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

Plan Eurozone Solving Addressing an old problem International Reserve Currency 2

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 3

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

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 5

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…  6

The Trilemma Fixed Exchange Rate Open Capital FlowsSovereign Monetary Policy

The Eurozone 8

9

Domestic economic autonomyXR stability Weak currency Strong currency 10

Sectoral XR preferences summary XR stability preference High/fixed low/float/ monetary autonomy XR strength preference Strong currency Nontradable Weak currency Export-orientedImport-competing Financial services ??? Exporters in other countries – keep them out of our elections! Imperialist colonial powers? Get them out of our countries! 11

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… 12

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

Why? 14

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

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.” 16

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 17

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 18

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 19

French-German fight in 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 20

: 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 21

Realignment (against DM) details UK: 1990/ /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/ /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 ( ): Italian lira lost 63%; the French franc 45.2%; Irish pound 41.4% 22

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 level! 23

Thank you WE ARE GLOBAL GEORGETOWN! 24