EMU_History_and_Theory_1 - EMU History and Theory Dr. Aad...

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EMU History and Theory Dr. Aad van Mourik
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EMU definition Single currency Or: irrevocably fixed exchange rates Additional features: Single monetary policy Free capital mobility Common pool of foreign exchange reserves
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Gold standard (1870-1914) Gold parities determined exchange rates Internal convertibility External convertibility Automatic balance of payments adjustment: Relative price mechanism Monetary mechanism
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Bretton Woods Bretton Woods Agreement: Fixed peg between the US$, which was convertible to gold and a number of international currencies. Ended in 1971.
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Bretton Woods Agreement Principles: In 1944, 44 countries met in New Hampshire Countries agreed to peg their currencies to US$ which was convertible to gold at $35/oz. Agreed not to engage in competitive devaluations for trade purposes and defend their currencies. Weak currencies could be devalued up to 10% w/o approval. IMF and World Bank created
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Bretton Woods Agreement Ended in 1971 1971 Crisis: On May 4, 1971, the Bundesbank buys $1 billion on the exchange market to maintain the parity value. On the next day they buy $1 billion in the first hour of trading. Bundesbank abandons the parity rate and lets the mark float upward relative to the dollar. Austria, Belgium, the Netherlands, and Switzerland follow suit.
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1971 Crisis March 19, 1972, Japan and most of Europe floated their currencies Floating currencies considered to be a temporary fix. Still going on today
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Werner Report (1972) observed danger of competitive devaluations leading to trade distortions. Hence, EMU target was introduced for 1980, and the “Snake” was set up.
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1973-1979 Snake - joint float against dollar or “Snake in the Tunnel” system of crawling currency peg between EU member countries. Countries’ currencies fluctuated within +/-1.125% against each other and +/- 2.25% against the US$.
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From the Snake to EMS The snake Agreeing on bilateral exchange rate parities No enforcement mechanism EMS Adds support mechanism. Allows for prompt realignments to avoid misalignments.
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The EMS: Past and Present Originally: answer to Bretton Woods collapse. In the end DM emerged as anchor currency Bundesbank dominant 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.
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ERM: optional feature of EMS A parity grid: (bilateral) parities against central unit (ECU) margins of fluctuations (+/- 2.25%). The E.C.U.: as unit of account Mutual unlimited support: exchange market interventions short-term loans. Realignments:
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EMU_History_and_Theory_1 - EMU History and Theory Dr. Aad...

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