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Paul J. J. Welfens European monetary union has been discussed for more than three decades and is likely to be realized in 1999. One may anticipate generous interpretations of the fiscal convergence criteria. Such generosity consistent with the Maastricht Treaty might impair the credibility of the ECB and the stability of the Euro, respectively, despite the fact that inflation is a monetary phenomenon and has little to do with government deficits, unless they were financed via the printing press, which is excluded in the Maastricht Treaty. The European Commission's forecast of spring 1997 suggests that Italy will have problems in joining the EMU starter group as the is expected to be 3. 2% in 1997 and even 3. 9% in 1998. A Italian deficitlGDP ratio fully developed EMU group (with all 15 cowltries included) would represent 38% of the OECD GDP, slightly higher than the U. S. with 33% (Japan 21%). The exports/GDP ratio of EU countries is 30%, the ratio with respect to exports outside the EU would be 10% (Japan, U. S. 8%). The share of the U. S. dollar in international currency reserves fell from 67% to 40% in 1995, while the share of European currencies increased from 13% to 37%. Prior to the EMU, market participants have to anticipate whether a transition to 1999 will bring windfall losses or gains in various bond markets.

Inhaltsverzeichnis

Frontmatter

Introduction

Introduction

Abstract
European monetary union has been discussed for more than three decades and is likely to be realized in 1999. One may anticipate generous interpretations of the fiscal convergence criteria. Such generosity consistent with the Maastricht Treaty might impair the credibility of the ECB and the stability of the Euro, respectively, despite the fact that inflation is a monetary phenomenon and has little to do with government deficits, unless they were financed via the printing press, which is excluded in the Maastricht Treaty. The European Commission’s forecast of spring 1997 suggests that Italy will have problems in joining the EMU starter group as the Italian deficit/GDP ratio is expected to be 3.2% in 1997 and even 3.9% in 1998. A fully developed EMU group (with all 15 countries included) would represent 38% of the OECD GDP, slightly higher than the U.S. with 33% (Japan 21%). The exports/GDP ratio of EU countries is 30%, the ratio with respect to exports outside the EU would be 10% (Japan, U.S. 8%). The share of the U.S. dollar in international currency reserves fell from 67% to 40% in 1995, while the share of European currencies increased from 13% to 37%.
Paul J. J. Welfens

Transition and Long Interest Rates in Germany

Frontmatter

A. EMU and Long Interest Rates in Germany

Abstract
Has the expectation that monetary policy might in the foreseeable future be in the hands of a European monetary institution maintained long interest rates in Germany at higher levels then they would otherwise be? Since the future European Central Bank (ECB) might be expected to adopt some weighted average of the traditional monetary policy stances of its members—tougher than most, perhaps, but not as tough as the Bundesbank, implying higher expected inflation and perhaps credibility premia—this idea has a fair amount of intuitive appeal. Moreover, it is consistent with three sets of facts, which have each received considerable attention in recent months: First, opinion polls indicate that a large majority of Germans (almost two-thirds, according to a September 1995 report in The Economist) oppose a common currency, presumably because the D-Mark has a track record of stability while the future European currency does not2. If this view is shared by financial markets, it could contribute to relatively high long yields.
Jeromin Zettelmeyer

B. EMU and Outsiders: Fixed versus Flexible Exchange Rates

Abstract
If European Monetary Union (EMU) commences as planned under the timetable and convergence criteria of the Maastricht treaty, a two-speed arrangement likely will follow. Under this arrangement a core of countries will form a monetary union, leaving a periphery that does not initially participate. The existence of such a periphery raises the issue of the appropriate exchange rate relationship vis-à-vis the core. This paper analyses some key aspects of this choice.
Paul Bergin, Mathias Moersch

Financial Markets and Monetary Policy

Frontmatter

C. Foreign Exchange Vehicles Before and After EMU: From Dollar/Mark to Dollar/Euro?

Abstract
The present paper analyzes the phenomenon of media of exchange in the foreign exchange (forex) market in general and then looks at the potential of the euro, as the future single currency of the European Union, to become such a foreign exchange vehicle in particular. The forex vehicle function is one dimension of an international medium of exchange. As first described clearly by Swoboda (1969), in a world with N national moneys only a small number of the N(N-1)/2 potential bilateral currency markets is actually open and most of the “cross-currency” transactions is performed through a medium of exchange, the forex vehicle. For example, at the present time the exchange of Canadian dollar (CAD) against Swiss franc (CHF) is most often broken down into two transactions — each one involving the US dollar (USD) — CAD/USD and USD/CHF.2 However, a forex vehicle does not have to be unique (Hartmann, 1994). In today’s forex markets a Danish kroner (DKK)/French franc (FRF) transaction usually goes through the Deutsche mark (DEM) — DKR/DEM and DEM/FRF — and not through the USD (Danmarks Nationalbank, 1992). It is important to notice that the roles of the dollar and the mark in these examples are a question of the internal organisation (exchange structure) of the forex market, which differs from the original payments structure in international trade and investment (Krugman, 1980).
Philipp Hartmann

D. Does a Core-Periphery Regime Make Europe into an Optimal Currency Area?

Abstract
The argument for a two-speed regime in Europe is that a small number of countries have already achieved sufficient convergence in their structures to benefit from the advantages of a single currency without risking large adjustment costs. The periphery group would, by default, be those countries which are unable or unwilling to achieve sufficient convergence by 1999. That distinction is made on the basis of the theory of optimal currency areas, which specifies the conditions under which a single currency would be advantageous. In this paper we adapt a formal model of optimal currency areas to show how those conditions can be transformed into testable propositions on whether there is sufficient symmetry in shocks and transmission mechanisms to make the formation of a currency union worthwhile. This, it turns out, depends on rough equality of the size and positive correlations between shocks across the union; and on the equality in impact and timing of the transmission of policy changes or external shocks. We apply these results to ask if the core-periphery distinction is the appropriate response to the difficulty of creating a monetary union in Europe. Does Europe really have a better chance of achieving monetary union if it proceeds in two (or more) stages, with the periphery left to catch up in its own time? Or is the evidence for that so weak that we must assume that such a distinction is politically driven and likely to be a long-run state of affairs?.
Maria Demertzis, Andrew Hughes Hallett, Ole Rummel

E. Competitive Neutrality of Monetary Policy Instruments for EMU

Abstract
According to the time-schedule for the European Monetary Union, the issue of monetary policy instruments is on the agenda for the year 1996 So far, no official document exists which gives any indication of the future instruments which may be expected. On the contrary, this area remains wide-open for debate.
Lukas Menkhoff

Fiscal Aspects of the Maastricht Treaty and Political Economy of Transition

Frontmatter

F. Self-Fulfilling Public Debt Crises

Abstract
This paper will show that under certain conditions highly indebted countries could fall into a low credibility trap. This occurs when a government is judged to be not credible by financial markets. It then has to pay a risk premium through higher interest rates. The higher debt service burden that results, if inflation is kept low, makes it even more likely that the authorities will abandon their attempt for stabilization and try to reduce the real value of the debt through a inflation. As a result, this further increases the risk premium demanded by financial markets and could possibly lead to a spiral of increasing interest rates until the government caves in.
Daniel Gros

G. EU Labor Markets Inside and Outside the Monetary Union

Abstract
This paper looks at the question of the impact of membership of the European monetary union (EMU) on the labor market and in particular on unemployment. It examines both the role of exchange rate flexibility as a mechanism for offsetting the effects of labor market rigidities and the implications of monetary union on the feasibility and effectiveness of structural reforms to reduce unemployment within Europe.
Richard Jackman

H. Political Economy of EMU and Stabilization Policy

Abstract
The Maastricht way to European Monetary Union is another attempt by the Community to achieve full monetary integration. An earlier approach was the Werner plan as envisaged in 1970 where within a decade the exchange rate would be irreversibly fixed and capital controls be abolished, while an EC central bank system would pursue monetary policy; the fiscal policies would be decided at the EC level by an authority that would be responsible to the European Parliament. Facing two oil price shocks in the 1970s the EC countries gave up their plans to proceed with monetary union for some time. The Maastricht approach to EMU is different and suggests that there will be a common monetary policy, while fiscal policies will remain at the national level. It is constrained by the fiscal convergence criteria.
Paul J. J. Welfens, André Jungmittag

Necessary Amendments for a Functional EMU

Frontmatter

Deficits, Debts and the Stability Pact

Abstract
Twenty-seven months before the start of European Monetary Union (EMU), national efforts to meet convergence have already resulted in major achievements. Today, already 9 or 10 countries satisfy the criteria for inflation, interest and exchange rates. Despite these positive results, uncertainties remain about the EMU starting on schedule because of insufficient convergence with regard to the fiscal criteria. This view is not only wrong, but also dangerous. Due to inappropriate communication from authorities, financial markets may have renewed doubts about the timing of EMU and these speculative turbulences could then destroy the convergence results that have been already achieved. In order to prevent this unfavorable evolution, a credible stability pact is needed to strengthen popular and financial market confidence.
Stefan Collignon

Preparing for EMU

Abstract
1. The project of European Economic and Monetary Union (EMU) gained greater credibility at the Madrid summit in mid-December 1995. The political commitment to adopt the single currency, named the Euro, on 1 January 1999 was confirmed.
Robert Raymond

Doctrinal Amendments for a Functional EMU ? A Few Reminiscences of Economic History

Abstract
Current discussions about the amendments and additions to the EMU part of the Maastricht Treaty focus on the institutional framework. The necessity and timeliness of this focus is suggested by the comparative ease with which agreement on some important issues was reached in late 1995 and early 1996. The large degree of approval won by Finance Minister Theo Waigel for his proposal of a stability pact is one case in point. Another is the swift adoption of the Verona agreement on the relation between the “ins” and the “outs”. A third, and perhaps the most important, is the apparent consensus in the currency and bond markets on the scenario of a flexible interpretation of the debt criteria of the Maastricht Treaty in early 1998 combined with a continued firm commitment of EMU members to these criteria after 1999.
Michèle Schmiegelow

European Monetary Union from a German Perspective

Frontmatter

Compromise Should not Undermine the Credibility of the Euro Currency

Abstract
By now, there is a general perception of an inherent conflict among the three goals for a common European currency. They are as follows: Sticking to the beginning of 1999 as a start date, the strict fulfillment of the convergence criteria and the large number of participants involved. The question of where to compromise will have to be decided on a political level. It is, however, certainly useful to remember that the three goals have different justifications.
Hans Jäckel

EMU: A German Viewpoint

Abstract
1. Europe is marked by great tensions between its economic and currency areas (Predöhl, 1971). The European economic area, one of the cornerstones of what is fundamentally still a tricentric world economy, is divided into numerous nationally defined currency areas. In Europe this leads to sharp deviations from the optimum spatial situation such as exists, for example, in the United States whose economic area is not subdivided by many national borders with disintegrating effects. Thus there are still fourteen currencies in the European Union alone. In practical terms this means that substitutive core internal trade in Europe, which accounts for some two thirds of cross-frontier European “foreign trade”, cannot be organized according to purely economic, spatial laws. For Europe, compared with the United States (and also Japan), this entails the continuation of many barriers to trade and, accordingly, a less than optimum division of labor. The corresponding costs have been estimated by the Commission to be equivalent to 3 to 5% of European national product (Cecchini Report). What is at stake here, given the completion of the internal market, is:
(a)
a significant cost reduction because firms can produce for wider sales areas through economies of scale,
 
(b)
increased efficiency in firms, not least because of a rationalization of the industrial structure as a result of more competitive markets,
 
c)
a division of labor between firms that is closer to the optimum situation as a result of a better utilization of comparative cost advantages, and
 
(d)
greater market dynamism and stemming from this, more innovation.
 
Heinrich Matthes

EMU: A Bank’s Perspective

Abstract
We still expect the currency union to come on January 1st 1999. It needs to be a success. For one thing, the new currency needs to be as stable as the DM and the conversion must also be organized smoothly. To guarantee this, there are three fields in which political decisions and improvements are necessary.
Jürgen Pfister

Opportunities and Risks Associated with European Monetary Union

Abstract
The Monetary Union will complete the single market and stimulate European integration. EMU makes sense in both political and economic terms, in particular onemployment policy grounds. It contributes to a European profile and through the introduction of the Euro to a tangible European identity. The denationalization of monetary policy adds to political stability and helps to constrain the rise of nationalism. The DM hegemony, like the hegemony of a member state in any other policy area, contradicts the spirit of equal opportunities and partnership. These are fundamental principles of European integration. Monetary union increases the chance of a better co-ordination of economic, fiscal, employment and social policies and is urgently required in order to improve the EU’s international competitiveness. The policy mix where monetary policy stabilizes the economy and secures employment will only be feasible if policies, such as industrial policy, are embedded in a European framework. With the creation of the European Central Bank, the EU will receive its first federal decision-making body.
Christa Randzio-Plath

Backmatter

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