The creation of the European Monetary Union (EMU)

Table of content

Introduction

1. Preceding events leading to EMU

2. The Delors Report and the Stability and Growth Pact

3. Conclusion

Introduction

The creation of the European and Monetary Union (EMU) has been one of the most determined and successful projects carried out by the European Union (EU) – and it is still in progress since eleven EU-countries are, following the Maastricht treaty, legally required to join the Eurozone as soon as they meet the convergence criteria. The reasons for the creation of EMU have been widely discussed among scholars; some focus on the request for political integration that would resulted from an EMU, some claim that the EMU was established to promote growth and investment. The assignment will hence “discuss how the creation of EMU was both an economic and politically driven process”. Chapter 1 outlines events and agreements which indirectly led to the EMU. Chapter 2 assesses the Delors Report and the Stability and Growth Pact (SGP) which affect EMU directly^[1]. Chapter 3 concludes by analysing the mentioned 30-year process leading to the EMU and gives a brief outlook. This approach has been chosen because it is essential to study the historical events leading to the Delors Report and finally the Treaty on European Union (TEU) in order to analyse the creation of EMU.

1. Preceding events leading to EMU

The idea of fixed exchange rates is not new. The world’s main currencies were already fixed in terms of gold with the Gold Standard lasting from 1870 to the 1930s, and in line with the Bretton Woods system from 1944 to the early 1970s. When the Bretton Woods system began to falter in the late 1960s, European Community (EC) governments started thinking about a regional exchange rate regime. They feared that exchange rate instability disrupts trade, even until now, there has been little empirical evidence for this (Leddin and Walsh 2003). In addition, they knew that instability in the foreign exchange markets made it very complicated to run the Common Agricultural Policy, whose target was to establish a common price for agricultural products throughout the Community. Some European political élites also viewed monetary integration and a single currency as a way to bring together nation-states in order to warrant political stability and cooperation across the EU (McNamara 2005).

The common approach towards a monetary integration and a single currency led to the Werner Report in 1969. It was the first programme for an EMU written out by a study group of high-ranking EC and national officials, and chaired by Pierre Werner, the Prime Minister of Luxembourg. The Plan had originally been drawn up at the EC’s summit in the Hague by Willy Brandt, the German Chancellor, and Georges Pompidou, the French president, starting a enduring series of Franco-German efforts towards monetary integration (ibid). While the report gave a timetable on EMU, it was rather indistinct on its institutional set-up (Werner Report 1970). The Plan was approved in 1971 by the EC’s national political leaders, but it was never realized due to a lack of political will and poor economic circumstances resulting mainly from the collapse of the Bretton Woods system in 1971 and the oil crisis in 1973.

In 1972, a more modest plan towards a common exchange rate regime, the so-called ‘snake in the tunnel’ was launched, again, driven by concerns about intra-EC trade. EC-countries agreed, without a treaty base, to hold their currencies in a fluctuation band of +/- 1.125 per cent around a central rate and in a +/- 2.25 per cent band against the dollar. However, the system never became stable. It suffered from several opt outs, as from France and the UK, and large realignments (Leddin and Walsh 2003), especially during the oil crisis when Member States’ currencies fluctuated sharply. By 1977, the snake was reduced to a zone based around the “Deutschmark”, with only five out of nine Member States remaining (McNamara 2005). The main rationale for the break down of the snake was missing economic policy coordination, resulting in different inflation rates between the member states. While France and the UK practiced more expansionary fiscal and monetary policies (Leddin and Walsh 2003), following the Keynesian Theory (Huber 2003), Germany focussed on a monetarist policy of price-stability.

In 1979, following a Franco-German initiative, the Community decided to re-launch monetary integration at the Brussels European Council by creating a European Monetary System (EMS). The goal was to form closer monetary policy co-operation between Community countries, resulting in a ’zone of monetary stability’ in Europe. The main components of the EMS were the European Currency Unit (ECU), the Exchange-Rate Mechanism (ERM), and various credit mechanisms (Leddin and Walsh 2003).

In line with the ERM, member states had to keep their exchange rates within a 2.25 per cent fluctuation band above or below each bilateral central rate, except Italy, Spain, and Portugal, which had a margin of 6 per cent, and the UK, which at first stayed outside the system (ibid.). The ERM was based on a system of quasi-fixed exchange rates, since realignments were permitted and the margin of fluctuation was flexible. The main reasons that the EMS came into force, despite huge scepticism and pessimism regarding the ability of the European Union in general, were again both of economic and political nature. First, there were concerns about trade within Europe. Secondly, Helmut Schmidt, the German chancellor and Giscard D’Estaing, the French president, wanted to strengthen European institutions to offset what they viewed as US mis-management of the western world’s affairs (McNamara 2005).

Between 1979 and 1983, the EMS suffered from eight realignments and several crises, driven by a lack of policy co-ordination between EMS countries (Nugent 2003). Germany continued to practice a tight monetary system, whereas François Maurice Mitterrand, the French president, implemented expansionary socialist measures. In the 1980s, policy-makers, including Mitterrand, views increasingly converged around a German-influenced price stability model. The result was a more stable EMS between 1983 and 1992 (Leddin and Walsh 2003).

However, in late 1993, the EMS suffered from a major currency crisis, resulting from various issues, namely increased German interest rates as a result of German unification in 1990; discrepancies in European and US monetary policies; the Danish ‘no’ vote in a referendum on the TEU on 2 June 1992; speculative attacks in some member states and finally pressure by currency speculators, most notably George Soros, forcing the UK’s Conservative government to withdraw the Pound from the ERM on ‘Black Wednesday’, after only having participated in ERM for two years. As a result, the EU finance ministers finally widened the EMU fluctuation margins to +/- 15 per cent in August 1993. Despite the many crises, it is notable that the French franc survived with its peg to the Deutschmark since 1987. Thus, the two most important currencies in the ERM were basically kept within the 2.25 per cent fluctuation margin (ibid.).

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^[1] Given the scope of the essay, the first two chapters will only give an overview of the events occurring from the 1960s to today and will not address all theories involved in the creation of EMU, such as intergovernmentalism versus neo-functionalism (Andrew Moravcsik 1998 cited in Wallace, Wallace, and Pollack 2005), and the participation of an epistemic community (Kaelberer 2003).