The Eurosystem in the International Monetary System

Focus

THE EUROSYSTEM IN THE factors that contribute to the international responsibility of the euro area (Section 3), the article INTERNATIONAL MONETARY examines the possible implications of the euro for SYSTEM the relationships among the three key currencies (Section 4). It then discusses the scope and meth- ods of international co-operation in a tripolar system (Section 5) as well as its institutional frame- TOMMASO PADOA-SCHIOPPA* work (Section 6).The role of the euro in relation to non-key currencies (Section 7), particularly those he introduction of the euro will have far- seeking an external anchor for their monetary pol- T reaching implications not only for the evolu- icy, is then considered. Finally, the article ends with tion of central banking and monetary policy, but a short conclusion (Section 8). also for international monetary and financial relations and the world economy at large. It will modify the environment in which players outside the The underlying rationale euro area, the large as well as the medium and small ones, will operate in the years to come. It will With the stipulation of the Maastricht Treaty in 1992 therefore entail new responsibilities for policy- (the “Treaty”), Europe has adopted an entirely new makers in Europe. approach to the choice of the monetary order of a group of interdependent but sovereign countries. The purpose of this article is to offer the reader an Going beyond fixed exchange rates between national overview of how the Eurosystem views its role as a currencies, it has created a single currency and estab- major actor in international monetary relations. The lished a single central bank. The importance of this article suffers from a very important limitation in that step is apparent if one looks back over the last 50 it is confined to only one aspect, albeit a crucial one, years and considers the repeated attempts to stabilise of “monetary relations”, i.e. exchange rate relations. exchange rate relations through adjustable peg Although for decades the latter were seen as the sole regimes. The evolution of international monetary The crucial role of the Eurosystem monetary issue generated by international interde- relations illustrates that i) open trade and ii) free in exchange-rate pendence, the reader should be aware that this is no international movement of capital render iii) fixed relations longer the case. Over the last quarter of a century,with exchange rate systems hardly compatible with iv) the emergence of a global monetary and financial independent national monetary policies. Exchange market, the agenda for international monetary co- rates pegs have repeatedly been chosen to stabilise operation has expanded considerably. It now includes trade and financial relationships between economi- such key central banking fields as the efficiency and cally interdependent countries, at both the global and soundness of the payment systems and the stability of the European scale. If, however, the policies of the the banking industry and securities markets. Co-oper- countries involved diverge, markets question whether ation in these areas has in fact progressed at a faster exchange rate commitments can and will be main- pace than in the field of exchange rates. tained. As the doubt grows, pressure may become enormous and eventually lead to the abandonment of The next section outlines the background against the peg. The four elements mentioned above form which the euro came into being, showing how its what is sometimes called an “inconsistent quartet”. creation constitutes a rather unique answer to the problems and contradictions of international eco- In the Bretton Woods System the inconsistency nomic interdependence. After highlighting the size became apparent in the 1960s when the development of an international capital market made it pos- * Tommaso Padoa-Schioppa is a member of the Executive Board of the European Central Bank. sible to circumvent official restrictions and controls.

CESifo Forum 18 Focus

It became increasingly difficult to subordinate eco- convergence in Europe was achieved through con- nomic policies to the exchange rate objective. When siderable fiscal consolidation and successful disinfla- the policy stance in the United States (the anchor tion. Financial markets rewarded these efforts with country) came into conflict with anti-inflationary lower interest rate differentials and relatively stable preferences of other important players (such as foreign exchange relations. Germany), the dollar became increasingly overval- ued and tensions grew.With economic fundamentals EMU is not just an evolution or a tightening of in the United States deteriorating sharply specula- previous arrangements such as the European tive activity in the foreign exchange market reached “snake” and the EMS. It is not a binding interna- a level far exceeding the defensive capacity of tional agreement to co-ordinate monetary policies. national authorities. A devaluation of the French Rather, it is a complete change of regime, the franc and a temporary floating of the German Mark establishment of the same monetary order that were, at the end of the 1960s, the first signs of the normally exists within a nation: one currency, one coming breakdown of the system. Eventually, the central bank, and one monetary policy. The coun- Bretton Woods regime collapsed as a result of the tries that have transferred their monetary compe- waning of the two conditions that had ensured its tencies to a new supranational institution, howev- initial success: a balanced macroeconomic situation er, retain their separate sovereignties in many in the anchor country and limited capital mobility areas, and even in the economic field. This is the between national financial markets. unprecedented feature of EMU.

Intra-European relations went through a similar It appears from this glance at the past that two dif- A single currency at experience. Europe’s exchange rate peg moved ferent solutions have been chosen, at the global and the European level from a US dollar to a Deutsche Mark standard, the European level respectively, to resolve the same was combined with which took various forms and lasted until the problem. In both cases the inconsistent quartet had a floating-rate advent of the euro. Its main manifestation, the come about as a result of rising capital mobility. To system at the global level European Monetary System (EMS), was designed overcome the inconsistency, one element of the quar- in full awareness of the two drawbacks of the tet had to be dropped. The international community Bretton Woods regime: inflexibility and asymme- decided to drop the fixed exchange rate element and try. Flexibility was pursued, for more than half of moved to a regime of floating rates. Europe decided the ERM “narrow band” life, through timely to drop independent monetary policy and founded a realignments (11 between 1979 and 1987). As to single currency to complement the Single Market. symmetry, no currency was explicitly given a lead- The solution adopted for one area would not have ing role and parities were decided by “common been possible, or would not have worked, in the other accord” in relation to the ECU currency basket. In area. Europe, in particular, could – and, in a way, was practice, however, the Bundesbank led the mone- almost compelled to – move to the single currency tary policies of other members and the German because its economic and financial integration had Mark was de facto the anchor of the system. gone extremely far and because it was politically ready to establish common institutions. Using the jar- However, even intra-European relations came under gon of today’s debate on exchange rate regimes, the increasing strains as a result of capital liberalisation approaches taken by the world and by Europe and the creation of a single market in banking and respectively correspond to the two “corner solu- financial services. Economic and Monetary Union tions” that are sometimes seen as the only viable (EMU) was decided upon and enshrined in the ones in a world of capital mobility. The unresolved Treaty, not only for reasons of “high politics”, but problem of exchange rate arrangements for non-key also to remove the inconsistency of the quartet and currencies will be discussed below. to firm up the Single Market. When uncertainties about the ratification of the Treaty pointed to the risk that Monetary Union might not come about, an A new player on the field exchange rate crisis erupted because markets redis- covered domestic imbalances and policy contradic- The advent of the euro has brought a new player tions. Only the substantial widening of the fluctua- onto the field. “Euroland” (a name that was quickly tion band to ± 15% in August 1993 restored calm in adopted for the euro area) is, in economic terms, the market. In the years that followed, economic around the same size as the United States and twice

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as large as Japan. With almost 300 million people, it ters. Establishing such a system would have required produces 15% of world GDP (the United States pro- the leading industrial countries to agree on desirable duces 20% and Japan 8%). Accounting for approxi- exchange rate levels and to act in order to keep mar- mately 20% of world exports (the United States ket rates within a range of permitted fluctuation. accounts for 15%, Japan 8.5%), it is the largest trading partner in the world economy. In the debate that followed those proposals, the Eurosystem expressed serious reservations about In the monetary and financial field the euro, assum- the feasibility and desirability of any scheme that ing the mantle of the German mark and its other would attempt to enforce stability between the predecessors, has from the start been the second dollar, the euro and the yen. The Eurosystem international currency. Euro/dollar trading is the warned that as long as major players conduct inde- most active and liquid segment in the foreign pendent and domestically-oriented monetary poli- exchange market at the global level, followed by the cies such schemes would be impossible to reconcile dollar/yen currency pair. As for international bonds, with the increasing mobility of capital, as the the US dollar and the euro now jointly account for occurrence of the inconsistent quartet has proved 80% of new issuance, making the international bond in the past. In today’s highly integrated and market increasingly a two-currency market. As a extremely liquid international capital markets, the reserve currency, the share of the euro is expected amounts of funds that can be mobilised to push a to have contracted somewhat in 1999 from the 15% currency out of the target zone far exceed the of its legacy currencies, because German mark amounts that proved sufficient to destabilise both reserves held by euro area central banks are no the Bretton Woods regime and the EMS. None of longer recorded as foreign reserves. However, there the leading central banks would now be willing to are signs that official authorities outside the euro forego domestic policy objectives in order to area, in particular in Asia where the bulk of global absorb or create the large amounts of liquidity official reserves are held, are gradually diversifying needed to defend the exchange rate objective. their portfolios towards the euro. It is true that pressures may be generated by unjus- As a reserve The new economic player created by the single cur- tified market sentiments, uncertainty or mispercep- currency, the share rency has come hand in hand with a new institutions about the conditions and prospects of an econ- of the euro is likely tion, the Eurosystem. This institution is the world’s omy, as has been the case with the euro in late 1999 to have fallen below the 15% of its second most important central bank. and early 2000. The belief that “markets are always legacy currencies right” is indeed naïve and unjustified. Even when in 1999 These “size” factors obviously generate an interna- they are wrong, however, markets are stronger than tional responsibility for the euro area policy-mak- policy-makers. Moreover, and most importantly, ers, particularly the Eurosystem. Three questions they tend to correct their own mistakes and to can be asked in order to explore the issues con- reflect, over time, the so-called “fundamentals”, be fronting the Eurosystem. First, what kind of they divergences in relative cyclical positions, differ- exchange rate regime will be established between ent patterns of monetary policies, changes in com- the major currencies? Second, what implications petitiveness, or macroeconomic imbalances. will the euro have for international co-operation? Third, what role will the euro play in relation to In theory, a fixed rate system allows one country or non-key currencies? area to benefit from a higher degree of freedom if the other two countries or areas were willing to follow in line. In practice, however, the hierarchical structure Three floating currencies displayed by both Bretton Woods and the EMS – in the sense that in both systems one country was lead- With regard to the exchange rate regime, the intro- ing the monetary conditions of the others – could not duction of the euro has coincided (it was indeed be reproduced in the new environment. Given the largely a coincidence) with proposals for tighter comparable economic weight of the United States exchange rate arrangements among the three main and the euro area, a hierarchy would be politically currencies. In particular, the concept of target zones, unacceptable. The three regions taken together are first advocated by Williamson in 1986, seemed to gain too far from conforming to the usual economic crite- renewed favour in Germany and in some other quar- ria for an optimum currency area. Furthermore, the

CESifo Forum 20 Focus increasing relevance of emerging markets for global to address these externalities, and indeed they try trade, capital flows and also crisis potential means to. However, since they have been given only very that co-operation among the three main global play- limited instruments, it is the task of countries them- ers alone would be difficult to sustain. selves to internalise global externalities.

The truth of the matter is that it would be neither Secondly, compared to its predecessor central realistic nor desirable to attempt to establish a kind banks, the Eurosystem is a much stronger interna- of European Monetary System, or a less ambitious tional player, is much less vulnerable to external variant thereof, at the global level. The EMS owed shocks and influences, produces much greater much to factors specific to the European Union external effects with its own actions. Owing to its (EU), such as relatively homogenous economic struc- sheer size and to the size of Euroland, the tures, a very high level of economic and political inte- Eurosystem makes a considerably larger contribu- gration and a comprehensive institutional edifice. tion to world affairs and has a correspondingly Even so, the EMS itself came under great pressure larger role and responsibility. These observations when full mobility of capital was established and suggest that the Eurosystem should adopt an active markets questioned its credibility and sustainability. and positive attitude towards international mone- The degree of co-ordination and political commit- tary co-operation. ment that would be required for a system of more or less fixed exchange rates to function on a global scale Coming to more specific considerations, the first – and thus to overcome the inherent inconsistency question is whether the three main currencies will problem mentioned before – is so great that it cannot continue to exhibit the high degree of exchange- Two opposing factors are at work be realistically expected from the major players in rate variability witnessed over the past 25 years. regarding the future the foreseeable future. This is why floating exchange Looking ahead, two factors linked to the introduc- exchange-rate rates among the major currencies are bound to stay. tion of the euro may be at work and pushing in variability of the three major opposite directions. currencies

Co-operation: Scope and Method The first factor is the fact that Euroland is far less open than its national components, although its ratio What requirements will be laid down, for interna- of exports of goods and services to domestic GDP, at tional co-operation and the Eurosystem, by a 17.1%, is well above that of the United States (11.0%) three-currency system where exchange rates are or Japan (11.5%). Euroland, Japan and the United market-determined? States are all large and rather closed economies. The strong and unsurprising positive correlation between Before addressing the specifics of this question, two a country’s openness and its willingness to take the broader observations should be made. Firstly, in the exchange rate into account in policy-making suggests present state of the world the preservation of eco- that attitudes towards exchange rate developments nomic order requires nation-states to be conscious will be relatively neutral in the coming years. This of their international responsibilities. This is a mat- might lead to greater exchange-rate variability. ter of both enlightened self-interest and “international public spirit”. Indeed, in a world where coun- The second factor is the fact that all the three tries or regions are economically and financially countries or regions clearly gear their monetary interdependent there are, as in any “single econo- policies towards medium-term price stability and my”, certain public goods which are “public” with have an independent central bank. Although, of respect to the world itself. Global financial stability course, price stability is never a permanent acquisi- or the maintenance of open trade are prominent tion, some of the special circumstances behind the examples. As long as countries are sovereign in the high inflation of the 1970s and 1980s in many conduct of their policies, such international public industrialised countries are no longer there. The goods cannot be expected to automatically result “culture of stability” and the conviction that mon- from the spontaneous behaviour of market partici- etary policy can best contribute to economic pants and national governments, because such spon- growth and employment by ensuring an environ- taneous behaviour tends to ignore the numerous ment of stable prices now characterise the world externalities that arise at the international level. In economy. This positive combination should lead to principle, international institutions and forums exist more stable exchange-rate relations.

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On the whole, we cannot expect, for the years to depreciated against the dollar from the mid-1990s come, a significant decline in exchange-rate vari- onwards. The resulting exchange-rate variation in ability, in the form of both short-term volatility and Asia – in some cases exceeding 50% – has con- prolonged misalignments. We shall continue to see tributed to banking crises and deep recessions in large day-to-day movements in exchange rates, these countries, and it has been one of the main often driven by one-day market reactions to events mechanisms of global contagion and systemic risks. that are quickly forgotten the next day. We shall also continue to see deep and long exchange-rate These considerations illustrate that wide swings in waves that, over quarters and years, seriously affect the world’s major exchange rates have indeed had competitive positions. damaging consequences not only for the three major countries or regions but for the internation- Should a wide variability of exchange rates be a al economy as a whole. The latter consequences cause for concern? My answer is a clear yes. arise because the United States, Japan and Although little can be done about it, we should not Euroland influence the world business cycle and fail to notice the costs and damages it may inflict have strong trade, financial and exchange rate links on economic activity, financial stability and the to third countries. smoothness of international relations. If large and prolonged, variability may negatively affect macro- However if, as argued above, exchange-rate stability economic stability and distort the allocation of real is unlikely to become an end in itself for the three and financial resources. It may determine shifts in major economic players in the global economy, not competitiveness with distribution and even politi- least because it would lead to a re-occurrence of the cal implications. As a result, it may fuel trade con- inconsistency problem, what kind of objectives could flicts and protectionist pressures. be set for co-operation arising from those concerns? Unfortunately, rather limited ones. When large Even limiting the observation to the last two exchange-rate movements result from inadequate decades, several examples of harmful consequences macroeconomic and structural policies within the Wide variability of of wide exchange-rate variability can be recalled. three major economic areas, international co-opera- exchange rates is a The overvaluation of the US dollar in the mid-1980s tion may generate peer pressure for the adoption of cause for concern and its subsequent sharp weakening was the first appropriate corrections. When volatility arises from prominent example of a major exchange-rate mis- market uncertainties or misperceptions of actual or alignment since the collapse of the Bretton Woods future policies, co-operation conducted in a trans- system. The reversal was finally triggered by the parent manner may be supportive in correcting mar- Plaza and Louvre accords, which ended a period of ket perceptions. A very recent example is the posi- “extreme neglect” of the exchange rate and marked tion the G7 expressed – in October 1999 and again in the return to active co-operation. Since the mid- January 2000 – on the yen. Although an adjustment 1980s, the movements of the yen – which exhibited of the large and opposite current account imbal- high variability along a rising trend from 250 yen ances of the United States and Japan arguably per US dollar in mid-1985 to 85 yen per US dollar in requires a rise in the yen/dollar rate, too rapid a rise mid-1995 – have been a continuous concern to poli- was seen by the G7 as detrimental to the strengthen- cy-makers in Japan and its trading partners and ing of the long awaited Japanese recovery. have at times also given rise to protectionist tensions. This exchange-rate variability also partly What instruments are available to pursue such interacted with the rise and subsequent bursting of objectives? Very few, and they are rather inade- the Japanese asset price bubble in the late 1980s. quate for the task of removing “undesirable” variability from the foreign exchange market. A third example is the global financial crisis of Inadequacy pertains, in the first place, to diagnostic 1997-98, which was caused, inter alia, by unsustain- instruments. We have a sufficiently precise quanti- able exchange rates in emerging market economies. tative measure of price stability (the value of In many of the Asian economies concerned, the cri- money in terms of goods and prices) and there is lit- sis was partially due to movements in the dollar/yen tle controversy about its desirability. Much less can exchange rate. As these countries had linked their be said, however, for the value of money in terms of exchange rates to the dollar, they suffered major another money: assessing the “equilibrium” losses in competitiveness when the yen sharply exchange rate and hence undesirable exchange rate

CESifo Forum 22 Focus variations is much more difficult and controversial. more efficient and perhaps facilitates the formula- Second, prevention, i.e. measures aiming at building tion of common understandings. It is true that no greater stability into the market mechanism itself, is G3 has come into being as yet as a result of the also controversial and hardly effective. Restrictions euro, nor is this likely to come in the near future. on capital movements or “sand in the wheels” in the However, the debates within the G7 have rapidly form of “Tobin taxes” on transactions, which belong evolved from a round table of seven countries to a to this category of measures, are technically diffi- focused discussion on the three major economies, cult to enforce and would only work if all countries their situations, how they interact and the implica- agreed to adopt them, which is quite unlikely. Thus, tions for the rest of the world. only symptomatic cures are left, in the form of dec- larations and occasional interventions. This is what Second, the euro leads to complication. This needs a key industrial countries have resorted to in the last few words of explanation. Euroland is a currency quarter of a century. On some occasions these cures area that corresponds not to a state, but to a region- have proved effective. On the whole, however, they al entity formed by several largely sovereign states. have not fundamentally corrected the imperfec- From an economic policy point of view, this pecu- tions of the market mechanism. liarity complicates the co-operative game because it introduces an entity, a player, where different policies (monetary, fiscal, structural) are conducted at The institutional framework different levels (European, national, sub-national). In other words, while Japan and the United States Since the breakdown of the dollar-based adjustable are single-tier entities, Europe is a multi-tier one. peg, exchange rate co-operation among the main eco- From an institutional point of view, the complica- nomic areas has completely changed. It used to be tion relates to the fact that all international organi- At the institutional based on firm rules (for the dollar, convertibility to sations and forums are built on the twofold pre- level, the euro brings a simplifica- gold; for the other currencies, pegging to the dollar) sumption that their members are countries and that tion, a complication, and on an institution, the IMF, empowered to ensure policy responsibility rests with the countries. To and innovations their implementation. Now, there are no rules, nor fully accommodate the Eurosystem in organisations does the institution play a significant role. Discussions such as the IMF, the BIS, the G7 or the OECD on macroeconomic and exchange rate developments would require rather difficult adjustments because take place within the small group of G7 Finance Euroland is neither a country nor a single-tier poli- Ministers and Central Bank Governors. In the G7 no cy-maker. In the present international institutional formal decision-making procedures have been estab- framework, both the Eurosystem and the EU still lished, the IMF has been relegated to the modest role have a somewhat special position, because they can- of a technical secretariat, the agreed conclusions not claim the status of full members. At the same rarely modify the policy that would otherwise be cho- time, the countries that have adopted the euro have sen and implementation of the conclusions is volun- also changed their positions, because they are no tary. No mechanism of this kind would allow policy to longer responsible for one of the key policies that be conducted effectively within a country. So, nobody form the object of international co-operation. should be surprised by its great weakness for ordinary Furthermore, in forums such as the G7 or the G10, international policy-making. The mechanism hardly the Eurosystem also speaks on behalf of numerous functions other than as a tool for crisis management. countries (eight for the G7, six for the G10) that are Indeed, only a crisis or a near-crisis provides the extra not members of those same forums. For procedures incentive to reach agreements that go beyond involving consultation and the circulation of infor- exchanges of views and information. mation this is clearly a complication.

What does the introduction of the euro bring to this Third, the euro has brought about innovation. In the system? Paradoxically, it brings both a simplification second half of the 20th century the foundation and and a complication; but it also brings innovations development of the EU has brought two major nov- that may exert an influence in the years to come. elties in the field of international relations: the supranational and the regional character of its con- First, let us consider the simplification. By reducing struction. The euro has galvanised and further to three the number of relevant players, the advent advanced such innovations. Europe, once the theatre of the euro makes the process of co-operation of tragic conflicts originated by unfettered nation-

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states, has created and successfully applied two for- try-specific characteristics, such as the size of the mulas that, in my view, will also be increasingly need- economy, its trade and financial linkages, and the ed in the organisation of global relations. A degree development and soundness of its financial sector. of supra-nationalism is a sine qua non condition for Intermediate solutions, including pegs and managed an effective provision of international public goods, floating, will remain the preferred option for a num- just as a national power is indispensable for the pro- ber of countries unwilling to go for a more radical vision of national public goods. A degree of region- surrender of their monetary sovereignty and yet alism in organising relations between countries is an seeking an external anchor. Regional links and indispensable intermediate layer in a world where political objectives will also play a role in the deci- the number of sovereign countries has grown to sion on the appropriate strategy in any specific case. almost 200. Only the future will show whether these two innovations will find their way into the institu- Even now, a significant number of countries, espe- tional profile of global forums and organisations. cially in central and eastern Europe and Africa, have Working to this end should be regarded as a special monetary or exchange-rate regimes involving the task for the EU, Euroland, the Eurosystem, and the euro in an exclusive or partial role.1 These arrange- member countries. ments are mainly a legacy of past links to the former national currencies of the euro area countries. In the future, the euro can be expected to gain further Key currencies as anchors importance as a reference or anchor currency for the more than 80 countries located in what could be The implications of the advent of the euro for the called the “European hemisphere”, i.e. the international monetary system are not confined to European, Mediterranean and African regions. In the relationships with the two other key currencies. particular, small open economies entertaining signif- They also derive from the decisions of non-key icant trade and financial links with the EU may currencies seeking to anchor their monetary policy increasingly resort to the euro as a reference curren- to one of the major currencies. cy. The group of accession countries is a prominent case. In their efforts to achieve economic and finan- Unlike the three major economies, many of the cial integration with the EU these countries will The euro will also almost 200 countries of the world do assign, and will serve as an anchor devote special attention to the exchange rate. for the monetary probably continue to assign, a central role to the Moreover, accession to the EU will at some point be policy of other exchange rate in the formulation of their monetary followed by participation in the exchange rate mech- Countries policies. The reasons for this range from the small- anism ERM II and, eventually, the adoption of the ness and openness of the economy to a need to euro. As to non-accession countries within the build credibility rapidly to strong trade links with, European hemisphere, for virtually all of these the and financial dependence on, a large neighbouring EU is by far the largest trading partner, the base of country. Over the past decades, the means most fre- their financial system and a counterpart in important quently chosen by “third” countries to integrate the bilateral agreements in the fields of trade, technical exchange rate in their monetary policy strategy has assistance and support for economic development. consisted in pegging the national currency to a To the extent that these countries seek an external major currency, often the US dollar. In a world of monetary anchor, the euro is the natural choice. capital mobility, this may no longer be the only, or the most effective, means. Indeed, in the aftermath For the United States, and even more for Japan, a of the Asian crisis, those who view pegs as being similar process of regional clustering around the inherently unstable argued that either free floating major economy of the area seems less likely. In the or firm fixing in the form of currency boards or American hemisphere, comprising 35 countries, “dollarisation” should be preferred to any interme- regional co-operation is at an early stage of devel- diate regime. The Mexican and the Asian crisis have opment, is mainly confined to trade arrangements, actually shown that the requirements for sustaining and has a weak institutional structure not involving pegged exchange rates have become increasingly any binding legislation or supranational powers. demanding. Nevertheless, in the discussion, which is The NAFTA agreement is mainly a free trade still ongoing, a consensus is emerging that no single formula meets the needs of all countries at any one 1 For a description of these arrangements see the article entitled “The international role of the euro”, in the August 1999 issue of the time. Any strategy has to be consistent with coun- ECB Monthly Bulletin, pages 31–53.

CESifo Forum 24 Focus arrangement without a monetary or exchange-rate countries of the European hemisphere is less than dimension. The same holds for the Mercosur coun- a third of that of Euroland! tries, whose trade links (sometimes closer with the EU than with the US) make it difficult to peg exclusively to the dollar. Of course, the US dollar Conclusion nevertheless plays and will continue to play a dom- inant role in the American hemisphere, as the cur- This article specifically centres on a review of the rent issue of dollarisation in Argentina and implications of the euro and the Eurosystem for Ecuador illustrates. what has been, over around half of the last 50 years, the key aspect of the international mone- With regard to the East Asian and Pacific region, tary system, i.e. exchange-rate relations. On the the prospects for the Japanese yen to play the role one hand, it shows that for the relationships of reference currency seem remote. While the between the three key currencies these implica- European economies moved away from the dollar tions are likely to be limited. On the other hand, it standard as soon as the Bretton Woods system col- gives an idea of how far-reaching the implications lapsed, Asian economies generally remained on could be in other fields, such as the institutional the dollar standard for another 25 years, until the framework of international organisations and crisis of the late 1990s (partly resulting from the forums or the monetary strategies of the many exchange rate regimes themselves) severed that third countries which seek an external anchor for link. Most emerging market countries in Asia have their policies. This is new ground where predictions rather diversified trade connections with all and the formulation of a policy are very difficult. regions of the world. Their external trade with Japan is about the same as that with Europe and The advent of the euro and the Eurosystem opens The advent of the somewhat less important than that with the United a new chapter in the history of national and inter- euro and the eurosystem implies States. This configuration would hinder a peg national monetary regimes. Both Euroland and its a new reality to international partners, be they the major exclusively to the yen, even though the crisis has which all players clearly shown these countries that the yen cannot economies of the world or smaller players, will need to adapt be excluded from their currency arrangements. As need time to adapt to the new reality, to under- a result, many small open Asian-Pacific economies stand in full its implications, and to design the best may continue to face difficulties in choosing a sin- policies to address them. gle external anchor. The financial crises of these emerging market economies in 1997-98 illustrated As Otmar Issing explains in another article of this their vulnerability to exchange rate variability journal, the Eurosystem quickly understood that a among key currencies. monetary strategy mechanically repeating the highly successful approach of the Deutsche Bundesbank would not have been appropriate for the newly cre- Of the three key currencies, the euro may there- ated euro area. This is all the more true for the fore be the one which develops the most important design of an international policy for the Eurosystem. international role as an anchor. Active promotion The economic and financial conditions as well as the of the role of the euro as an anchor by the EU and historical and political constraints of the pre-euro the Eurosystem should be ruled out, as it would be world were so different from what is already emerg- inconsistent with the key policy mandate defined ing and will become ever more visible, that using by the Treaty. This role should only come about as past schemes as the paradigm for the future would a result of unilateral decisions by third countries. be misleading. A combination of firmness on the key The Eurosystem will have to follow it closely and mission to preserve price stability and of openness also to define its position. A fear of potential on the strengthening and improvement of interna- implicit constraints deriving from an expansion of tional monetary governance is the way forward. the international role of the euro would be neither justified nor appropriate. Euroland is large enough, and the Eurosystem is sufficiently strong and independent, to have little to fear. After all, this role was not refused by Germany vis-à-vis the ERM countries, whose GDP in 1990 was triple that of Germany, while the total GDP of the 85 non-EU

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