At the latest by the spring of 1998 – the time to decide who
participates in the final stage of EMU by 1 January 1999 – EU members
will have to reach an understanding on the currency relationship linking
the Ins and the Outs. Three elements will determine the understanding
reached: the scope defined by the Maastricht Treaty, the likely
preferences of the Outs and the common interests of the Ins.
The Treaty is vague in its wording on outsiders. There is a
presumption that some EMS arrangement will continue for the Outs:
participation in ‘normal margins of fluctuations’ is listed as one
of EMU’s entry requirements. Since entry was presumed to be a prime
ambition for the Outs, the Treaty drafters did not see the need to be
more specific. There are no provisions for obliging the Outs to enter an
arrangement, only the incentive to do so in order to retain the rights
to enter EMU if economically qualified.
The preferences of the likely Outs will range widely. At one extreme,
if the UK government chooses to exercise its right not to opt into
monetary union initially, it will not be interested in any exchange rate
arrangements with the Ins. The current UK preference is to regard a
tough domestic inflation objective as a substitute for participation in
an EMS-like arrangement. This argument is hardly acceptable to the Ins
since it could not guarantee that misalignments would not arise between
sterling and the single currency.
Other likely Outs show less reluctance to consider an explicit
currency link, although Sweden shows some sympathy for the UK position.
Spain and Portugal have shown a preference for managing their currencies
inside the EMS. Denmark, which has opted out of EMU, has indicated that
it will seek a tight arrangement with the Ins. Italy and Finland may
declare a central rate in the EMS during 1996.
What should be the response of the Ins? Their common interest is to
get some hold on the exchange rates of the currencies of the Outs vis-à-vis
the single currency in order to contain misalignments. In particular,
they will be anxious to avoid anything like a repetition of the large
and rapid currency changes of 1992/3 and, on a lesser scale, 1995.
Free-riding by the Outs on those who have joined EMU could mean the end
of the single market for all EU countries. The general formulation in
Article 109m of the Treaty that ‘each Member State shall treat its
exchange rate as a matter of common interest’ is clearly not enough to
prevent exchange rate misalignments and volatility.
Since the Ins cannot oblige the Outs to enter into a formal
arrangement, there should be incentives for them to join additional to
preserving their candidacy for entry. The Outs will be concerned that
their initial non-participation in EMU would further lower the
credibility of their monetary policies. Merely declaring a central rate
against the euro within margins so wide that they are unlikely to be
tested before they have to be given up would not constitute a boost to
credibility. To make the bargain attractive for the Outs something
firmer may have to be offered.
Unfortunately the logical additional element – foreign exchange
interventions with a mandatory component for both the European Central
Bank (ECB) and the central banks of the Outs – has a bad reputation
since the futile attempts in 1992/3 to defend the old EMS rates largely
by this means. The Bundesbank claims that heavy use of interventions at
that time resulted in a significant loss of monetary control in Germany.
But even accepting this argument, one that is not well underpinned by
empirical evidence, two changes will have occurred between 1992/3 and
1999:
- The degree of asymmetry will be much larger between the ECB and
the individual central banks of the Outs than existed between the
Bundesbank and the smaller central banks; the Outs will have to
tailor their interest rate policies very closely to that of the ECB.
- The fluctuation margins will be wider than in 1992/3 (though I
believe that they should be narrowed in 1999), changing the balance
in interventions further towards those inside the margins. A higher
degree of discretion is necessarily attached to such interventions.
In short, the Ins should be generous in offering the Outs mutual
support facilities with the ECB in order to keep currencies stable
while preparing them for subsequent entry.
The case for such bold arrangements is stronger, the closer an Out
country is to joining. If there is a firm determination to enter, but
interest rates remain stubbornly far from those in the monetary union,
hence keeping a country on the wrong side of one or more of the
convergence criteria, there may be a case for offering that country
associate status. That would mean a fully fixed exchange rate with an
intervention arrangement, but with an obligation for the Out country to
follow ECB policy rigidly, and without voting rights in the ECB Council.
Such a currency board arrangement could generally facilitate rapid full
entry into the monetary union.
Niels Thygesen Thygesen is Professor of Economics at the
University of Copenhagen, a Senior Research Fellow at the Centre for
European Policy Studies in Brussels and a member of the Delors Committee
on EMU, 1988–9. This article reviews research reported in ‘Prospects
for EMU by 1999 – and reflections on arrangements for the
outsiders’.