European monetary union

The Treaty of Rome (1957) implementing the European Economic Community (EEC) did not provide for specific provisions to monitor the exchange rates of its member coun- tries' currencies. Only from the mid 1960s did European political leaders, confronted with the collapse of the international monetary system, consider ways to protect the EEC from the harm caused by growing exchange-rate instability. This led to the Werner Report of 1970, which proposed economic and monetary union over the next decade - a proposal that never materialized. As such, European authorities fell back on specific mechanisms to promote a (relative) stability of foreign exchange rates, notably via the European Monetary System (EMS), which operated from 1978 to 1998.

The idea of establishing a monetary union in Europe resurfaced in the late 1980s, in the context of revitalizing the European construction. In 1988, an ad hoc committee chaired by Jacques Delors, then President of the European Commission, was set up in order to propose steps for creating an economic and monetary union. The ensuing report laid the foundations of such a union, resulting in the adoption of the Maastricht Treaty of 1992. The main provision of this Treaty, which took effect on 1 January 1999, was to implement a single currency in Europe. However, not all member countries of the European Union (EU) adopted the euro, as the Maastricht Treaty provided convergence criteria that needed to be met before countries were allowed to join, and an opt-out (opt-in) clause for Denmark and the United Kingdom. Currently (June 2014), 18 member countries out of 28 have adopted the euro as their single currency.

Further, with the establishment of the single currency, the Maastricht Treaty promoted the establishment of a European Central Bank (ECB), whose responsibility includes the conduct of monetary policy across the whole euro area and price stability (an inflation rate below, but close to, 2 per cent over the medium term). To complement and strengthen the effects of the single monetary policy, a Stability and Growth Pact was established in 1997, designed to safeguard sound public finances.

Prior to the Maastricht Treaty, various assessments of the potential costs and benefits of forming an economic and monetary union in Europe were carried out. In particular, the Commission of the European Communities (1990) insisted on the efficiency gains and their positive impact on economic growth that would result from the elimination of exchange-rate uncertainty and transactions costs. It also insisted on the economic benefits that would result from price stability. It acknowledged that the loss of monetary and exchange-rate policies as instruments of economic adjustment at the national level would represent a major cost. However, it argued that this cost should not be exagger- ated, since the exchange rate of the European single currency against foreign currencies could fluctuate, and since most of the EU member countries within the EMS had already abandoned the exchange rate instrument. Finally, by becoming a major international cur- rency, the European currency would allow banks and firms to conduct international busi- ness in their own currency, and member States would spare external reserves and speak with a single voice in the field of international monetary and financial affairs.

Despite this vision, the implementation of the European single currency (the euro) did not prevent the EU from stagnating. In fact, in 2002, the European Commission asked a panel of distinguished economists to examine the ways and means of making the EU eco- nomic system deliver. The ensuing report (Sapir et al., 2003) did not incriminate the euro itself, but laid the blame for the unsatisfactory economic growth of the EU on its failure to become an innovation-based economy. The report recommended a drastic change in economic policies in order to face this situation.

It should also be mentioned that another expected outcome of the European monetary union was the improvement of political cohesion among its member States. Needless to say, this is also far from being a success at the time of writing.

With the benefit of hindsight, we may now note that the way monetary union has been implemented in Europe bears significant responsibility for economic stagnation and unemployment across the euro area. From the beginning, it was plain that the economic systems of its member countries were too heterogeneous to support fixed exchange rates and a one-size-fits-all monetary policy. Referring to Mundell (1961), many economists rightly argued that the euro area was not an "optimum currency area". The convergence criteria dealt mainly with nominal variables only (stability in price levels, interest rates and foreign exchange rates), not with structural features such as disparate wage and social security levels.

All in all, the realization of European monetary union was done in a nonsensical way. For instance, its member countries were invited to abandon their monetary sovereignty, yet they are still not members of a single payment system. This is because their national currencies were not replaced with a truly single European currency, despite the changes in the currencies' names: the European system of cross-border payments (TARGET2), in fact, does not allow for the settlement of payments, as was made obvious by Germany's accumulation of TARGET2 balances in the aftermath of the euro-area crisis that erupted in 2009. In a truly unified currency area, as in any country with its own domestic cur- rency, all payments would be settled through the central bank. This is not what occurs in the euro area as regards TARGET2 payments with respect to the ECB. In light of the persistent heterogeneity of its member countries' economies, the EU should take advantage of its uncompleted monetary union to use the euro as a common currency for international payments, both within and outside the euro area, and restore its member countries' sovereignty with regard to the exchange rates of their still domestic currencies and to their monetary policies. The ECB would act thereby as an international clearing house built on the model of the International Clearing Union once designed by Keynes (see Rossi, 2012).

See also:

Bretton Woods regime; Euro-area crisis; European Central Bank; International settle- ment institution; Optimum currency area; TARGET2 system.