Why Economic and Monetary Union Is an Important Objective for Europe

WHY ECONOMIC AND MONETARYUNION IS AN IMPORTANT OBJECTIVE FOR EUROPE Niels Thygesen JLhe European Community's (EC) ambition to create an Economic and Monetary Union (emu) diat includes die introduction of a common currency and a European Central Bank (ecb) to run a joint monetary policy puzzles many American observers of die EC's effort to achieve greater integration.1 Some critics believe diat die economic benefits from such a move will be questionable while odier analysts defend die move but insist mat it can only be justified in political temis.2 1 This paper uses the terms "final stage of EMU," "full monetary union," and "a common currency" as synonymous expressions, but relies primarily on the common currency as the central element. The latter means a single currency for all member states, whereby all the respective national currencies are replaced in accordance with the final stage of EMU. According to die Maastricht Treaty (Art. 109), member states must set a date for the replacement at the start of the final stage. 2 See Martin Feldstein, "Does European Monetary Union Have a Fuaire?" Paper presented at a conference, "The Monetary Future of Europe," organized by the Center of Economic Policy Research, La Coruna, Spain in 1992. This strategy, though, would be very risky because then monetary union would run well ahead of political union and the order of integration of the existing large federal states would be reversed. Niels Thygesen is professor of economics at the University of Copenhagen and associate senior research fellow at the Center for European Policy Studies (ceps) in Bnissels. He was a member of the Delors Committee on Economic and Monetary Union in the European Community from 1988 to 1989. Earlierversions ofthe paper were presented at a conference in La Coruna, Spain, organized by the Center for Economic Policy Research (cepr) in December 1992, and at a conference in Vitznau, Switzerland in September 1993, organized by Center d'Études Juridiques Européennes, Université de Genève. 17 18 SAIS Review WINTER-SPRING 1994 This criticism ofemu has recendy become widespread in Europe as well. The Maastricht Treaty, signed in February 1992, which has emu as its central and most elaborately stated objective, ran into major difficulties at the ratification stage. Danish voters narrowly rejected the Treaty in a referendum in June 1992, although this result was reversed in a second referendum in May 1993. French voters passed die Treaty by a very narrow margin in September 1992, while ratification in die United Kingdom nearly brought down the government before it finally approved die Treaty in lateJuly 1993. Germany, the largest EC country and traditionally a motor of integration, had visible misgivings about Maastricht, particularly over the requirement to give up die deutschemark (dm), the source and symbol ofGermany's strength. Though voter misgivings about Maastrichtwere probably motivated more by odier aspects ofdie Treaty dian by emu and a common currency, the ratification battles clearly demonstrated that many Europeans had grave doubts about die feasibility ofachieving Maastricht's monetary objectives widiin die tight time schedule set forth in die Treaty.3 The political uncertainty spilled over into the financial markets. The European Monetary System (ems), which had been seen as an essential stepping stone to emu, reeled under unprecedented capital flows in September 1992. Two major currencies, the Italian lira and British pound, were forced to leave the system. Turbulence continued throughout die winter of 1992-93 as three ofdie remaining ems currencies were devalued and several odiers were attacked even diough diey had not been considered misaligned. Two ofthe currencies, die Spanish peseta and Portuguese escudo, were devalued again in May. In July, tensions reemerged and foreign exchange interventions once more took on unsustainable proportions. Finally, in early August, die Council ofFinance Ministers widened die ems margins drastically—from plus or minus 21A percent to 15 percent—while maintaining the central rates. This move was designed to make life more difficult for speculators by increasing the foreign exchange risk and to give countries greater scope for conducting differentiated interest rate policies than in die old ems. Member states have so far used die additional freedom with caution. To some, the two interacting destabilizing processes—die...