The early up and downs in the working of the EMS which were characterised by currency realignments and strict exchange controls set the EU members to think about having a monetary union. In 1989, the Delors Committee recommended a three-stage transition for the formation of a European Monetary Union (EMU).
In the first stage, all EU members were to join the Exchange rate Mechanism (ERM) of the European Monetary System (EMS). In the second state, exchange rate bands were to be narrowed and Certain macroeconomic policy decisions placed under EU control. In stage three, the national currencies of EU countries were to be replaced by a single European currency and all monetary policy decisions were to be vested in a European Central Bank.
The Maastricht Treaty:
On 10 December, 1991, the leaders of the EU countries met at Maastricht in the Netherlands and agreed to establish a single European currency which is called the Euro. In February 1992, the 15-member countries signed the Maastricht Treaty for the European Monetary Union (EMU). It called upon the members to start stage two of the Delors Plan on 1 January, 1994 and stage three not later than 1 January, 1999.
Its Main Features:
The Maastricht Treaty lays down that EU countries must satisfy four macroeconomic convergence criteria before they can be admitted to the EMU. They are:
(1) The rate of inflation in the country must not be more than 1.5% above the average of the three EU member countries with the lowest inflation rate.
(2) The country must have maintained a stable exchange rate under the Exchange Rate Management System without devaluation.
(3) The country must not have a public deficit higher than 3% of its GDP, except temporarily and in exceptional circumstances.
(4) The country’s public debt must be below or near 60% of its GDP.
The Treaty provides for a regular monitoring of criteria (3) and (4) by the European Commission and for imposing penalties on countries that violate these two criteria and fail to correct excessive deficits and debts.
Besides this Treaty, the EU members signed the Stability and Growth Pact (SGP) in 1997 which further tightens the fiscal measures by laying down the medium-term budgetary objective of being near to balance or surplus. It also sets out a timetable for levying penalties on countries that fail to correct excessive deficits and debts.
By May 1998, eleven EU countries had satisfied the convergence criteria and became founder members of the EMU. Britain and Denmark had ratified the treaty but they did not join it and retained their national currencies. Sweden and Greece failed to qualify in terms of criteria to be members. Greece subsequently joined in 2001.
The time table for the implementation of EMU and adoption of the Euro was divided into three stages:
In the first stage, the European Central Bank (ECB) was established on 30 June, 1998 at Frankfurt (Germany) for a smooth change-over of the currencies of member nations to the Euro. The main functions of the Bank till the circulation of Euro coins and bank notes from 1 January, 2002 were to control inflation and create confidence of the global financial markets in the Euro.
In the second stage, beginning 1 January, 1999, the central banks of EU countries adopted the Euro as a single monetary unit.
In the third stage beginning January, 2002 more than 14 billion Euro bank notes and 50 billion Euro coins replaced national currencies and bank notes and coins of members. They were made available at all banks, and post offices. Till 31 December, 2002, banknotes of each Euro area country could be exchanged at banks in the country concerned. At least until the end of 2012, national central banks will exchange free of charge their old national banknotes against the Euro. In most countries, the redemption periods are longer or even indefinite.
The EMU currency consists of Euros of 100 cents. The Euro banknotes have seven denominations of 5,10,20,50,100, 200 and 500 Euro. The Euro coins have eight denominations of 1, 2, 5, 10, 20, 50 cent and 1 and 2 Euro.
Euro coins have a European side and a national side on which national symbol of the issuing country appears. But Euro banknotes do not have national symbols. They are uniform throughout the EU. Countries like Britain which have their own currencies in circulation have fixed exchange rates with the Euro and it circulates in such countries.
The European Central Bank (ECB) and national central banks (NCBs) of 15 EU countries form the European System of Central Banks (ESCB). The NCBs of the EU countries who have not joined the Eurozone are members with special status.
They conduct their respective national policies but do not take part in decision making of the EMU and the implementation of its policies. All heads of NCBs sit on the ECB general council which conducts monetary policy for the entire Eurozone.
(i) The ECB conducts foreign exchange operations,
(ii) Holds and manages the official foreign exchange reserves;
(iii) Promotes the smooth operation of the payment system; and
(iv) Supports the policies of its member banks.
The Euro, as the international currency of the European Monetary Union, was weak against the dollar in the beginning. To begin with, it opened at 1 EUR = $ 1.16 in 1999. But when the Euro actually started operating in January 2002, it fell to 1 EUR = $ 0.89. With the U.S. budget and current account deficits widening and the U.S. Federal Reserve (central Bank) reducing the bank rate to as low as 1%, the Euro rose 46% against the dollar in the past two years. It surged to a record high of $ 1.29 in February 2004.
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