8.6 Monetary union in Europe

that it is very difcult to persuade the richer national governments to increase their

contributions to the EU budget in order to provide greater assistance to the poorer

member countries. It is this argument that leads to the view that for the monetary

union to work, it must sooner or later be supported by a single scal policy across

the union, implying a strong element of political union. Much of the opposition to

the single currency stems from a rejection of the idea of political union.

The second relevant difference between the EU and single countries such as the

US concerns the mobility of labour. Differences among regions are less serious if

unemployed or poorly paid workers are easily able to move to obtain jobs or higher

pay. There are many forces operating against labour mobility in single countries –

social and family ties, the educational needs of children, lack of information about

working and living conditions in other regions and, particularly important in the

UK, wide differences in the price of housing and lack of exibility in the market for

rented accommodation. However, it is certainly true that the existence of different

languages and the extent of cultural differences together with differences in educational

systems and social security and pension regulations cause labour mobility across the

EU to be much lower than it is across the UK or the US. This is likely to remain the

case for a long time, despite all the efforts of the European Commission to overcome

these differences. And yet it is also true that the adoption of the single currency is very

likely to contribute to increasing the mobility of labour in Europe. It is also clear that

these concerns about growing differences in economic performance among countries

essentially stem from the single market, not simply from the single currency.

The argument against the single currency sometimes concentrates on the problems

associated with a common monetary policy. This is principally the ‘one size does not

t all’ argument – that the interest rate chosen by the European Central Bank is

unlikely to be suitable for all member countries because different member countries

will, at any one time, be at different positions on their business cycles. Since 1999,

it has frequently been argued that Germany needed lower interest rates than those

set by the ECB because of its slow economic growth and high unemployment,

while Spain and Ireland, which were experiencing much faster rates of growth and

inationary pressures, would have appreciated higher rates of interest.

One difculty with the argument is that it applies at national level as well. When

the Monetary Policy Committee of the Bank of England makes its monthly decision

about UK interest rates, the interest rate chosen is very likely to suit some regions

more than others. It is also likely to suit some sectors of the economy more than

others. In recent years, there has often been a conict between the needs of a boom-

ing housing market and those of an export sector suffering from the low level of

demand in the world economy. Conditions in the housing market have sometimes

appeared to call for no change or for an increase in the rate of interest at the

same time as the export sector would clearly have beneted from a signicant fall

in interest rates.

Obviously, however, a single interest rate is likely to be less satisfactory the greater

are the differences across the economy. Looking at the question in this way makes

it clear that the underlying issue again concerns the extent to which the single

market supported by the single currency is likely to lead to convergence or divergence

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Chapter 8 • Foreign exchange markets

among members. Certainly, if the single market is a success, business cycles of the

different member countries should come into line and the common monetary policy

should, over time, cause fewer problems across the monetary union.

8.6.1

The single currency in practice 1999–2006

The	single European currency, the euro, came into existence on 1 January 1999.

It began trading at a rate against the US$ of a1 $1.1743 and against sterling of

a1 £0.7058. However, it quickly began to fall in value. Despite occasional upward

movements, it continued its general slide until October 2000 when it reached

a1 $0.8273 and a1 £0.5747, a fall of 30 per cent against the dollar and of 20 per

cent against sterling. This was despite the fact that several members, most notably

Germany, had wanted the euro to be a strong international currency.

The basic reason given throughout the period for the slide in the value of the

euro was the high unemployment rates and low rates of growth in the major EU

economies, particularly in Germany. This convinced the markets that the ECB would

need to keep interest rates low. The ECB had started with an interest rate of 3 per cent.

1

This was lowered in early April 1999 to 2/2per cent. The ECB gave no indication

that it was unduly concerned about the fall in the value of the euro and thus there

seemed no immediate prospect of an increase in interest rates to try to stem the fall.

In addition, politicians and central bank ofcials often made conicting statements

concerning the euro, giving the markets the feeling that the ECB would be happy

just to let things drift. The markets did not like this apparent lack of leadership.

Under these circumstances, other factors, which might normally not have had much

impact on the currency, provided additional excuses for selling the euro. These

included the resignation of the president and members of the European Commission

and the NATO bombing of Serbia and Kosovo. It was suggested that there would

need to be genuine news about improved fundamentals underlying the value of the

currency to push up the value of the euro, whereas it would fall merely on the basis

of rumour and political uncertainty. Nor was the market fully convinced that the

ECB would, despite its constitution, be immune from political pressure. This con-

cern was strengthened by the confusion over the length of the term of ofce of the

rst president of the ECB, Wim Duisenberg of the Netherlands.

Duisenberg was appointed in 1998 to serve an eight-year term. However, there

had been conict over his appointment because of the fear of some member states,

notably France, that Duisenberg’s approach to policy would be too conservative

and that monetary policy might be deationary. It was generally accepted that there

had been a behind-the-scenes agreement that Duisenberg would serve only half of

his full term of ofce and would then be replaced by a French nominee, although

Duisenberg consistently denied this. In the event, he retired from the job on his 68th

birthday, on 9 July 2003, having served just over ve years of the eight-year term.

In addition to the worry about leadership, because the euro was a new currency

there was no rm view as to the long-run exchange rate indicated by economic fun-

damentals. The starting exchange rate of the euro was simply a weighted average of

the values of the eleven participating currencies at the end of December 1998. There

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