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European Payment Union (1950-1958)


European Payment Union (1950-1958) Facilitated multilateral clearing of payment imbalances. The Bank of ... (De facto, 1946-1958, De Jure 1958-1971) ... – PowerPoint PPT presentation

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Title: European Payment Union (1950-1958)

History of the European Monetary Integration
  • European Payment Union (1950-1958)
  • Facilitated multilateral clearing of payment
    imbalances. The Bank of International Settlements
    acted as a clearing house.
  • European Monetary Agreement (1958-1972)
  • Many European currencies became convertible. The
    Agreements facilitated central banks in making
    settlements in gold and dollars.

Bretton Woods System (De facto, 1946-1958, De
Jure 1958-1971)
  • Currencies were allowed to fluctuate by 1
    margin of fluctuations with respect to dollar.
  • European currencies could fluctuate as much as 4
    with each other since ? 1 against the meant
    ?2 against each 2 margin of fluctuations for
    EC currencies (against each other). other.
  • European Monetary Agreement (1958-1971) implied
    narrower margins 0.75 margin of fluctuations
    with respect to dollar and 1.5 with respect
    to each other EC currency.
  • December 1971-Smithsonian agreementgt a 7.9
    devaluation of the dollar against gold setting
    1ounce of fine gold38. Also, DM was revalued
    by 4.6, Dutch Guilder by 2.8 and 7.7 for yen
    against gold. (All references to the gold content
    of a currency was formally abolished by IMF in
  • With the Smithsonian Agreement on December 1971,
    the band was enlarged to ?2.25

Why fixed rates?
  • General dislike of EC countries for floating
    exchange rate regimes because of
  • a) its negative impact on trade and investment
    flows due to exchange rate volatility,
  • b) experience in 1919-1926,
  • c) difficulties to administer the CAP under the
    flexible exchange rate regime when the
    fluctuations in exchange rates make it possible
    to revise price supports to farmers,
  • d) inherent instability of the flexible exchange
    rates due to speculation.

Basle Agreement (Snake in the Tunnel ) (1972)
  • EC currencies jointly moving within a dollar
  • Bilateral exchange rates with respect the dollar
  • Bilateral exchange rates among European
    currencies ?1.
  • (2.25 band)
  • (Narrower Band for European currencies)
  • Intervention mechanism and monetary support for
    member countries.

Snake in the Tunnel
Bilateral band among European currencies ?1
Fluctuation band against the dollar ?2.25
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European Monetary System (1979) and The Exchange
Rate MechanismERM(1979-1998)
  • Shepherded by Schmidt and DEstaing A zone of
    monetary stability and a nursery for European
    Monetary Union (EMU). ERM was the institutional
    mechanism for stability between EC currencies
    while floating them against all others, including
    the dollar.
  • Creation of a cocktail currency, a numéraire
    ECU (European Currency Unit) consisted of
    weighted values of EC currencies based on their
    GDP and trade. Just as the dollar was at the
    center of the BW system and was its de facto
    numéraire and reserve asset (the dollar was as
    good as gold), the ECU was the reserve asset of
    the EMS (used for settlement of accounts between
    Central Banks) and its unit of account.

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European Monetary System (1979) and The Exchange
Rate MechanismERM(1979-1998) (Continued)
  • The ERM created a set of central rates of
    exchange between participating currencies
    expressed in terms of ECU.
  • Each currency was to maintain exchange rates
    vis-à-vis each other within 2.25 of the
    central rate, subject to the possibility of a
    formal realignment. (For Italy and Ireland, later
    for UK (1990), and Spain (1989), this was 6.
    Italy moved to 2.25 in 1990 but left it again
    after the EMS collapsed in 1992).
  • Financing facilities and short-term credits were
    provided to member Central Banks.
  • Possibility of realignments allowed within the
  • The Central bank of the weak (strong) currency
    had a legal obligation to defend these margins
    by buying its weak currency (selling its strong

The Exchange Rate MechanismERM
  • Frequent realignments at first, less frequent
    later, no realignment after 1987 (the hard EMS)
    Compare 27 currency realignments in 1979-1983
    (Soft EMS) with only 12 parity changes in
    1983-1989 (Hard EMS)
  • DM as the nominal anchor currency due to her low
    inflation. Other currencies targeted a constant
    exchange rate against DM and were able to
    import Germanys low inflation success and the
    credibility of the Bundesbank.
  • The EMS A mechanism to embark anti-inflationary
    policies through relatively fixed exchange rates
    with respect to DM (the low inflation currency).
  • The period was a stepping stone to full Monetary
    Union. With its narrow bands, infrequent
    realignments and its orientation on DM,
    participation in the hard EMS implied that the
    resort to independent monetary policy would be
    undertaken only under exceptional conditions.

The Exchange Rate MechanismERM
  • The Disintegration of the EMS during the 1992 and
    1993 Exchange Rate Crises Under Conditions of
    almost fixed exchange rates (after 1987) and
    capital mobility.
  • 1992 Lira and Peseta Crisis ? Divergent inflation
    rates from German levels (30 higher in Italy
    compared to Germany), loss in competitiveness and
    balance of payments problems which proved
    unsustainable. Expectations of devaluation breed
    speculation (sell Lira and buy DM! Once the
    devaluation occurs, buy back Lira and gain a
    windfall profits.)

The Exchange Rate MechanismERM
  • 1993 Pound and French Franc Crisis? No evidence
    of divergent inflation patterns and
    competitiveness of France or UK relative to
  • An irrational speculative attack on these
    currencies driven by an Anglo-Saxon plot
    against the monetary unification?? Not really!
    The policy conflicts between Germany on the one
    hand, and Britain and France on the other about
    the appropriate monetary policy to deal with
    the1992 recession which hit these economies.
    Complications of the German unification in 1990gt
    Large increase in German government spending
    created inflationary pressures. But Bundesbank
    was determined to fight inflation through
    restrictive monetary policy (high interest
    rates!). Britain and France, by contrast, opted
    for an expansionary policy with low interest
  • Speculators noticed that UK and France were about
    to cut their links with the Mark, and attacked
    the pound and the franc (sold pound (franc),
    bought DM) leading to a sharp depreciation of
    both of these currencies against the mark.
  • Two currencies-Italian Lira and UKs pound- were
    driven out of the system.
  • The resolution of the second crisis was to widen
    the bands of fluctuation to 15-not too
    different from a free float, quasi-floating
    exchange rate regime.

The Exchange Rate MechanismERM
  • The role of speculation and impossibility of
    realigning currencies in a speculation-proof
    manner. Dispelled the illusion that Germany would
    feel bound to support the system against
    speculative attack by unlimited intervention in
    the forex markets. During these crises, Germany
    supplied DM to the Central Banks of the weak
    currencies so as to support their fight against
    the speculative attack (buying their weak
    currency by selling DM while maintaining the
    fixed exchange rate with DM). But after a while,
    large increases in DM money supply led Bundesbank
    to stop supplying DM as it was getting too
    difficult to sterilize the DM expansion. Large
    increase in DM supply meant Bundesbank would
    relax its restrictive stance on monetary policy
    but it was unwilling to do so with inflation as
    its top priority. Unconditional defense of the
    weak FF and pound would mean changing their
    policy stance.

The Exchange Rate MechanismERM
  • After 1987, the EMS became almost a fixed
    exchange rate regime and quite rigid with
    infrequent realignments of the exchange rates.
    Quasi-fixed exchange rate regimes like EMS are
    prone to speculative attacks unless the countries
    coordinate economic policies well. Speculation
    inevitably proves self-fulfilling and some call
    for capital controls to reduce the amount of
    funds that can be mobilized by speculators to
    protect such regimes. True, capital mobility
    affected the timing and the dynamics of the
    disintegration of the EMS, but it was not
    responsible for its inherent instability under
    conditions of divergent economic conditions and
    policy preferences.
  • The crises did not, however, spell the end of
    aspirations for a monetary union. Just the
    opposite Full monetary union was the only viable
    fixed-rate solution, this was well understood.

The EMS from 1993 to 1998
  • Enlargement of the band of fluctuation to 30 (
    15) reduced the scope of speculative attacks
    after 1993.
  • The start of European Monetary Union (EMU) was
    scheduled for 1 January 1999.
  • Maastricht Treaty (1991) One condition for entry
    into the EMU was that the candidate countries
    would maintain the exchange rates within the band
    from January 1, 1997. This raised the cost of
    devaluation for the applicant countries.