A Bit of History

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A Bit of History

The idea of a single currency throughout Europe has been discussed as long ago as the 60s. The economic problems of the 70s delayed the politicians, but the first steps were taken with the Exchange Rate Mechanism (ERM), which began in 1979. The idea was that if the currencies of Europe could stay together in this fixed (but adjustable) exchange rate system for a significant period of time, and then they could join together and form one currency.

The next big step was the signing of the Single European Act in 1985. This committed members of the EU (including those, like the UK, who were not yet part of the ERM) to creating a 'single' market in Europe, totally free of barriers to trade. Labour and capital would also flow freely across boundaries.

The Maastricht Treaty was signed in 1992. This outlined a three-stage plan for movement towards full monetary union (European Monetary Union - EMU)

A Bit of History

The three stages

Stage one

Stage one seemed fairly innocuous. It simply involved the creation of a 'Monetary Committee' who would advise governments on how to proceed with the next two stages, including help to set up the European Central Bank (ECB). Technically this stage started on the 1st January 1993, which was the same day that the single market in the EU was meant to be in operation (it wasn't really a totally free single market for a good few years).

Stage two

Stage two involved the creation of the 'European Monetary Institute'. It took over the whole process; co-ordinating monetary policies and helping countries get ready for the single currency. Its main job was to make sure that the economies of the EU converged in terms of the following criteria:

Inflation

Each country's inflation rate had to be within 1.5% of the average of the lowest three countries.

Interest rates

Each country's long-term interest rates (using the rate of long term government bonds) were to be no more than 2% of the average of the lowest three countries.

Yearly government debt

This refers to the PSNCR or budget deficit. Each country's yearly government debt must be no more than 3% of its GDP.

National debt

Each country's national debt (total government debt) must not be more than 60% of its GDP.

Exchange rate

Each country should be within the narrow bands of the ERM for at least two years leading up to the start of the single currency. This criterion became a bit redundant after the bands were widened to ±15% after the problems of 1992/3.

It was important that the economies converged before the start of the single currency. If they were to have the same currency, which implied the same interest rate, then it was important that the participating economies were more or less the same, as they would, effectively, become one economy. An interest rate change in the UK is not always right for the prosperous South East as well as the struggling North East. This applies to the single currency area as well, where a rate change that is right for Germany might not be right for Ireland.

Stage three

Stage three started on the 1st January 1999. The single currency replaced all of the currencies of the thirteen participating countries and the ECB became the central bank, with control over monetary policy, for all thirteen countries.

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