The Economics Book

(Barry) #1

254


dealing with situations when
business cycles weren’t completely
synchronized across the region.
The most obvious of these would
be fiscal transfers—taking taxes
from one area enjoying growth
and redistributing to another in
recession. This last condition,
and the failure to implement it,
was to have grave consequences
for Europe.


Introducing the euro
The idea of a single currency for
Europe began taking shape in 1979,
when the European monetary
system (EMS) was formed to
stabilize exchange rates. Finally, in
1999, the eurozone (the area of the
single currency) was established
with 11 member states of the
European Union (EU). While EU
states traded heavily with each
other and their institutions had
removed restrictions on the
movement of labor, capital, and
goods, it was deemed necessary to


implement further constraints on
euro membership to ensure that the
currency could function effectively.
The “convergence criteria,”
enshrined in the 1992 Maastricht
Treaty, were drawn up to make sure
that all those countries wishing to
join the euro would share similar
economies and be at similar stages
in their business cycles (growth or
recession). The previous exchange
rate mechanism (ERM) had already

attempted to fix national currencies
against each other within the EU.
The euro went a step further,
removing all national currencies
and, in effect, permanently fixing
exchange rates. Important new
rules on government debt were
introduced. Under the stability and
growth pact of 1997, no country
was to have a national debt of
more than 60 percent of its gross
domestic product (GDP) and the

EXCHANGE RATES AND CURRENCIES


Robert Mundell Born in Kingston, Canada, in 1932,
Robert Mundell studied at the
University of British Columbia in
Vancouver before moving to the
University of Washington in
Seattle. He earned his PhD at the
Massachusetts Institute of
Technology in 1956. He was
professor of economics at the
University of Chicago from 1966–
74, when he moved to Columbia
University in New York.
Apart from his academic work,
Mundell has acted as adviser to
the governments of Canada and
the US, and to organizations
including the United Nations and

the International Monetary
Fund. Alongside his work
on optimal currency areas,
Mundell developed one of the
first models to show how
macroeconomic (whole economy)
policy interacts with foreign
trade and exchange rates. He
was awarded the Nobel Prize in
economics in 1999 in recognition
of his work on macroeconomics.

Key works

1968 International Economics
1968 Man and Economics
1971 Monetary Theory

Crowds gather in Frankfurt,
Germany, for the launch of the euro,
the single currency of the eurozone, on
January 1, 1999. For a while the euro
traded alongside national currencies.

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