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Economic and Monetary Union and the Euro

1. History – Adopting the Euro

The European Economic and Monetary Union (EMU) is an agreement between participating European nations to share a single currency, the euro, and a single economic policy with set conditions of fiscal responsibility. There are currently 27 member-states of varying degrees of integration with the EMU. Sixteen member states have adopted the euro: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia, Spain, from 1 January 2008 Cyprus and Malta, and, from 1 January 2009, Slovakia. Three other member states, the United Kingdom, Denmark and Sweden, have no immediate plans to adopt the euro. Other member states are in various stages of euro adoption and are expected to join the Eurozone within the next ten years.

In the wake of the Second World War, most currencies of the industrialised world were tied closely to the US-Dollar under the so-called ‘gold standard’ under the Bretton Woods System. The de facto supremacy of the Dollar and forced devaluations of several European currencies led European politicians to seek to redress this imbalance through greater economic integration between European nations.

Plans for a single European currency began in 1969 with the Barre Report, issued by the then six-member European Economic Community (EEC). This was followed later that year by a meeting of the Heads of State or Governments in The Hague to plan the creation of an economic and monetary union. The process was delayed by the collapse of the Bretton Woods System in 1971 after President Nixon's unilateral decision to make the dollar inconvertible to gold and by the oil crisis of 1972. Meanwhile, the EEC grew to include nine states, many of which were hesitant to give up their national currencies.

Currently, participating European countries can be integrated into three different economic stages, which correspond to the historical stages of EMU development.

Stage I

In 1979 the European Monetary System (EMS) was established to link European currencies and prevent large fluctuations between their respective values. It created the European Exchange Rate Mechanism (ERM) under which the exchange rates of each member state’s currency was to be restricted to narrow fluctuations (+/-2.25%) on either side of a reference value. This reference value was established in an aggregated basket of all the participating currencies called the European Currency Unit (ECU), which was weighted according to the size of the member state's economies.

In the late 1980s the market of each member state grew closer to its neighbours, shaping what would eventually be called the European Single Market. International trade in the Single Market could be hindered by exchange-rate risk – despite the relative stability introduced by ERM – and the increased transaction costs that this brought. The creation of a single currency for the Single Market seemed a logical solution, and thus the idea of a single currency was brought back to the fore.

The European Commission of Jacques Delors passed the Single European Act in February 1986, which aimed to remove institutional and economic barriers between EC member states and established the goal of a common European market. In 1989, plans were drawn up to realize the EMU in three stages. Although the processes of Stage I began with the EMS in 1979, the first stage officially began in 1990, when exchange rate controls were abolished, thus freeing capital movements within the EEC. In 1992, the three-stages envisioned by the Delors Commission were formalized in the Maastricht Treaty, including economic convergence criteria for adoption of the common currency. In effect, this transformed the EEC into the European Union. Criteria for membership in the European Union and adoption of the euro are set out by three documents. The 1st is the Maastricht Treaty of 1992, which entered force on 1 November 1993. Later that year, the 2nd was created by the European Council in Copenhagen and the creation of the “Copenhagen Criteria,” which clarified the general goals of the Maastricht Treaty. The 3rd is the Framework contract negotiated with each accession country before joining the EU. The criteria have also been clarified by EU legislation and by decisions of the European judiciary over the years.

The 1st Stage of EMU development can be correlated to a current candidate country first meeting the Copenhagen Criteria and then joining the EU.

Stage II

At the December 1995 summit in Madrid, Germany successfully argued to change the name of the ECU to the “euro,” The so called “Madrid scenario” also set out a transition period between the introduction of the euro in accounting and later as a cash currency.

In the second stage of the EMU, the European Monetary Institute (EMI) was established as a forerunner of the European Central Bank (ECB). In June of 1997, the European Council in Amsterdam agreed to the Stability and Growth Pact and set up the ERM II, which would succeed the European Monetary System and the ERM after the launch of the euro. The following year the European Council in Brussels selected eleven countries to adopt the euro in 1999 and the ECB came into being, tasked with establishing monetary policy for the European Union and with overseeing the activities of the European System of Central Banks -- national banks which would implement the decisions of the ECB, print money and mint coins and assist the initial euro countries in meeting the convergence criteria.

The 2nd Stage of EMU development can be correlated to a recently acceded member state entering the ERM-II, where it must stay for at least two years before adopting the euro.

Stage III

On 1 January 1999 the euro was adopted in non-physical form, with the exchange rates for 11 of the then 15 member states' currencies fixed on the last day of 1998. The Exchange Rate Mechanism (ERM) was succeeded by the ERM-II, which functioned similarly to the original ERM but within the context of an extant euro currency. The ECB began enforcing a single, monetary policy with the assistance of the Central Banks of each member state, and the three-year transition period set out in Madrid began, to last until 1 January 2002. In mid-2000 the Commission announced that Greece could formally join the single currency’s 3rd stage on 1 January 2001.

The euro was a virtual currency for the 12 countries of the so-called ´Eurozone´– Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Spain and Portugal. It was used in accounting, and firms could conduct euro-denominated transactions safe in the knowledge that the exchange rates among the member-states were fixed. Euro-values appeared on bank accounts next to national currencies to acclimate the populace to the new currency.

For each state to adopt the new currency on 1 January 2002, they had to meet the “Convergence Criteria“ set out by the Maastricht Treaty. The criteria include four requirements.

  • Currencies has to stay within the bands set by the ERM for at least two years
  • Long-term interest rates could not be more than two percentage points higher than those of the three, best-performing member states
  • Inflation had to be below a reference value (within 3 years prices may not be higher than 1,5% of best performer)
  • Government debt had to be below 60% of GDP (or moving towards this objective) and budget deficits below 3%

In preparation for the introduction of the euro on 1 January 2002, over 14 billion banknotes worth some €633 billion were printed, and 52 billion coins were minted using 250,000 tonnes of metal. In the run-up to 1 January 1999, the pessimists reigned, spreading fear and confusion. In the media stories mounted that such a massive currency changeover could not succeed. But such fears proved to be unfounded. Bank machines supplied the new currency the minute after midnight and citizens were spending euros within days.

The 3rd Stage of EMU development can be correlated to a member state that, having joined the ERM-II and maintaining the Convergence Criteria for at least two years, joins the Eurozone.

Exchange rate development

On its first trading day at the Frankfurt stock exchange, 4 January 1999, the euro was at 1.1789 to the US-Dollar. From that day the euro decreased in value, falling below the euro-dollar-parity only one year later and continuing to fall until 26 October 2000, when the new currency reached its lowest point with US$0.8225. Over the year the average exchange rate was US$0.95.

The euro did not recover until the introduction of cash euro in 2002, rising from US$0.90 to US$1.02 at the end of 2002. One year later it reached US$1.24. In November 2004, it passed the mark of US$1.30 and on 30 December 2004 it finished on its record high of US$1.3668. In the course of 2005 the euro then dropped to US$1.18 in December and then, in November, below its starting point. In 2006 the euro rose to between US$1.1813 on January 2nd and US$1.2958 on June 5th. At the end of the year the currency peaked to its record high after easily breaking the US$1.30 mark and seemed set to stay there.

With the credit crisis deepening throughout 2007 and 2008, the euro soared to a new high of $1.5990 in mid-July 2008. By the end of the year, the euro had also reached near parity with UK pound sterling.


Key points

  • Plans for a single currency started in the late 1960's
  • Three levels of EMU integration: EU Accession, ERM-II, Eurozone
  • Maastricht Treaty of 1992, Copenhagen Criteria of 1993, individual Accession Framework
  • Four Convergence Criteria to join Eurozone


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