THE NEGOTIATION OF AN ASYMMETRICAL EUROPEAN MONETARY SYSTEM AND THE DECISION OF HIGH INFLATION COUNTRIES TO JOIN THE SYSTEM Anna Solé del Barrio TESI DOCTORAL UPF / 2019 DIRECTORS DE LA TESI Dr. Fernando Guirao Piñeyro, (Departament Economia i Empresa, Universitat Pompeu Fabra) Dra. Pilar Nogues-Marco, (Département d‟Histoire, Économie et Société, Université de Genève) DEPARTAMENT D’HUMANITATS Acknowledgments First of all, I would like to thank my supervisors, Fernando Guirao and Pilar Nogués-Marco for all their help, support and patience during all this period. They really contributed to my intellectual growth and academic formation. I would also like to thank my colleagues of the area of Economic History of the Department of Economics and Business in UPF, Albert Carreras, Xavier Tafunell, Enriqueta Camps, Fernando Guirao, Peter Wardley, Ángel González and Kaloyan Stanev. I have learned a lot from all of them and working with them is always a pleasure. I am grateful to Enriqueta Camps, who organizes the seminars of Economic History and gave me the opportunity to present in few occasions, in which I obtained meaningful feedback. Finalment voldria agrair a la meva família i amics per tot l‟amor i afecte rebut i, molt especialment, a la María Teresa, que sap com n‟és de difícil escriure una tesi i m‟ha ofert un suport totalment incondicional. Sense cap dubte, res d‟això hagués sigut possible sense el Javi, que m‟anima i ajuda en els moments difícils, però, sobretot, amb el seu optimisme fa que gairebe tots siguin moments bons. iii Abstract The EMS negotiations were centred on the debate on symmetry. High inflation countries struggled to introduce elements to force a more symmetrical functioning of the system than the Snake. However, these attempts found the strong opposition of the German government, which was able to impose its stance in all aspects determining the symmetry of the system. The main reason for this was that Germany benefitted from a bigger bargaining power during the discussions, mainly explained by the particular institutional design of monetary policy in Germany, in which the Bundesbank enjoyed a strong reputation and an exceptional degree of autonomy. For countries like Italy or Ireland, the EMS design did not meet their minimum requirements to join. However, both countries decided to join the system anyway. In these countries, domestic debates on EMS membership were highly influenced by other economic and political national discussions, which would determine their eventual decision to join the EMS Resumen Las negociaciones sobre el SME se centraron en el debate de la simetría. Los países de inflación elevada intentaron introducir elementos que impusiesen un funcionamiento del sistema más simétrico que el de la Serpiente. Sin embargo, estos intentos se encontraron con la oposición alemana. El gobierno alemán consiguió imponer su postura en los aspectos que determinaban la simetría del sistema. La principal razón por la que Alemania consiguió imponerse fue su mayor poder de negociación durante las discusiones, que se explica principalmente por el diseño institucional de la política monetaria en Alemania, donde el Bundesbank gozaba de gran reputación y un nivel excepcional de autonomía. Para países como Italia e Irlanda, el SME no satisfacía sus principales requisitos. No obstante, ambos países decidieron entrar. En estos países, los debates domésticos sobre el SME estuvieron fuertemente influenciados por otras discusiones sobre cuestiones económicas y políticas. v Introduction From a general perspective, the process of European economic integration, and in particular monetary integration, has been traditionally analysed as a unidirectional route, progressively turning less integrated economies into more integrated economies. In the case of monetary integration, it is interpreted as a path leading from floating to fixed exchange rates and, eventually, to a monetary union. This process of economic and monetary integration, according to neo-functionalist approaches, is the result of a learning process and an improvement of the efficiency of European institutions and mechanisms of decision making. European economic and monetary integration has been studied under the assumption that it was an irreversible process, in which every stage was a preparation for the next one. However, it is important to take into account that this process has been characterized by recurrent crises and, in many occasions, these crises were precisely the reasons that accelerated integration. In several occasions, it was the response to short term problems during these crises what conditioned the design of the long-term integration strategy, instead of a long-term project devised to reach the final stage of the process. In that sense, the current design of the European institutions is the result of the concrete conditions experienced by European countries at the moment in which they were created. The political and economic crisis that is affecting the European Union nowadays imposes the need of reassessing all the process of integration, in particular what refers to monetary vii integration. A re-evaluation of the process of negotiation leading to the launching of the European Monetary Union and its eventual functioning is relevant to understand the present crisis of the Eurozone. Frequently, the European Monetary System (EMS) is considered the predecessor of the European Monetary Union and the ECU (European Currency Unit), the currency basket created with this new monetary arrangement, the predecessor of the Euro. Conversely, at the moment of the launching of the EMS, it was by no means seen as a step leading necessarily to a monetary union. The design of the European Monetary System was the outcome of the particular circumstances of the second half of the 1970s, and was an attempt to address the causes of the extremely high inflation rates, the volatility of exchange rates and, in general, the awful results in terms of monetary stability. It is true that the EMS had an impact on the future European developments in the field of monetary integration and, in this regard, it had long-term consequences. Still, the design was addressing the short-term problems which characterized the last part of the 1970s, although it ultimately determined an institutional design that was intended to be permanent and irreversible. The second half of the 1970s was characterized by very high inflation rates and volatility of the exchange rates. There were essentially two main causes of the inflation of the 1970s. The first factor of inflation was cost-push inflation, produced not only by the increases in oil prices, but also by a surge in labour costs resulting viii both from declining productivity and the mechanisms of wage indexation that were in force in many European countries. The second factor of inflation was the monetization of budget deficits. In the majority of countries, the first reaction to the crisis was the adoption of expansionary economic policies. Also, in most countries, by that time, there was a prevalence of fiscal policy over monetary policy, leading to, in different degrees depending on countries, monetization of deficits. In fact, with respect to economic policies, the 1970s were a transition period. Most countries were still in a Keynesian paradigm but, as a result of the dreadful consequences of expansionary monetary policies in terms of inflation, there were several experiments to find alternative approaches to the management of money supply. A new economic consensus grounded on Monetarist ideas started being built during that period, although it did not consolidate until the 1980s. During the last part of the 1970s, different countries investigated alternative mechanisms to impose monetary rigour. There were several debates on aspects such as wage determination, independence of monetary policy, and use of the exchange rate to impose monetary stability, among others. The negotiations leading to the launching of the EMS were conditioned by these inflationary tensions that characterized the period, and took place in the framework of this general debate on the role of monetary policy and its institutional design, in which the Keynesian paradigm started being abandoned, but the new Monetarist consensus was still not consolidated. ix The discussions about the EMS design concentrated on the issue of asymmetry. Asymmetry is defined as the capacity of one of the members of the agreement (in the case of the EMS, Germany) to choose independently its monetary policy, forcing the others to adjust to that standard. Since some of the elements of the system were not clearly defined in the agreement, or ended functioning differently to what was established, it is important to distinguish between asymmetry in the design and asymmetry in the functioning. The concept of asymmetry applied to the design of the system refers to the explicit election of the German mark as the numéraire of the system and the definition of rules regarding intervention obligations and credit facilities accordingly. Asymmetry in the functioning refers to the adoption of different patterns of intervention by Germany on the one side and other countries on the other, leading the German mark to become eventually the standard of the system, although the design was intended to be symmetrical. There is an intense debate in literature about the symmetrical or asymmetrical character of the EMS and the reasons for this asymmetry. Although a few authors claim that both the design and functioning of the EMS were symmetrical, the majority of scholars assert that the EMS was asymmetrical, due either to an asymmetrical design from the beginning or to an asymmetrical functioning. The debate about symmetry is connected to the debate about the motivations and factors behind the new monetary arrangement. Authors who interpret the European Monetary System as an anti-inflationary device, the aim of which was to impose monetary rigour and import the Bundesbank‟s reputation, assert that x the EMS was necessarily asymmetrical, owing to this disciplinary nature.