The Euro and the European Central Bank

By Wrase, Jeffrey M. | Business Review (Federal Reserve Bank of Philadelphia), November 1999 | Go to article overview

The Euro and the European Central Bank


Wrase, Jeffrey M., Business Review (Federal Reserve Bank of Philadelphia)


In order to form a more perfect economic union, establish a single financial market, provide a high level of employment, promote convergence of economic performance, and secure the benefits of sustainable and noninflationary growth, 11 European countries have established a common currency and a European Central Bank. The formal introduction of the new monetary unit, called the euro, occurred on January 1, 1999. On that date, the old national currencies officially became subunits of the euro, much as the nickel and quarter are subunits of the dollar. (See Table.)

TABLE

Conversion rates between the national currencies of the 11 member countries and the new euro were irrevocably fixed at midnight, local time, on December 31, 1998. Between January 1, 1999, and June 30, 2002, one euro will be equivalent to the following amounts of each of the 11 currencies:

Austrian shilling 13.7603

Belgian franc 40.3399

Dutch guilder 2.20371

Finnish markka 5.94573

French franc 6.55957

German mark 1.95583

Irish punt 0.787564

Italian lira 1936.27

Luxembourg franc 40.3399

Portuguese escudo 200.482

Spanish peseta 166.386

Thus, a German mark is a bit over half a euro, and a French franc is a bit more than 15 euro cents.

Fifteen countries passed a major milestone on the road to monetary union in 1992, when they signed the Treaty on European Union, commonly called the Maastricht Treaty, which outlined a basic structure for the alliance. Of those 15, only 11 actually joined the European Monetary Union (EMU): two opted out for now, and two others have not yet met the economic criteria established for membership in the union.(1) The EMU countries decided that the benefits of having one common currency instead of 11 different ones will outweigh the costs, especially given the amount of travel and trade that takes place between these countries.(2)

To facilitate adoption of a single currency, the EMU countries also established, after a great deal of preparation, a European Central Bank (ECB) that sets a single monetary policy for the 11 members. (See Foundations of and the Legal Framework for the Euro.) The new setup is similar in some respects to that in the United States, in which the states share a common currency (the dollar) and central bank (the Federal Reserve). The ECB took responsibility for monetary policy on January 1, 1999. We'll have more to say about its functions and operations later.

THE TRANSITION PERIOD

In the transition period -- January 1, 1999, to December 31, 2001 -- a consumer can use the euro for noncash transactions, but euro notes and coins will not yet circulate. To buy something with euros during the transition period, a consumer can use a credit card or traveler's check, or she can make an electronic funds transfer or write a check. Euro-denominated bank accounts, credit cards, and traveler's checks have been available since January 1, 1999.

During the transition period, the "optional use principle" applies: no one can be forced to use the euro or be prevented from using it. For example, a bank customer with an account denominated in German marks may work for a company that has chosen to pay employees in euros. The customer can choose to switch to a euro account, if the bank offers such accounts, but the bank may not convert the account against the customer's wishes.(3)

Also during this period, many merchants in the 11 member countries of the EMU are marking prices in both the national currency and euros. However, merchants are not legally obligated to show two prices. And although using euro-denominated checking or credit card accounts while still using a national currency may be confusing, it's part of the cost of monetary transition.

There are other costs, aside from shopping inconveniences. For example, Europe's three million plus vending machines will need to be reconfigured at an estimated cost of between $100 and $500 per machine, depending on the machine's age. …

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