The Maastricht treaty marked an important shift in European monetary arrangements. While discussion of a single currency in western Europe was certainly not new even in official circles, none of the earlier plans had been agreed by the relevant national governments. By providing a specific path to European monetary union (EMU), the treaty moved the discussion of a single European currency from the theoretical to the practical. Events since the signing of the treaty, however, in particular the exchange rate problems experienced by a number of countries in 1992 and 1993, have made the exchange rate path to EMU envisioned at that time less tenable.
This paper focuses on two issues associated with EMU. It examines, first, which countries might benefit from entry into EMU before the millennium, and second, which exchange rate policies are best designed to move countries with individual national currencies to a currency union. On the first issue, a considerable amount of empirical work has been done to assess the suitability of EU members’ joining EMU, looking at both the potential benefits and costs. The paper provides a brief overview of this literature, concluding that Germany and its immediate neighbors (Austria, Denmark, France, and the Benelux countries) are more suitable for EMU than other members of the EU. However, relatively little is known about whether all, some, or no countries would benefit economically from joining a single currency before the millennium because knowledge of the benefits from EMU, which is an essential part of any assessment of the economic value of membership, is too uncertain to provide the required level of precision.
The second issue that is discussed is the exchange rate path to EMU. A path to EMU was initially provided by the Maastricht Treaty. As far as monetary policy and exchange rates were concerned, the treaty outlined a, gradual evolution from a system limiting exchange rate fluctuations between member countries to the permanent and fixed exchange rates implied by a single currency using the existing exchange rate mechanism (ERM). In the autumn of 1992 and 1993, however, the ERM came under market pressures that forced Italy and the United Kingdom to suspend membership, the Nordic currencies to abandon their unilateral pegs against the ECU, Ireland, Portugal, and Spain, to devalue their parities, and the remaining participants to widen the bands of fluctuation of their currencies from 2¼ percent to 15 percent.
These developments are inconsistent with the gradual evolution of the exchange rate regime envisioned in the Maastricht treaty. The second part of the paper discusses possible exchange rate arrangements in the transition to EMU. The focus is on the experience of earlier exchange rate regimes, with particular emphasis on the pre-1914 gold standard. These experiences suggest that one potential way of avoiding financial instability during the transition would be to announce at an early stage the parities at which different currencies would enter EMU. Such a policy would work, however, only if governments were willing to accept the implied limitations on domestic policies needed to validate such a commitment.