Background of European Union
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Transcript Background of European Union
The European Currency Crisis
1992-1993
Cynthia Diaz
Hazel Gonzalez
Daniel Monge
Introduction of European Union
1970’s, Collapse of the Bretton Woods System
The European Economic Community (EEC)
(Germany, Italy, France Netherlands,
Belgium and Luxembourg)
European Union
Added Portugal, Denmark, Spain, U.K., Finland Greece, Austria, Sweden, and Ireland,.
30 yr Transition : European Monetary System (EMS).
European Monetary System
/ Monetary stability
Exchange rate variability
EMS:
Floating the exchange rate.
1. European Currency Unit (ECU)
2. Exchange Rate Mechanism (ERM)
What is the purpose for EMS?
Europe in the global economy.
Create Europe Bond
Common Agricultural Policy (CAP).
To control fluctuations of the currency and improve coordination of
monetary policy decisions among countries apart of the union.
Effect of the EMS
EstablishedCentral exchange rates for each currency
Brought responsibility of countries in the EU to stay with band rates.
Stable currency of the group ‘German Mark’
Unofficial reserve currency: The Deutsche Mark (DM)
German Central Bank (Bundesbank)
Factors Behind the Crisis
•
Deutsche Mark became the anchor in the European
Monetary System (EMS)
• Due to Germany's strong economy after the split of
East and West Germany
• Deutsche Bundesbank had low inflation
Germany Gained Economic Strength
◦ Became free to set monetary policy for itself
Other countries had reduced control due to reserves
needed to adjust to the edge band of the mark.
The Crisis
Reunification of Germany (East & West)
◦ Merged large rich economy of the West with poor
smaller economy of East
West Germany transferred savings to the East
◦ Caused the government budget deficit to rise from 5%
to 13.2%
Government increased money supply and initiated many
development projects to gain economic growth
◦ German interest rates rose about 3% in 1991 and 1992
to try to ease inflation
Germany’s Effects
Germany’s high interest rates made European
countries worse
◦ Britain, France, Italy and other countries were
restrained from taking corrective monetary policy
actions.
Britain, France, & Italy economies suffered such
high deficits that they were forced to adopt a
low interest rate policy
◦ currency devaluation would help the devaluing
country by boosting exports, and allowing the
country to regain the flexibility it needed to
stimulate its economy through interest rate cuts
Speculation
Analysts speculated that these countries might soon
give up their support for the ERM
Due to speculations and a weakening currency
◦ September 16, 1992 : Black Wednesday
◦ UK’s prime minister and cabinet members tried all
day to boost up the sinking pound and avoid
withdrawal from the ERM
Black Wednesday Outcome
The British government raised the interest rate
from 10% to 12% to try to get speculators to
buy pounds
◦ Market knew that the government could not afford to
keep interest rates high for long
Investors kept selling the pounds and eventually
Britain was forced to withdraw from ERM
Britain Treasury spent approximately ₤27 billion
of reserves in trying to defend the pound by
selling Deutsche Mark and buying pounds.
http://www.youtube.com/watch?v=AHDsO7gvX
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Speculative Attacks Continue
Speculative assaults
◦ helped traders make billions at the expense of
European central banks
◦ caused Spain and Portugal devalue their currencies
against the German Mark.
French Franc was a major target because they had
high interest rate, slow growth, & rising
unemployment
◦ political pressure before elections demanded a cut in
the French interest rates
◦ speculators betted that France would devalue the
franc or withdraw from the ERM
The Fall of the French Franc (₣)
Speculative attack against the Franc
◦ made the central banks of France and
Germany intervened aggressively
◦ central banks tried to hold their exchange rate
◦ central banks kept buying Francs and selling
Marks.
The countries succeeded momentarily but
France’s foreign currency reserves were
nearly depleted
The Fall of the French Franc (₣)
Continued
Speculative attacks continued to hit the Franc
◦ speculators knew France needed lower interest rates
to help stimulate the economy and reduce
unemployment.
France’s and Germany’s central bank continued
to intervene directly to support the Franc
◦ Interest rates were raised to defend the Franc
Germany and France gave up defending the
exchange rate link.
After the Fall
Speculators won
◦ They secured huge profits by buying back the
devalued Franc
The EU finance ministers and central
bankers
◦ allowed the widening of the currency trading bands
to fluctuate within 15% around a central rate
A total of about 60 billion Mark ($35 billion)
was spent by the German trying to prop up
the French currency
Maastricht Treaty
Signed on February 7, 1992 in Maastricht,
Netherlands
Set the convergence criteria for a country to qualify
for participation in EMU
◦ Inflation within 1.5% of the best three of the European
Union for at least a year
◦ Long-term interest rates must not be more than 2% points
higher than the lowest inflation member states
◦ Being in the narrow band of the ERM ‘without tension’
and without initiating a depreciation, for at least two years
◦ Government deficit to GDP must not be more than 3%
and a government debt/GDP ratio of no more than 60%
The treaty entered into force on November 1, 1993.
European Monetary Institute
Established as the forerunner of the European Central Bank
◦ intended to strengthen monetary cooperation between the member states
and their national banks
◦ supervise ECU banknotes.
European Council
◦ adopts the Stability and Growth pact to ensure budgetary discipline
◦ establishes a new Exchange Rate Mechanism (ERM II) to provide
stability with the Euro and other national currencies.
European Central Bank (ECB) is created
Conversion rates between the 11 participating national
currencies and the euro are established