The Response of Europe to the Collapse of Bretton Woods

From the EMS to the EMU

U.S. Dollar Crisis, 1977-1978 During the years 1977-78, overly expansionary

monetary policy in the United States leads (again) to increasing rates of inflation and a deterioration of the U.S. balance of payments. Again, the dollar comes under attack again. From early 1977 to October 1978, the dollar lost 20%

of its value. In Europe, in response to this foreign exchange

market instability, 9 European countries establish the European Monetary System (March 1979) The goal of the EMS is to promote exchange rate

stability within this European group.

German Mark: 1973 - 1978

The EMS and Time Line to the Euro March 1979: The European Monetary System

agreement called for: The original 9 European currencies to be pegged to one

another, thus in essence establishing a fixed exchange rate regime amongst these countries. Countries set up the ECU, which is a basket of these 9 currencies. The UK joins the ERM in October 1990. In reality, all ERM members are linked to the German mark and

to Germany’s monetary policy. February 7, 1991: Maastricht Treaty signed (in the

Netherlands). This treaty calls for the adoption of a “single” currency, and a

single central bank, in Europe by 1999. Countries becoming part of the single currency area needed

to meet specified economic and financial criteria before they could adopt the single currency.

Some countries were given an “op-out” option, with the U.K. in particular, electing not to join.

The Euro Time Line January 1, 1999. The European Monetary Union (EMU) is

officially created. With the EMU: Eleven countries “irrevocably lock” their national currencies to the

single currency, the euro. These “locked” rates were based on the exchange rates between

these national currencies on January 1, 1999. For example: 1,936.27 Italian lira = 1 euro; 1.95583 German marks =

1 euro, etc. The euro starts trading on foreign exchange markets on this date

January 1, 2002. euro notes and coins are introduced into circulation and over a short period of time all national money is withdrawn. Greece joins the Euro zone on January 1, 2002, and Slovenia

joins on January 1, 2007, bringing the current number of countries in the euro zone to 13.

Who’s in the Euro Zone?

1999: The initial 11 participants were Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland.

The number increased to 12 on 1 January 2001, when Greece joined.

Slovenia became the 13th member of the euro area on 1 January 2007, followed one year later by Cyprus and Malta.

On January 1, 2009 Slovakia joins and brings the current Euro-zone total to 16.

 

The European Central Bank As part of the European Monetary Union, the

European Central Bank (ECB) was created. Headquartered in Frankfurt, Germany

It is modeled after the German Bundesbank. Thus, the ECB is highly independent and low inflation became

its main objective. See: http://www.ecb.int/home/html/index.en.html

Primary objective of the ECB is to maintain “price stability” within the euro-zone. Price stability is defined in the ECB charter at less than 2% This inflation targeting goal is achieved through ECB interest

rate policies. But many (even in Europe) see the ECB as operating

within too narrow a mandate. Especially true with high rates of unemployment in key euro

zone countries.

The Euro-Zone and Exchange Rate Risk In essence, the single currency of the

eurozone has removed exchange rate issues for transactions within the euro-zone itself. However, the euro itself is still a floating currency

against the other currencies of the world. Thus, exchange rate issues exist for foreign

companies (e.g., American firms and U.K. firms) doing business in the euro-zone and euro-zone countries doing business outside of the singe currency area. This is important to remember.

Stability Within the EMU

The Euro Against the USD Note: Exchange rate on first trading day: $1.18 (American Terms) Source: http://fx.sauder.ubc.ca/