The IMF & the European Economic and Monetary Union
On January 1, 1999, the third and final stage of European Economic and Monetary Union (EMU) began. On that date, countries participating in EMU locked their bilateral exchange rates and adopted the euro as their common currency, with monetary and exchange rate policy determined by area-wide institutions.
Chronology of Events
In May 1998, the Council of the European Union, meeting at the level of the heads of state or government, announced that the 11 countries that had indicated their intent to be among the initial members—Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain—had qualified to participate in EMU. As inputs to their decision, they had before them March 1998 reports published by the European Commission and the European Monetary Institute (EMI)assessing how countries had complied with the convergence criteria established by the Maastricht Treaty in the areas of inflation, public finances, interest rates, and exchange rates.
Convergence Criteria for Participation in EMU
With a view to guiding markets in the run-up to EMU, it was agreed that exchange rate mechanism (ERM) central rates would be used as the basis for locking exchange rates on January 1, 1999, and Central Banks committed to ensure that these rates prevailed in the market on December 31, 1998. On June 1, 1998, the EMI ceased to operate and the European Central Bank (ECB) commenced operations. The ECB took over responsibility for monetary policy in the euro area on January 1, 1999. From the start of EMU, participants' national currencies continued to circulate but as subunits of the euro rather than as independent currencies; euro notes and coins will be introduced on January 1, 2002 and national notes and coins will be withdrawn by June 30 of that year.
EMU in a Longer Perspective
EMU is largely driven by the expectation of a number of economic benefits, including lower transaction costs, reduced exchange risk, greater competition, and a broadening and deepening of European financial markets.
During the nearly 20-year existence of the ERM, cooperation among central banks steadily strengthened. Progress in convergence proved sufficient to allow EMU to begin in 1999. The achievement of low inflation, in particular, provided a propitious starting point. But greater progress in tackling structural rigidities and some further strengthening of fiscal positions remains essential for EMU's long-term success.
What EMU Means for the IMF
Implications for IMF membership. EMU countries remain individual members of the IMF. Since the Fund's Articles of Agreement confine membership to countries, the euro area as such is not able to appoint a Governor or appoint or elect Executive Directors in the IMF. In December 1998, the ECB was granted observer status at selected Executive Board meetings.
Implications for IMF surveillance. Regular consultations with members (under Article IV) continue to be held with individual countries. However, an Article IV consultation with a member cannot be completed without the Fund having had an opportunity to assess monetary and exchange rate policies. Therefore, discussions with representatives of the relevant EU institutions are needed as part of the Article IV consultations with individual euro-area countries. These discussions, and consideration by the IMF's Executive Board of the monetary and exchange rate policies of the euro area are, as a practical matter, held separately from those with individual euro-area countries, but are considered an integral part of the Article IV process for each member. Discussions at the EU level also cover fiscal and structural policies from a regional perspective to provide a setting for the discussions on monetary and exchange rate policies.
Implications for the SDR. Prior to EMU, the SDR basket included the currencies of the five IMF members with the largest exports of goods and services (U.S. dollar, deutsche mark, Japanese yen, French franc, and pound sterling). Since the launch of EMU, the euro has replaced the currency amounts of the deutsche mark and the French franc in the SDR valuation basket.
Policy Framework and Supporting Institutional Arrangements
With the start of EMU, the scope for national monetary policy, which already was constrained by the exchange rate mechanism ERM, disappeared. Instead, the ECB determines euro-area monetary policy. The Statute of the European System of Central Banks and of the ECB provides for the ECB's independence and gives clear priority to the goal of price stability. In October 1998, the ECB's Governing Council agreed on a monetary policy strategy consisting of three elements. First, price stability was defined as an annual rise in the Harmonized Indices of Consumer Prices (HICP) below 2 percent, to be achieved in a medium-term context. Second, a prominent role was given to money, signaled by a quantitative "reference" value for the growth of a broad aggregate, derived in a manner consistent with price stability. Third, in parallel with an analysis of monetary growth, a broadly-based assessment of the outlook for future price developments is to be made using a range of economic and financial indicators. In December 1998, the ECB announced that the reference value for broad money growth would be 4.5 percent. This reference value does not apply to a specific time frame, but is to be reviewed on a regular basis, with the first review scheduled for December 1999. Agreements were also reached on the so-called ERM2, which provides a framework for maintaining stable exchange rates between the euro and the currencies of EU countries outside the euro area that choose to participate in the new exchange rate mechanism.
The discretion that a euro-area country retains in managing its foreign reserve assets is limited: part of the assets have been transferred to the ECB, and transactions above certain limits involving foreign assets that are retained by a country are subject to ECB approval.
Responsibility for exchange rate policy is divided between the Council of Ministers and the ECB. The Council, acting unanimously, can enter into formal exchange rate arrangements with non-EU countries, on the basis of a recommendation from the ECB or, in the absence of such a recommendation, after consulting with the ECB in an endeavor to reach consensus consistent with price stability. It may also formulate general orientations for the exchange rate which, it was agreed, should only be provided in exceptional circumstances and which should be consistent with the maintenance of price stability. In the absence of such arrangements or orientations, the management of the exchange rate is the responsibility of the ECB.
Fiscal and labor market policies, while continuing to be decided mostly at the national level, are subject to closer EU surveillance. In this regard, the Stability and Growth Pact, agreed in June 1997, sets out the surveillance procedures of national fiscal policies, strengthening the framework in the treaty aimed at avoiding "excessive" deficits. Also, the October 1997 Treaty of Amsterdam explicitly recognizes employment policies as a matter of common concern and sets out procedures for their surveillance.
Ministers of the euro-area countries can meet (as the Euro-11 group) to discuss issues related to the single currency. However, formal surveillance and coordination decisions remain the prerogative of the full Council of Ministers (ECOFIN).