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Account for French and German policy towards EMU?


1)      Intro

2)      What is EMU, history?

3)      What is the policy? Friendly.

4)      Common objectives towards EMU (economic)

5)      French policy (restore le Frank fort)

6)      German means (closer political co-operation)

7)      Practical outcomes - Germany forcing France and others to fiscal prudence. France using EMU for a supranational EU.

8)      Conclusion – EMU halves debt repayments for states and benefits hugely all parties involved in lobbying. Thus by now economic motives for the EU far stronger reasons for supportiveness.

This essay is about two aspects of the European Monetary Union: why it was created and what sustains its development at the present day. Both of these issues are looked from the France and German perspective, which were the main actors in forming the EMU. It is quite clear that the policy towards EMU is supportive in both of these countries, so this essay outlines the reasons for this positive attitude. I will concentrate on the political issues, although I do have to give a brief overview of the economical ones. Furthermore, I will try to distinguish between the reasons for support in the two countries, however, I will also try to show that most of the distinctions have diminished and that the reasons for supporting EMU are much the same everywhere today.

Monetary Union is normally considered the ultimate stage in the economic integration between countries. It involves the irrevocable fixing of the currencies between the two countries and the full liberalisation of capital markets. The countries that have joined EMU will have their monetary policy conducted centrally by ECB and their currencies will be replaced by euro.

Monetary Union will also set the stage for inevitable political co-operation. Value added tax rates must eventually harmonise for traded goods and the fiscal policies of the member states must be co-ordinated and not overly expansionary. It is however arguable whether these changes are inevitable in a global economy anyway.

The idea of a monetary union was first advanced at the end of 1960-s with the creation of Werner Plan, with the main aim of reducing volatility in financial markets. However, due to financial turmoil this did not prove successful. Second try was made in 1979 with the introduction of the EMS. This system was a lot more relaxed and survived until the next major crises in 1990-s. Then finally Maastricht treaty in 1989 set out the EMU with three stages, two of which have been completed successfully and the third one is on its way.

Considerable support has always been put on the monetary union by France and Germany. Underlying the support in both countries are the underlying economic findings of efficiency gains made by the numerous research projects in the Commission. Most of the benefits are microeconomic. It is estimated that about 1% of GDP is lost every year due to the hassle associated with changing foreign currencies. The other major advantage of EMU is the elimination of exchange rate uncertainty. Although the exact magnitude is hard to qualify, I think the fair estimate of the cost of exchange rate volatility would be the price of an option that allows all exporters exchange the value of their planned exports to the foreign currency in a year’s time. Now the price of this option, when bought from the well-developed capital market depends only on the volatility. The price is zero if the rates are fixed, with the volatility experienced by the EUR/USD rate the price would be about 15% of the value of the contract. If countries export about 40% of their GDP, this will mean a gain of 6% of GDP per year (I could become famous by publishing this J).

On the macro-economy level, however, the EMU will eliminate the possibility of an independent monetary policy. This policy is viewed as being important when countries are hit with asymmetric shocks; it allows them to smoothen the transition path. However, the option is often abused by countries in order to gain competitive advantage in front of others. EMU forces countries to co-operate among themselves.

There are many criticisms to these economic reasons, mainly arising from the age-old optimal currency area literature. However, all of these studies use a partial equilibrium model and thus miss the essential point: although they can find costs to a particular sector, the benefits are normally spread among the society, are hard to measure and thus are left unnoticed. For example, some view the unemployment arising from the fact that all the currency exchangers will be left without job a bad thing. However, one must look at the big picture instead, option prices in capital markets allow us to do just that.

Politics is the second set of motivators for the monetary union. Although it is common for both countries to think that monetary union will lead to supranational Europe, at least the historical motives for the EMU were quite different for France and Germany.

French political motives for EU were to do with her currency. The idea was that through EMU frank could once again become a major currency in the international arena alongside with DM. France’s ideology (together with Benelux countries) was always that monetary union should be established first and then economical unification will follow.

The main motives for Germany for political union were officially to tie Germany politically into the Europe in order to prevent World War III. Thus, it seems that Germany’s policy was mainly to create a closer political union. However, recently Germany has been much more to do with maintaining the value of DM without sacrificing too much on unemployment and competitiveness. The issue here was mainly to do with the frank competitive devaluations in the middle of 1980-s, which totalled about 46% in value. Thus, Germany has been particularly keen in forcing countries to adhere to the strict Maastricht convergence criteria. However, it has found it very hard to keep to spending limits itself after the unification. In any case, the normative view in Germany seems to be that one needs an economic convergence before monetary union. It only accepts it because of the political benefits it brings.

Although the political motives were important with the original Werner plan, with the Maastricht treaty the economic effects largely dominate. The fact that EU countries have been able to reduce the interest rate down to 3% and it is 6% in the UK, means that the value of euro is (6-3)% * 60%=2% of GDP per year (countries have about 60% of national debt). This arises purely because of the reduced repayments on the national debt. Thus the supportive policy towards EMU can at present be accounted almost entirely by the economic benefits it brings.


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