Living with the euro: the user's guide to 1999
Monday 25 March 1996
Financial markets are already becoming highly exercised about this. However, if my experience is anything to go by, the main focus so far has been on what will happen before the start date. It is time to focus on what life will be like after 1999. Here are some pertinent questions and answers.
When will the single currency be launched? Assuming the Maastricht timetable sticks, the intention is to launch the euro on 1 January 1999. However, there has been increasing talk of a "technical delay" or of "stopping the clock at one minute to midnight". Either device might be used to delay the launch date for up to a year, while continuing to proceed under the umbrella of Maastricht. On launch day, the European Central Bank will formally become responsible for monetary and exchange rate policy; the euro will become a currency in its own right; and exchange rates will be totally fixed against the euro within the EMU group.
So domestic currencies such as the mark will continue to exist? Up to a point. Although many transactions will continue to be denominated in marks, francs etc, and although these national currencies will continue to circulate in the form of notes and coins, they will no longer be genuine independent currencies. They will be freely interchangeable in infinite quantities at fixed rates against the euro and will, in theory, simply be different names for the same currency, the euro. There will be no "big bang". The euro will develop its role at different speeds in different markets until July 2002, when all other currencies will be finally withdrawn.
Isn't the interim period just like the old ERM? No, it is not. Under the old ERM, national currencies remained the responsibility of the national central banks, even though they were linked together (within 2.25 per cent margins) against each other.
There was no supranational organisation that guaranteed to intervene without limit to keep the currencies totally fixed against each other. In particular, when there was a speculative rush into marks, the Bundesbank often failed to sell enough marks in the foreign exchange markets to keep the exchange rates fixed. This was because such operations would have increased the German money supply - not acceptable to the Bundesbank. Eventually, this precipitated the break-up of the system.
Isn't there a risk that the Bundesbank will act the same way under EMU? No, because it will not be allowed to. The Bundesbank will have no control over monetary policy in Germany, and will be able to issue marks only under the authorisation of the ECB. It will therefore become nothing more than an operating arm of the ECB.
If there is a speculative rush into marks and out of euros or francs, the ECB will simply order the issue of an infinite number of marks until the speculation stops.
Does that mean the the system cannot break up? In theory, the system cannot break up. And in practice, it is far less likely to break up than the old ERM. But we cannot be absolutely certain of its durability. For example, if people think that there is a risk of a future German government pulling out of the system, and re-establishing the mark as an appreciating currency in its own right, they may choose to hold marks in preference to either francs or euros in the early stages, just in case.
This would cause problems, since the money supply in Germany would then increase sharply, and that in France would diminish.
This could cause loud political complaints about inflationary forces in Germany and about recessionary forces in France. And the fact that the system lacked absolute credibility with either markets or politicians could potentially cause such currency shifts to snowball.
How could this be controlled? The EU hopes that the problem would never arise in the first place.
If they pick the right exchange rates at the start (not necessarily the present ones, which of course raises another problem of how and when to set the right rates), and if they convince people that they will always provide enough marks for euros to keep the exchange rates totally fixed, sizeable speculation against the parities may never occur. But if it does, they will allow the interest rate on the mark to fall below that on the franc and euro, thus discouraging people from holding too many marks.
But you said that there would be a single monetary policy? How can there be more than one interest rate? Good point.
The ECB will conduct all of its internal monetary policy interventions in euros, and hope that the interest rates on marks and francs will be almost exactly equal to those on the euro.
But if the markets believe there is a risk of a future change in the exchange rates, they will force interest rates to diverge between the mark and franc to compensate them for this risk, and there is nothing the ECB can do to prevent this.
Of course, such interest rate divergences will be highly inconvenient to say the least, since they may be directly the opposite of what the French and German economies need in terms of monetary policy.
So you think the system could end in disaster after all? It is not very likely, provided that the initial launch is at the right exchange rates, and provided it commands wide political consent from all members.
But if the launch is rushed, a subsequent bust-up is certainly a possibility, at least in the period when marks and francs are circulating alongside the euro.
Since the system could be broken up, does that mean a decision to join is reversible? Technically, a member state could choose to opt out fairly easily, at least up to 2002, when its own currency denominations would still be circulating in people's pockets, and in bank accounts. After that, with the euro holding a monopoly inside the EMU, it would be harder to withdraw, but still technically feasible. The trouble is that the knowledge that a sovereign government could one day withdraw would always prevent the system from attaining absolute credibility. It would be a potential fault line in the system.
What can be done to enhance credibility? The most obvious thing would be completely to withdraw all the domestic currency units (marks, francs, etc) immediately in 1999. But this has been stongly opposed by the Germans, probably because they fear that the early withdrawal of the mark would not be acceptable to the German electorate. So instead they prefer to proceed by stealth, leaving the mark in people's pockets to prevent a political furore, even though they know that control over monetary policy will be immediately ceded by the Bundesbank.
Isn't that a bit sneaky? Yes, very sneaky. But even the most arduous supporters of EMU think it would be difficult to sell the concept to the German electorate if they really knew what was going on.
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