to restrict the exchange rates of participating currencies within 


specified fluctuating margins. The EMS went through periodic currency realignments. Eleven realignments occurred between 1979 and 1987. events of 1990 when reunification of eastern and western Germany took place. This led to huge spending and fiscal expansion by Germany as well as borrowing and there was high inflation in that country. The German Central Bank, the Bundesbank raised interest rates to stem inflation. Other EMS countries like France, Italy and Britain were not growing fast, and they did not want to raise interest rates as that might have lowered real investment and pushed their economies into recession. They also did not want to devalue their currencies. The result was a series of speculative attacks on the EMS exchange parities. By 1993 the EMS wasforced to retreat to very wide bands which stayed till 1999.

The process of developing a common market that was started in 1957 when the EU (then called EEC) formed the customs union, was still incomplete in the late 1980s. There were government imposed standards and licence requirements in some countries. There were significant barriers to factor movements. In June 1985, the EU's executive body, the European Commission decided to work towards removing all barriers to trade and capital and labour movements by 1992. 

The early EMS had frequent currency realignments and widespread government control over capital movements. This led to significant manoeuvring for national monetary policies. In 1989, a committee headed by Jacques Delors, president of EC, recommended a transition to an economic and monetary union (EMU) and eventually to a single currency. This was followed by a meeting of the leaders of the EU on December 10, 1991, at the Dutch city of Maastricht and a decision there to place the EU on the path to EMU.

The EU countries moved away from the EMS towards the more ambitious goal of a single shared currency for four reasons. First, it was believed that a single EU currency would produce a greater degree of European market integration than fixed exchange rates by removing the threat of EMS currency realignments and removing the costs of currency conversion. The single European currency was seen as a necessary complement to the 1992 plan for unifying EU markets into a single, continent-sized market. Secondly, Germany's actions after 1990 and its position made some countries feel that EU's goals were being substituted by Germany's goals at the cost of their benefits. They felt the need of a European Central Bank.

Third, given the wide freedom of capital movements within the EU, it seemed not a good idea to keep national currencies with fixed parities; rather it was felt that a unified, single currency would be better. if the goal was to combine permanently fixed exchange rates with freedom of capital movements, a single currency was the optimal solution. Finally, it was hoped by leaders of EU, the participants in the Maastricht Treaty, that the Treaty's provisions would guarantee the political stability of Europe. A single currency was seen as signifying greater political cooperation as well.

The Euro is the name that has been given to common official currency unit. European countries, namely, Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, Portugal, Spain, and The Netherlands. These 12 countries along with the three other counties who are not part of the official currency unit of the euro, namely, Britain, Denmark and Sweden as you know constitute the European Monetary Union. 

Posted Date: 11/9/2012 7:11:31 AM | Location : United States

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