Breakdown of Bretton Woods: Werner Report Snake in the tunnel 4. European Monetary System (EMS) 5. Crisis in EMS
1. Bretton Woods
End of the Second World War, 1944, international agreement set up world trading community linked by fixed exchange rates with the American Dollar being the main international currency. Countries allowed to adjust value of their exchange rate only after periods of fundamental disequilibrium in balance of payments. Restrictions on international capital flows fair degree of certainty with respect to international economic transactions. The $US international currency America ran trade deficits provide $US to the world + the expansion of the American economy international engine of growth + export market. Problems: no mechanism resolved balance of payments problems accentuated OPEC price rises and subsequent crises
have to be evolutionary and cautious - France would only assent to a managed currency arrangement, also dispute over which strategy to adopt to achieve economic and monetary union. One group, [France, Belgium and Luxembourg] wanted to lock into irrevocably fixed exchange rate parities as soon as possible. West Germany and the Netherlands, wished to establish system of economic policy co-ordination before eventually progressing to a fixed exchange rate.
confined to a margin of 2.25 per cent. European currencies used as means of central bank intervention while dollar deployed to prevent the snake from leaving the tunnel. The six original members of the currency bloc joined by Ireland, the UK, Denmark and Norway Speculative waves engulfed international currency markets in February-March and June-July, 1972. June speculative attack against the British pound due to worsening UK balance of payments. Despite major intervention by the Bank of England, Banque de France and Brussels monetary authorities British withdrawal from the snake mechanism. Exposed the institutional weakness and limited resources devoted to defend the snake regime speculators targeted other European currencies. Quadrupling of oil prices by OPEC in mid 1973. Table 5.1 Estimated change in the current account of selected EEC countries in 1974 as a result of the increase in oil prices (including secondary effects) Country West Germany France Belgium/Luxembourg Netherlands Denmark United Kingdom Italy Ireland Lucarelli p. 87 Stagflation underlying tensions surfacing. German fear of inflation, France worried about growth. Table 5.2 Comparative Economic Indicators between France and Germany, 1972-74 1972 5.9 5.7 Inflation 1973 1974 7.2 14.0 7.2 7.0 1972 5.6 3.0 Economic Growth 1973 1974 6.6 4.7 5.5 0.5 $US Billion -5.8 -5.3 -1.2 -0.9 -0.9 -4.7 -4.2 -0.2 Percentage of GNP -1.6 -2.1 -2.5 -1.5 -2.8 -2.7 -3.0 -3.3
France Germany
5. Crisis in EMS
German Dominance Germany dominance: reputation for low inflation Other countries wanted to import Germanys reputation for low inflation used DM as main reserve currency, , monetary policy mimic Germany like Bretton Woods system, with Germany at centre . Domestic problems German domestic interests ahead of international role. Economic shock caused by German Unification:
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July 1992 East Germans traded f East German currency for DMas rush to buy the modern consumer goods consumption Also fiscal expenditures on East Germany as: 1) unemployment in East: demanded same wages as in west, without modern equipment or training so less productive. Enterprises could not produce goods of competitive quality or price bankruptcy and need to pay for training and support of the unemployed 2) Need to rebuild infrastructure in East - roads, etc, and to clean up the polluted environment. huge demand and in inflationary pressure. Government fear economy overheating and generating inflation main German economic fear tight monetary policy to lower inflation r interest rates demand for deutch marks Results in Currency Crisis To stay within bands relative to the DM rest of EMS had to implement tight monetary policy and interest rates output levels unemployment speculation Pressure on the Lira devalue in September 11 1992 speculators made profit: EMS could indeed be cracked. September 16, Black Wednesday Continued pressure for Lira to be devalued more and pressure on UK, costly draining of reserves. Ended up taking Lira and Pound out of the EMS system and allowed currencies to float. France also attacked, but managed to hang on Many other currencies had to be devalued: Spanish peseta, Irish punt, Portuguese Escuda.