Post on 16-Feb-2016
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The European Currency Crisis
1992-1993Cynthia Diaz
Hazel GonzalezDaniel Monge
Introduction of European UnionIntroduction of European Union1970’s, Collapse of the Bretton Woods System
The European Economic Community (EEC)(Germany, Italy, France Netherlands,Belgium and Luxembourg)
European Union Added Portugal, Denmark, Spain, U.K., Finland Greece, Austria, Sweden, and Ireland,.
30 yr Transition : European Monetary System (EMS).
European Monetary SystemEuropean Monetary System
Exchange rate variability / Monetary stability
EMS: 1. European Currency Unit (ECU) 2. Exchange Rate Mechanism (ERM)
Floating the exchange rate.
What is the purpose for EMS?What is the purpose for EMS?Europe in the global economy.
Create Europe Bond
Common Agricultural Policy (CAP).
To control fluctuations of the currency and improve coordination of monetary policy decisions among countries apart of the union.
Effect of the EMSEffect of the EMSEstablishedCentral exchange rates for each currencyBrought responsibility of countries in the EU to stay with band rates.Stable currency of the group ‘German Mark’Unofficial reserve currency: The Deutsche Mark (DM)German Central Bank (Bundesbank)
Factors Behind the Crisis• Deutsche Mark became the anchor in the European
Monetary System (EMS) • Due to Germany's strong economy after the split of
East and West Germany• Deutsche Bundesbank had low inflation
Germany Gained Economic Strength ◦ Became free to set monetary policy for itself
Other countries had reduced control due to reserves needed to adjust to the edge band of the mark.
The CrisisReunification of Germany (East & West)
◦ Merged large rich economy of the West with poor smaller economy of East
West Germany transferred savings to the East ◦ Caused the government budget deficit to rise from 5%
to 13.2%
Government increased money supply and initiated many development projects to gain economic growth◦ German interest rates rose about 3% in 1991 and 1992
to try to ease inflation
Germany’s EffectsGermany’s high interest rates made European
countries worse◦ Britain, France, Italy and other countries were
restrained from taking corrective monetary policy actions.
Britain, France, & Italy economies suffered such high deficits that they were forced to adopt a low interest rate policy◦currency devaluation would help the devaluing
country by boosting exports, and allowing the country to regain the flexibility it needed to stimulate its economy through interest rate cuts
SpeculationAnalysts speculated that these countries might soon
give up their support for the ERM
Due to speculations and a weakening currency◦ September 16, 1992 : Black Wednesday
◦ UK’s prime minister and cabinet members tried all day to boost up the sinking pound and avoid withdrawal from the ERM
Black Wednesday OutcomeThe British government raised the interest rate
from 10% to 12% to try to get speculators to buy pounds ◦ Market knew that the government could not afford to
keep interest rates high for longInvestors kept selling the pounds and eventually
Britain was forced to withdraw from ERM
Britain Treasury spent approximately ₤27 billion of reserves in trying to defend the pound by selling Deutsche Mark and buying pounds.
http://www.youtube.com/watch?v=AHDsO7gvXHQ&playnext=1&list=PLCDCB8FC42E6B0E3E
Speculative Attacks Continue Speculative assaults
◦ helped traders make billions at the expense of European central banks
◦ caused Spain and Portugal devalue their currencies against the German Mark.
French Franc was a major target because they had high interest rate, slow growth, & rising
unemployment◦ political pressure before elections demanded a cut in
the French interest rates◦ speculators betted that France would devalue the franc
or withdraw from the ERM
The Fall of the French Franc (₣)Speculative attack against the Franc
◦ made the central banks of France and Germany intervened aggressively
◦ central banks tried to hold their exchange rate◦ central banks kept buying Francs and selling
Marks.
The countries succeeded momentarily but France’s foreign currency reserves were nearly depleted
The Fall of the French Franc (₣)Continued Speculative attacks continued to hit the Franc
◦ speculators knew France needed lower interest rates to help stimulate the economy and reduce unemployment.
France’s and Germany’s central bank continuedto intervene directly to support the Franc
◦ Interest rates were raised to defend the Franc
Germany and France gave up defending the exchange rate link.
After the FallSpeculators won
◦ They secured huge profits by buying back the devalued Franc
The EU finance ministers and central bankers◦ allowed the widening of the currency trading bands
to fluctuate within 15% around a central rateA total of about 60 billion Mark ($35 billion)
was spent by the German trying to prop up the French currency
Maastricht Treaty Signed on February 7, 1992 in Maastricht, Netherlands Set the convergence criteria for a country to qualify for
participation in EMU◦ Inflation within 1.5% of the best three of the European Union
for at least a year◦ Long-term interest rates must not be more than 2% points
higher than the lowest inflation member states◦ Being in the narrow band of the ERM ‘without tension’ and
without initiating a depreciation, for at least two years◦ Government deficit to GDP must not be more than 3% and a
government debt/GDP ratio of no more than 60% The treaty entered into force on November 1, 1993.
European Monetary Institute Established as the forerunner of the European Central Bank
◦ intended to strengthen monetary cooperation between the member states and their national banks
◦ supervise ECU banknotes. European Council
◦ adopts the Stability and Growth pact to ensure budgetary discipline◦ establishes a new Exchange Rate Mechanism (ERM II) to provide
stability with the Euro and other national currencies. European Central Bank (ECB) is created Conversion rates between the 11 participating national
currencies and the euro are established