Economic and Monetary Union in a Multi-Tier Europe
Arrowsmith, John, National Institute Economic Review
It is now looking increasingly plausible that, at some point between the middle of 1997 and the beginning of 1999, a number of EC Member States (perhaps even a majority) will move to the final stage of Economic and Monetary Union. The macro economic consequences of EMU and the costs and benefits of participating are already the subject of active and extensive academic analysis. Very little attention has so far been given to the question of how a two-tier EMU, with only some EC countries participating in Stage 3, would function and what implications there might be for those remaining in Stage 2.
The purpose of this Note is to highlight some of these issues, which will need to be studied and understood in much greater depth before a decision is taken. It looks at the legal and institutional framework set out in the Maastricht Treaty, the relevant experience of nearly-fixed European exchange rates from 1987 to 1992 and the economic and political implications of particular country configurations in a two-tier EMU, concluding that mutually satisfactory management of such a relationship will require greater political will and co-operative spirit than has been in evidence so far.
Almost five years ago, on 1 July 1990, Stage 1 of Economic and Monetary Union (EMU) came into effect in the twelve Member States of the European Community. Of itself, this was a quite minor step enshrined in two pieces of secondary Community legislation(1) which formalised existing arrangements and procedures for coordinating economic and monetary policies. It did not require any amendment of the Treaty of Rome and few of the Community's citizens were aware that it had taken place. Yet that step was regarded by most Member States' governments as a public affirmation of their commitment to proceed in two further steps, to a single monetary policy and a single currency, within the foreseeable future.
1990 was, in a number of other respects, a year of considerable significance for European monetary integration. The lira moved from the wider ([+ or -] 5 per cent) fluctuation band of the Exchange Rate Mechanism (ERM) to join the seven Community currencies already in the narrow ([+ or -] 2 1/4 per cent) band and sterling moved into the ERM to join the peseta in the wider band. Coinciding with the start of Stage 1, on 1 July 1990 a Council Directive(2) requiring the complete liberalisation of capital movements (by the end of 1992) came into effect. On the same day, the monetary unification of East and West Germany took place, seeming to provide an illustration of how, if the political will existed, the creation of a monetary union and adoption of a single currency need not be a traumatic economic or logistical undertaking.
Yet each of these events was before long to contribute to a crisis of confidence that threatened to throw into reverse the process of European integration. Within three years of the start of Stage 1, despite the formal opening of the Single Market on 1 January 1993 and the signing on 7 February of the Treaty on European Union(3) at Maastricht, with its timetable for achieving monetary union in less than six years, the sense of Europhoria had all but evaporated. The ERM, which had come to be seen as a guarantee of safe passage to monetary union, was breaking apart: the European economy was in recession, unemployment and inflation were both rising and public finances were deteriorating [ILLUSTRATION FOR CHARTS 1 AND 2 OMITTED].
Now, the conjunction of circumstances has changed again. Economic recovery in Europe is under way, inflation is subdued, unemployment is beginning to fall and public finances to improve. The reformulated ERM, with its fluctuation margins widened from [+ or -] 2 1/4 per cent and [+ or -] 6 per cent to [+ or -] 15 per cent, has withstood its first major test: the peseta and escudo were devalued by 7 per cent and 3 1/2 per cent on 6 March but both currencies have remained within the mechanism. …