chapter 20 - Optimum Currency Areas and the European...

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Optimum Currency Areas and the European Experience How the European single currency evolved 2 Major reasons prompted the Eu countries to seek closer coordination of monetary policies and greater mutual exchange rate stability. To enhance Europe’s role in the world monetary system Collapse of Bretton Woods caused a declining European confidence in the readiness off the Us to place its international monetary responsibilities ahead of its national interests. Eu countries hoped to defend more effectively in their own economic interests in the face of a self-absorbed US To turn the EU into a truly unified market eliminate trade barriers and transform the Eu into a huge unified market on the model of the US. Europeans officials believed exchange rate uncertainty and trade barriers were a major factor reducing trade within Europe. They also feared that E swings causing large changes in intra European relative prices would strengthen political forces hostile to free trade within Europe European Monetary System Germany, the Netherlands, Belgium, Luxemburg, France, Italy, Denmark and Ireland, 8 original participants in the EMS’s exchange rate mechanism, began operating a formal network of mutually pegged exchange rates in March 1979. A complex set of EMS intervention arrangements worked to restrict the exchange rates of participating currencies within specified fluctuation margins. Britain, Spain, and Portugal joined. However, Britain and Italy left the EMS exchange rate mechanism in September 1992 at the start of a protracted European currency crisis that forced the remaining member to retreat to wide exchange rate margins. The EMS’s operation was aided by safety valves that helped reduce the frequency of such crises. Most exchange rates “fixed” by the Ems could actually fluctuate up or down to +-2.25% until August 1993 and +-15% from August 1993. The EMS also developed generous provisions for the extension of credit from strong to weak currency members. The EMS also had capital controls that directly limited domestic residents’ sales of home for foreign currencies to reduce the possibility of a speculative attack. Ems went through period currency realignments. Capital controls served an important role of shielding members’ reserves from speculators in these adjustments. However, a removal of capital controls in 1987 increased the possibility of speculative attacks and thus reduced governments’ willingness openly to consider devaluing or revaluing. Removal of controls greatly reduced member countries’ monetary independence but freedom of payments and capital movements within the EU had always been a key element of EU countries’ plan to turn Europe into a unified single market. From 1987 to 1992 no adverse economic event was able to shake the ems’ commitment to its
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chapter 20 - Optimum Currency Areas and the European...

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