- International Monetary Fund
- Published Date:
- November 1990
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Occasional Papers of the International Monetary Fund
73. The European Monetary System: Developments and Perspectives, by Horst Ungerer, Jouko J. Hauvonen, Augusto Lopez-Claros, and Thomas Mayer. 1990.
72. The Czech and Slovak Federal Republic: An Economy in Transition, by Jim Prust and an IMF Staff Team. 1990.
71. MULTIMOD Mark II: A Revised and Extended Model, by Paul Masson, Steven Symansky, and Guy Meredith. 1990.
70. The Conduct of Monetary Policy in the Major Industrial Countries: Instruments and Operating Procedures, by Dallas S. Batten, Michael P. Blackwell, In-Su Kim, Simon E. Nocera, and Yuzuru Ozeki. 1990.
69. International Comparisons of Government Expenditure Revisited: The Developing Countries, 1975–86, By Peter S. Heller and Jack Diamond. 1990.
68. Debt Reduction and Economic Activity, by Michael P. Dooley, David Folkerts-Landau, Richard D. Haas, Steven A. Symansky, and Ralph W. Tryon. 1990.
67. The Role of National Saving in the World Economy: Recent Trends and Prospects, by Bijan B. Aghevli, James M. Boughton, Peter J. Montiel, Delano Villanueva, and Geoffrey Woglom. 1990.
66. The European Monetary System in the Context of the Integration of European Financial Markets, by David Folkerts-Landau and Donald J. Mathieson. 1989.
65. Managing Financial Risks in Indebted Developing Countries, by Donald J. Mathieson, David Folkerts-Landau, Timothy Lane, and Iqbal Zaidi. 1989.
64. The Federal Republic of Germany: Adjustment in a Surplus Country, by Leslie Lipschitz, Jeroen Kremers, Thomas Mayer, and Donogh McDonald. 1989.
63. Issues and Developments in International Trade Policy, by Margaret Kelly, Naheed Kirmani, Miranda Xafa, Clemens Boonekamp, and Peter Winglee. 1988.
62. The Common Agricultural Policy of the European Community: Principles and Consequences, by Julius Rosenblatt, Thomas Mayer, Kasper Bartholdy, Dimitrios Demekas, Sanjeev Gupta, and Leslie Lipschitz. 1988.
61. Policy Coordination in the European Monetary System. Part I: The European Monetary System: A Balance Between Rules and Discretion, by Manuel Guitián. Part II: Monetary Coordination Within the European Monetary System: Is There a Rule? by Massimo Russo and Giuseppe Tullio. 1988.
60. Policies for Developing Forward Foreign Exchange Markets, by Peter J. Quirk, Graham Hacche, Viktor Schoofs, and Lothar Weniger. 1988.
59. Measurement of Fiscal Impact: Methodological Issues, edited by Mario I. Blejer and Ke-Young Chu. 1988.
58. The Implications of Fund-Supported Adjustment Programs for Poverty: Experiences in Selected Countries, by Peter S. Heller, A. Lans Bovenberg, Thanos Catsambas, Ke-Young Chu, and Parthasarathi Shome. 1988.
57. The Search for Efficiency in the Adjustment Process: Spain in the 1980s, by Augusto Lopez-Claros. 1988.
56. Privatization and Public Enterprises, by Richard Hemming and Ali M. Mansoor. 1988.
55. Theoretical Aspects of the Design of Fund-Supported Adjustment Programs: A Study by the Research Department of the International Monetary Fund. 1987.
54. Protection and Liberalization: A Review of Analytical Issues, by W. Max Corden. 1987.
53. Floating Exchange Rates in Developing Countries: Experience with Auction and Interbank Markets, by Peter J. Quirk, Benedicte Vibe Christensen, Kyung-Mo Huh, and Toshihiko Sasaki. 1987.
52. Structural Reform, Stabilization, and Growth in Turkey, by George Kopits, 1987.
51. The Role of the SDR in the International Monetary System: Studies by the Research and Treasurer’s Departments of the International Monetary Fund. 1987.
50. Strengthening the International Monetary System: Exchange Rates, Surveillance, and Objective Indicators, by Andrew Crockett and Morris Goldstein. 1987.
49. Islamic Banking, by Zubair Iqbal and Abbas Mirakhor. 1987.
48. The European Monetary System: Recent Developments, by Horst Ungerer, Owen Evans, Thomas Mayer, and Philip Young. 1986.
47. Aging and Social Expenditure in the Major Industrial Countries, 1980–2025, by Peter S. Heller, Richard Hemming, Peter W. Kohnert, and a Staff Team from the Fiscal Affairs Department. 1986.
46. Fund-Supported Programs, Fiscal Policy, and Income Distribution: A Study by the Fiscal Affairs Department of the International Monetary Fund. 1986.
45. Switzerland’s Role as an International Financial Center, by Benedicte Vibe Christensen. 1986.
44. A Review of the Fiscal Impulse Measure, by Peter S. Heller, Richard D. Haas, and Ahsan H. Mansur. 1986.
42. Global Effects of Fund-Supported Adjustment Programs, by Morris Goldstein. 1986.
41. Fund-Supported Adjustment Programs and Economic Growth, by Mohsin S. Kahn and Malcolm D. Knight. 1985.
39. A Case of Successful Adjustment: Korea’s Experience During 1980–84, by Bijan B. Aghevli and Jorge Márquez-Ruarte. 1985.
38. Trade Policy Issues and Developments, by Shailendra J. Anjaria, Naheed Kirmani, and Arne B. Petersen. 1985.
36. Formulation of Exchange Rate Policies in Adjustment Programs, by a Staff Team Headed by G.G. Johnson. 1985.
35. The West African Monetary Union: An Analytical Review, by Rattan J. Bhatia. 1985.
34. Adjustment Programs in Africa: The Recent Experience, by Justin B. Zulu and Saleh M. Nsouli. 1985.
33. Foreign Private Investment in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1985.
30. The Exchange Rate System—Lessons of the Past and Options for the Future: A Study by the Research Department of the International Monetary Fund. 1984.
29. Issues in the Assessment of the Exchange Rates of Industrial Countries: A Study by the Research Department of the International Monetary Fund. 1984.
28. Exchange Rate Volatility and World Trade: A Study by the Research Department of the International Monetary Fund. 1984.
26. The Fund, Commercial Banks, and Member Countries, by Paul Mentré. 1984.
24. Government Employment and Pay: Some International Comparisons, by Peter S. Heller and Alan A. Tait. 1983. Revised 1984.
22. Interest Rate Policies in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1983.
Note: For information on the title and availability of Occasional Papers not listed, please consult the IMF Publications Catalog or contact IMF Publications Services. Occasional Papers Nos. 5–26 are $5.00 a copy (academic rate: $3.00); Nos. 27–64 are $7.50 a copy (academic rate: $4.50); and from No. 65 on, the price is $10.00 a copy (academic rate: $7.50).
Resolution of the European Council of December 5, 1978 on the establishment of the European Monetary System and related matters in Commission of the European Communities (1979), pp. 95–97.
Belgium-Luxembourg, Denmark, France, Germany, Ireland, Italy, the Netherlands, Spain (since June 1989), and the United Kingdom (since October 1990) participate in the ERM. Throughout this paper the term ERM refers to the mechanism, the participating countries therein, or their currencies. The term EMS is used in more general contexts. All EC countries are members of the EMS. All references to Germany are to the Federal Republic of Germany as it existed before October 3, 1990 when unification took place.
For further details, see Section II.
For further discussion of asymmetry, see Section II.
The EMCF was established in April 1973. It has served mainly as the administrator for various transactions under the European common margins arrangement and the EMS, in particular the VSTF.
Section A.5.2. of the European Council Resolution of December 1978 provides for the possibility of participation in the exchange rate and intervention mechanism of the EMS for “European countries with particularly close and financial ties” with the EC.
No complete information on the amounts and methods of intervention by ERM countries is available. Giavazzi (1989) provides a table surveying the intervention behavior of the five larger ERM central banks for January 1983-April 1986. The Deutsche Bundesbank, in its annual reports, publishes information on intervention in deutsche mark, with a breakdown according to obligatory and intramarginal intervention. For a summary, see Table 6.
The considerations for such a policy for Italy were stated by Carlo A. Ciampi, Governor of the Bank of Italy, in a speech on January 26, 1988; see Ciampi (1988), p. 59. For case studies of disinflation policy in Italy and Ireland, see Gressani, Guiso, and Visco (1988) and Kremers (1990). On Ireland, see also Jones (1990).
Russo and Tullio (1988) refer to “an implicit agreement on inflation …—namely, to converge toward the German inflation rate and to let the Federal Republic of Germany determine the anchor inflation rate of the system” (p. 63). On this issue, see also Rieke (1989).
For details, see Section III.
See fn. 1 above.
For the amounts of ECUs created, see Table 9.
See Ungerer, Evans, and Nyberg (1983), p. 15.
For details, see Ungerer and others (1986), p. 8.
For a further discussion of private ECU interventions, see Moss (1988). About the prospects for the private ECU in the context of further integration of financial markets see, inter alia, Folkerts-Landau and Mathieson (1989).
For details, see Ungerer and others (1986), p. 6.
Official Journal of the European Communities (henceforth OJ), L 178, July 8, 1988.
See texts of communiqués in Appendix II.
In the meantime, it has been made permanent.
See, for example, Szász (1988).
For further background information on these three realignments, see Ungerer and others (1986).
Vis-à-vis a group of 17 industrial countries.
As quoted in the official communiqué, reproduced in IMF Survey, October 7, 1985, p. 296.
Against a larger set of partner countries that includes a number of producers of primary commodities, the yen’s real effective appreciation was more-pronounced (11 percent versus 6 percent for the deutsche mark), reflecting Japan’s larger share of trade with the United States and with countries with dollar-linked currencies.
As quoted in the official communiqué, reproduced in IMF Survey, March 9, 1987, p. 75.
This commitment was reaffirmed by the seven major industrial countries in December 1987, at the Toronto summit in June 1988, and at the IMF/IBRD Annual Meetings in Berlin in September 1988.
A reference to the fact that the immediate effects of an exchange rate change on import and export prices are compensated, only after a lag, by the desired volume effects and thus may lead initially to a deterioration of the current account.
A further criticism of recent exchange rate management by the major industrial countries is that the discussion has always centered on nominal exchange rates. Even if, through intervention and other policy measures, the exchange rate targets were achieved, differences in prices and costs across countries would not prevent shifts in real exchange rates and hence relative competitiveness. It was the evolution of the latter that was relevant for the correction of current account imbalances.
In contrast, the inflation differential between the United Kingdom and Germany stood at 5.1 percentage points, well above the corresponding differential with respect to the EC and OECD averages.
This tax was repealed on July 1, 1989.
This hardening of the stance of monetary policy reflected concern about inflationary pressures, the rapid growth of wages, and a widening of the current account deficit.
Outflows of speculative short-term capital, together with a worsening trade performance contributed to a large loss of international reserves in August and early September 1987. Monetary policy was tightened and complemented by a package of exchange control measures announced on September 13, 1987. The measures included the reimposition of a ceiling on commercial bank credit to the private sector and the tightening of controls on leads and lags relating to trade payments.
Following the inclusion of the peseta in the ERM, movements of the currencies in the wider band vis-à-vis those in the narrow band were constrained by a limitation of ± 6 percent on cross-rates between currencies in the wider band. It was thus no coincidence that during periods when the peseta was close to its upper intervention limit (early September 1989), the lira remained close to the currencies of the narrow band. This de facto constraint on the lira is thought to have been a factor in the authorities’ decision to move the lira into the narrow band.
See Williamson (1983).
In this study exchange rate variability is defined either as the coefficient of variation of monthly exchange rates or as the standard deviation of the monthly changes in the natural logarithm of exchange rates in a year. The first concept of measurement appears more appropriate if the stable, or expected, exchange rates remain unchanged while the second concept appears to apply when the stable, or expected, exchange rates follow a trend.
The variance of a composite such as an effective exchange rate index is given by the (weighted) sum of the variances and the covariances of the components. Thus, if the components of the index are positively (negatively) correlated, the variance of the index will be greater (less) than the (weighted) sum of the variances of the components.
See Preamble to the Treaty establishing the European Economic Community.
Once convergence is achieved, nominal exchange rates can be adjusted to reflect relative costs and prices.
Specifically, for unit labor costs to measure competitiveness in one country relative to another appropriately, it must be assumed that (i) the development of input costs other than labor is broadly the same; (ii) the countries under consideration share a similar production technology; (iii) the structure of demand remains basically unchanged in both countries; and (iv) the focus is on short-run developments. For aggregate price indices to be meaningful indicators, it has to be assumed in addition that productivity growth in the nontraded goods sector in the countries under consideration is similar. Since these assumptions may not always be fulfilled, international divergences in the development of the traditional price and cost indicators do not in all cases imply that exchange rate stability is endangered. See Lipschitz and McDonald (1990) for a detailed discussion of these issues.
In the early 1980s, there was a general consensus among policymakers in Europe and elsewhere that inflation had to be brought down. In this situation, monetary policies that would have left it to the majority of member countries to determine the Community price level on an average basis were seen as suboptimal, particularly when many of these countries had domestic political problems in keeping inflation under control.
Whether convergence of deficits would be brought about by market forces or require coordination of fiscal policies is another, hotly debated issue. See Section V for a review of the different arguments.
Since Spain and the United Kingdom joined the ERM only in June 1989 and October 1990, respectively, they are classified as non-ERM countries in the discussion of developments that took place during the first decade of the ERM.
Austria, Norway, Spain, Sweden, Switzerland, and the United Kingdom were selected as European comparator countries. Australia, Canada, Japan, and the United States were chosen as non-European comparator countries.
Average trade balances relative to GNP for the group of ERM countries recorded a larger improvement through the 1980s than external current account balances, owing mainly to a very sharp rise in the trade surplus of Ireland (Table 14). Reflecting the extraordinary improvement of the Irish trade balance, the divergence in external trade positions among ERM countries increased in absolute terms through the 1980s, but declined somewhat in relative terms (measured by standard deviations corrected for movements of means or coefficients of variation). In the group of non-ERM countries, average relative trade balances deteriorated through the 1980s, while differences in trade performance remained high.
On the other hand, the emergence of large external imbalances has been regarded as an indication of greater capital mobility among ERM countries and therefore as of little concern to policy-makers.
While Collins (1988) did not find evidence of any shift in inflation behavior of ERM countries after 1979, Russo and Tullio (1988) and, more recently, Chowdhury and Sdogati (1990) came to the conclusion that ERM commitments played a positive role in bringing down inflation. See also Giavazzi and Giovannini (1988) and Harbrecht and Schmid (1988). On the question whether the EMS is providing a policy and operational framework for a credible disinflation strategy, see Thygesen (1988) and Rey (1988). For a detailed analysis of the process of disinflation in Italy and Ireland, see Gressani, Guiso, and Visco (1988) and Kremers (1990), respectively.
However, divergence measured by coefficients of variation is overstated when the sample mean approaches zero.
These countries are seen to have drifted away from the level of competitiveness that they had attained when they joined the ERM. See Melitz (1988).
In Italy, relative adjusted consumer prices increased more than relative adjusted unit labor costs and value-added deflators in manufacturing, which may reflect a sharper rise in the relative price of nontradables in this country than in Germany.
Profitability is measured by the ratio of value-added deflators to unit labor costs. An increase in unit labor costs with unchanged value-added deflators indicates a profit squeeze, reflected in a drop in the profitability indicator.
Evidence gleaned from export market share data provides support for these main conclusions (Table 25). The loss of export market shares for some of these countries can, however, be attributed to many factors, including changes in real exchange rates, shifts in the patterns of world trade flows, differences in output growth, and in certain nonprice aspects of competitiveness, with the share of newly industrializing countries in world trade generally rising. Also, the sharp depreciation of the dollar after 1985 substantially improved the competitive position of non-oil exporting countries with dollar-based currencies.
The deadline for Ireland and Spain and for Greece and Portugal, however, has been set at end-1992; for details see Section IV.
See, for example, Rogoff (1985).
See also the assessment of economic convergence in the EC by the Commission of the European Communities (1989b).
OJ, No. 43, July 12, 1960, and OJ, No. 9, January 22, 1963.
Council Directive 77/780/EEC of December 12, 1977, OJ, L 322, December 17, 1977.
Bulletin of the European Communities (Brussels), Supplement 2/86.
“Completing the Internal Market” (Brussels), COM (85) 310 final, June 1985.
“The principle of subsidiarity” defines the functions of higher levels of government as subsidiary to those of lower levels. In the EC context, the principle implies that the ceding of authority by the lower levels to the Community level should be limited to that minimum of collective decision making which is indispensable for the functioning of agreed Community policies and mechanisms. Under the “principle of harmonization,” Community rules, adopted to secure the necessary degree of coordination and commonality, enjoy pre-eminence over members’ national rules. Under the “principle of mutual recognition,” members agree to recognize each other’s national rules where no Community rule has been established.
Council Directive 88/361/EEC of June 24, 1988 for the Implementation of Article 67 of the Treaty, OJ, L 178, July 8, 1988.
Second Council Directive 89/646/EEC of December 15, 1989 (OJ, L 386/1, December 30, 1989) on the coordination of laws, regulations, and administrative provisions relating to the taking up and pursuit of the business of credit institutions and amending Directive 77/780/EEC.
Council Directive 89/647/EEC of December 18, 1988, OJ, L 386/14, December 30, 1989.
Council Directive 89/299/EEC, OJ, L 124, May 5, 1989.
The Committee on Banking Regulation and Supervisory Practices of the Bank for International Settlements (the Cooke Committee) was established in December 1975. In 1986, it proposed common definition, notably by the major industrial countries, of capital requirements for international banks, linked to banks’ risk exposure. In 1987, the United Kingdom and the United States, joined later that year by Japan, proposed convergence of their systems for monitoring banks’ capital adequacy. On this basis, the central bank governors of the Group of Ten countries in July 1988 endorsed a plan to harmonize minimum capital adequacy standards for international commercial banks. Apart from the coordinated approach now under way within the EC, the accord is implemented individually by the national authorities.
See, for example, Driffill (1988) and McDonald and others (1989).
Wyplosz (1988b), p. 87.
The background of the national treatment approach is discussed in Folkerts-Landau and Mathieson (1989), p. 19.
Russo and Tullio (1988, pp. 57–62) discuss in some detail four possible models of commonly agreed monetary policies that would go beyond discretionary coordination. While these rules do not imply a common policy based on a common monetary institution, they represent alternate approaches that could be followed by a common institution, such as a European central bank.
See Basevi and others (1975), Commission of the European Communities (1975) and (1976), and Vaubel (1978). More recently, see Russo (1988). See also the most recent proposal of the U.K. authorities, pages 43–44, below.
Committee for the Study of Economic and Monetary Union, Report on Economic and Monetary Union in the European Community (Luxembourg, 1989) (henceforth Delors Report), p. 33. For a general critical review of the parallel-currency approach, see Kloten and Bofinger (1988).
It has been favored by the Board of Academic Advisers to the German Federal Ministry of Economics (Wissenschaftlicher Beirat beim Bundesministerium für Wirtschaft, 1989a). Similar ideas can be found in the proposals of the U.K. Treasury, see below. See also Currie (1989).
Since these discussions are usually confidential, no published records exist. However, speeches and interviews by such officials shed some light on the nature of the issues discussed.
Economic and Social Review—“European Monetary System: 10th Anniversary Issue,” ed. by Michael Moore, Vol. 20 (January 1989); Journal of Common Market Studies—Special Issue: The European Monetary System (March 1989); De Grauwe and Peeters (1989); Giavazzi, Micossi, and Miller (1988); de Cecco and Giovannini (1989); Conference at the University of Bergamo, “The European Monetary System, Ten Years Later” (May 1989; unpublished); and Welfens (1990).
All page references in this paper are to the edition of the report cited in fn. 82 above. In a second part, the publication contains a collection of papers submitted to the Committee by individual committee members. These papers either deal with specific aspects of EMU or represent preparatory position papers.
Of the seven members of the Werner Committee only two were central bankers.
See also Gunter D. Baer and Tommaso Padoa-Schioppa, “The Werner Report Revisited,” Delors Report, pp. 53–60.
See the opinions expressed by the Chancellor of the Exchequer, Nigel Lawson, and the Prime Minister, Margaret Thatcher, respectively, before the Treasury and Civil Service Committee of the House of Commons, June 12, 1989, and before the House of Commons, June 29, 1989, United Kingdom (1989a).
United Kingdom (1989b), p. 5.
For critical responses, see, for example, Ciampi (1989b), Costa (1989), and Carli (1990). For a supportive view, see Brittan (1989). A concept, which in many respects is similar to the U.K. proposals, was presented by the Board of Academic Advisers to the German Federal Ministry of Economics (Wissenschaftlicher Beirat beim Bundesministerium für Wirtschaft, 1989a).
Major (1990), para. 12.
This concept of a “hard ECU” was not entirely new; similar proposals had been presented before. See Commission of the European Communities (1975) and Russo (1988).
See, for example, Pöhl (1990b).
See, for example, Costa (1989), Szász (1988), and Pöhl (1990a). For a variety of views opposing binding rules, see Lawson in United Kingdom (1989a), Wissenschaftlicher Beirat beim Bundesministerium für Wirtschaft (1989a), and Bredenkamp and Deppler (1990). See also Commission of the European Communities (1990a and b), discussed below. For comments on the interrelation between monetary and fiscal policy under fixed exchange rates, see Guitián (1988), p. 13 and Schinasi (1989), p. 407.
See, for example, Ciampi (1989b); Duisenberg (1989b); Pöhl (1990a); Doyle (1990); de Larosière (1990a and b); Chalikias (1990). See also discard d’Estaing, as quoted in Börsen-Zeitung, February 17, 1990. On this issue, see also a recent statement of the Deutsche Bundesbank of September 19, 1990, in which the consequences of establishing EMU and the conditions for assuring monetary stability are discussed (Deutsche Bundesbank, Monthly Report, October 1990).
This view is strongly reflected in the concept of Ordnungspolitik as developed by Walter Eucken and a number of Austrian, German, and Swiss economists. Ordnungspolitik could be defined as the underlying basic policy aimed at establishing and maintaining a certain economic order characterized by free markets, unrestricted competition, free international trade, and what has sometimes been called “nonpolitical money.”
In a study exploring the interconnections between politics and macroeconomics, Alesina (1989) found an inverse relationship between the degree of autonomy of a central bank and the inflation rate: among 17 industrialized countries, the 4 most independent central banks (Japan, the United States, and, especially, the Federal Republic of Germany and Switzerland) have been associated with four of the five lowest inflation rates (measured as an average for 1973–86).
Before the Treasury and Civil Service Commission, June 12, 1989 (United Kingdom, 1989a).
See Wissenschaftlicher Beirat beim Bundesministerium für Wirtschaft (1989b), para. 3. See also The Economist (1989).
OJ, L 78/23 and L 78/25, March 24, 1990.
Commission of the European Communities, “One Market, One Money,” European Economy, No. 44 (Brussels), October 1990. See IMF Survey, November 26, 1990.
For details, see the communiqué of the European Council meeting (Appendix II).
The limits are double the debtor quota of the short-term monetary support (STMS) mechanism (Germany, France: ECU 3,480 million; Italy: ECU 2,320 million; Belgium, the Netherlands: ECU 1,160 million; Denmark: ECU 520 million; Ireland: ECU 200 million).
The chronology was originally prepared by Peter Flanagan for Garry J. Schinasi’s paper, European Integration, Exchange Rate Management, and Monetary Reform: A Review of the Major Issues, International Finance Discussion Paper No. 364, Board of Governors of the Federal Reserve System, October 1989. It was updated by Mr. Schinasi.