EMU_History_and_Theory - EMU History and Theory Dr. Aad van...

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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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European Monetary System (EMS) 1979-1998 European Monetary System and European Exchange Rate Mechanism (ERM) ERM locked currencies in wider margins of +/-2.25% against each other. ECU Credit lines
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In Theory Symmetric system Currencies pegged to the ECU
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In Reality Asymmetric system Currencies pegged to the Mark Germany was the low inflation country Bundesbank had real independence Credibility bonus for other countries
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Bretton Woods Analogies Germany the center country Other countries even used marks as reserves
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ERM crisis 1992/93 Speculative pressure against the pound, the Lira and other currencies led first to the suspension of Pound and Lira from the ERM, to a number of devaluations and finally to a widening of exchange rate bands to +/-15%, i.e. in effect a suspension of the peg. The Lira re-joined at a later stage, the pound stayed outside.
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EMU_History_and_Theory - EMU History and Theory Dr. Aad van...

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