International Monetary Cooperation

The third stage of Economic and Monetary Union, EMU, commenced on 1 January 1999 with the adoption by 11 EU member states of the single currency, the euro. The irrevocably fixed conversion rates between the participating currencies and the euro were determined on 31 December 1998. Denmark does not participate in the single currency, but has as of 1 January 1999 participated in the new exchange-rate mechanism, ERM II. The European Central Bank, ECB, was established on 1 June 1998 and as from 1 January 1999 the ECB took over responsibility for monetary policy in the euro area from the central banks of the 11 participating member states.

In 1998 the work of the International Monetary Fund, IMF, was characterised by efforts to contain the crisis which arose in the foreign-exchange and capital markets of Asia in 1997.

The introduction of the euro

The third and final stage of Economic and Monetary Union, EMU, began on 1 January 1999 with the adoption by 11 EU member states of the single currency, the euro. The 11 euro area member states are Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. At the same time, the European Central Bank, ECB, took up its function as central bank to the euro area in cooperation with the national central banks of the participating member states.

The irrevocable fixing of exchange rates
The 11 member states to participate in EMU were selected by the heads of state or of government of the EU member states in May 1998. At the same time the bilateral conversion rates to apply as from 1 January 1999 between the currencies of these member states were announced. On 31 December 1998 the exchange rates of the participating cur-rencies vis-à-vis the euro were fixed irrevocably, after which the euro was born as an independent currency on 1 January 1999. As from this date the national currencies of the participating member states are sub-denominations of the euro, just as e.g. the øre is a sub-denomination of the krone. Box 6 shows the irrevocably fixed conversion rates.

Box 6 THE IRREVOCABLY FIXED CONVERSION RATES BETWEEN THE EURO AND
THE CURRENCIES OF THE PARTICIPATING EU MEMBER STATES

1 euro =		40.3399	Belgian francs
=		1.95583	D-marks
=		166.386	Spanish pesetas
=		6.55957	French francs
=		0.787564	Irish pounds
=		1,936.27	Italian lire
=		40.3399	Luxembourg francs
=		2.20371	Dutch guilder
=		13.7603	Austrian schillings
=		200.482	Portuguese escudos
=		5.94573	Finnish marks

The procedure on 31 December 1998 was determined by the requirements stipulated in the Maastricht Treaty that 1 euro be equal to 1 ECU on the introduction of the euro. This procedure began by the national central banks' calculation of the exchange rates for their national currencies, ensuring that the bilateral exchange rates between the participating countries' currencies were in accordance with the conversion rates which were pre-announced in May. The exchange rate for the official ECU was then calculated in order to fix the exchange rate for 1 euro. Against this background the Council of Ministers of Economic Affairs and Finance (ECOFIN) could adopt the irrevocably fixed conversion rates between the euro and the 11 euro area currencies as from 1 January 1999.

In the first three years the euro will exist solely as a "unit of account", i.e. as an electronic means of payment, as the denomination of securities, on price signs, etc., but not as physical money. Euro banknotes and coins will not be introduced until 1 January 2002. National banknotes and coins will continue to be in circulation as a means of payment until that date. During the following six months the national currencies will be withdrawn from circulation. As from 1 July 2002 euro banknotes and coins will be the only legal tender in the euro area.

The changeover weekend
During the changeover weekend from 1 January 1999 until the financial markets opened on 4 January the financial institutions of the euro area converted their payment systems, computer software, price quotation systems, etc. to euro. Most government bonds and many other securities were converted to euro. Denmark and other EU member states and third countries also made adjustments, but on a smaller scale than in the participating countries. The changeover weekend and the introduction of the euro on the foreign-exchange and capital markets on 4 January 1999 progressed smoothly without any significant problems.

EU member states outside the euro area
Denmark, Greece, Sweden and the UK have not adopted the single currency. As from 1 January 1999 Denmark and Greece have linked their currencies to the euro by participating in the new exchange-rate mechanism, ERM II (cf. the section on ERM II below).

Denmark fulfils the criteria for participation in the single currency, but claimed its treaty-bound right not to participate in the third stage by way of the Edinburgh Decision of 1992 which was approved in the Danish referendum on the Maastricht Treaty in 1993. Instead, Denmark is subject to the exemptions and rules stipulated in the Maastricht Treaty for member states which do not qualify to participate in the third stage, the member states with a derogation.

The UK also claimed its treaty-bound right not to participate in the single currency. The UK is not a member state with a derogation because the Protocol on the position of the United Kingdom in the Maastricht Treaty contains several more exemptions than those applied to the derogation member states. The UK government has reserved the right for the UK to participate at a later stage if EMU functions satisfactorily and is found to be economically beneficial to the UK. The British government has stated that any such participation will be subject to a referendum.

In December 1997 the Swedish Parliament adopted the government's recommendation for Sweden not to participate in the third stage from the outset, but with an option for participation at a later stage subject to popular approval in connection with an election or a referendum. Sweden does not meet the exchange-rate criterion for participation in the single currency.

Greece wished to participate from the start, but does not yet meet the conditions.

ERM II

As from 1 January 1999 Denmark has participated in the new exchange-rate mechanism, ERM II. The fixed-exchange-rate policy has thus been continued, but now vis-à-vis the euro, cf. p. 36. The krone's central rate vis-à-vis the euro is fixed at kr. 746.038 per 100 euro, with a fluctuation band around the central rate. The standard fluctuation band in ERM II is +/- 15 per cent. However, member states in a favourable convergence position may achieve an agreement on a narrower fluctuation band. Denmark has concluded an agreement for a fluctuation band of +/- 2.25 per cent, cf. Table 8. The Danish fluctuation band of +/- 2.25 per cent corresponds to the previous narrow band for the krone in the European Monetary System, EMS, until August 1993. The fluctuation band serves as a safety net since in practice the Nationalbank seeks to stabilise the krone within a narrower range.

The objective of ERM II is to ensure exchange-rate stability between the euro area and the non-participating member states. ERM II centres on the euro since the participating currencies have central rates against the euro, but in contrast to the previous ERM agreement no bilateral rates against each other.

Should the exchange rate of a currency participating in ERM II reach a limit in the fluctuation band, i.e. either the maximum or minimum value vis-à-vis the central rate, the ECB and the central bank in question must intervene in the foreign-exchange markets in order to hold the currency within the fluctuation band. In principle, intervention at the margins is automatic and unlimited, but can be suspended if it is in conflict with the primary objective of the ECB or of the relevant central bank. Flexible use of its interest rates by a central bank whose currency is under pressure is an important element of the set of ERM II agreements.

Certain elements of the new ERM II agreement are not stated explicitly in the old EMS agreement. This especially concerns the possibility of suspending intervention and the statement that interventions should be accompanied by other policy measures, including fiscal-policy measures. The different wording in relation to previous agreements, which in more general terms stipulated "other economic measures", reflects the gradual evolution of the ERM agreements since the first resolution of December 1978 on the establishment of the EMS.

However, in real terms there are no innovations in relation to the previous agreement. A precondition for the Bundesbank's accession to the EMS agreement was that intervention could be suspended should the primary objective of the Bundesbank be endangered. The EMS crisis in 1993 showed that this possibility existed. For a number of years it has also been widely acknowledged that intervention in the foreign-exchange market can support a fixed-exchange-rate policy, but a sound economic policy is a precondition for its success.

Table 8 CENTRAL RATES AND FLUCTUATION BANDS AGAINST THE EURO IN ERM II

Per 100 euro	Denmark	Greece
Upper limit	kr. 762.824	40,607.5 drachma
Central rate	kr. 746.038	35,310.9 drachma
Lower limit	kr. 729.252	30,014.3 drachma
Note:Applies as of 1 January 1999.

The principles and the main terms of ERM II are described in the resolution from the European Council in Amsterdam in June 1997. The technical guidelines are described in an agreement of 1 September 1998 between the ECB and the central banks of the non-participating EU member states⁽¹¹⁾.

The agreement on Danish participation in ERM II and the fluctuation band was concluded at the informal meeting of the ECOFIN Council on 25-27 September 1998 between the Ministers of Economic Affairs and Finance and the central-bank governors of the EU member states.

Greece also participates in ERM II. Its fluctuation band is +/- 15 per cent, cf. Table 8. Sweden and the UK do not participate in ERM II.

The European Central Bank

The European Central Bank, ECB, was established on 1 June 1998. At the same time the European Monetary Institute, EMI, which handled the preparations for the ECB, was liquidated. The ECB and the national central banks together constitute the European System of Central Banks, ESCB. In principle, ESCB comprises the national central banks of all 15 EU member states, but a number of the Maastricht Treaty's provisions on ESCB concern only the ECB and the central banks of the euro area member states, also called the Eurosystem.

As from 1 January 1999 the ECB is responsible for the formulation of monetary policy and for the management of a large number of central-bank functions for the euro area. In practice these tasks are handled predominantly via the national central banks. In connection with the establishment of the ECB the 11 participating countries' central banks have paid up a capital contribution of almost 4 billion euro, while the four non-participating member states have made a considerably smaller capital contribution, cf. below.

Box 7 THE ECB'S EXECUTIVE BOARD, APPOINTED ON 1 JUNE 1998

Wim Duisenberg, President of the ECB, term 8 years. Christian Noyer, Vice President, term 4 years. Otmar Issing, term 8 years. Tommasso Padoa-Schioppa, term 7 years. Eugenio Domingo Solans, term 6 years. Sirkka Hämäläinen, term 5 years.

The organisation of the ECB
The ECB has three governing bodies: the Executive Board, the Governing Council and the General Council. The former President of the EMI, Wim Duisenberg, was elected President of the Executive Board in May 1998, cf. Box 7. The Executive Board is responsible for the day-to-day running of the ECB, including implementation of the monetary-policy decisions of the Governing Council. The Governing Council consists of the Executive Board and the central-bank governors of the 11 euro area member states, totalling 17 members. The ECB's third governing body is the General Council, which comprises the governors of all 15 EU countries' central banks and the President and Vice President of the Executive Board. The Governing Council meets around every two weeks and the General Council meets once a quarter. The ECB has furthermore established a number of committees to prepare for the meetings of the governing bodies.

Danmarks Nationalbank participates in meetings of the General Council. The Nationalbank also participates in ECB committees when issues pertaining to the General Council are on the agenda. The Nationalbank contributes a minor amount in the form of a small capital contribution to cover the costs associated with meetings in which Denmark participates. The yield on this small capital contribution covers the Nationalbank's estimated share of the costs. The amount disbursed to the Nationalbank on the liquidation of the EMI exceeded this deposit.

The ECB's monetary-policy strategy and instruments
The ECB's primary objective is to maintain price stability in the euro area. The strategy to achieve this objective is based on three elements: a quantitative definition of price stability, a reference value for growth in a broad monetary aggregate, and the development in a number of economic indicators. The Governing Council has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2 per cent.

The reference value for growth in the broad monetary aggregate must be consistent with the quantitative definition of price stability and the expected real GDP growth in the medium term, adjusted for expected changes in the velocity of circulation in the money supply. For 1999 the reference value is fixed at 4.5 per cent. A broad monetary aggregate, M3, comprising currency in circulation and various types of bank deposits, is used.

Finally, as the third element of its monetary-policy strategy the ECB intends to monitor a number of economic and financial indicators relevant to the expected development in prices, e.g. the development in long-term interest rates, confidence indicators, measures of output, wage development, raw material prices and the exchange rate of the euro.

The ECB's monetary-policy instruments correspond to the instruments used by the majority of the EU member states before the introduction of the euro. The most important instruments are a marginal lending and deposit facility for the banks at interest rates above and below the overnight market interest rate. The ECB will use refinancing operations to steer the short-term interest rates within this interest-rate corridor. The main refinancing operations are weekly tenders with a maturity of two weeks. The ECB also conducts regular long-term refinancing operations as monthly tenders with a maturity of three months. The ECB may conduct fine-tuning operations in order to cushion the effects of unexpected liquidity fluctuations. Furthermore, the ECB may conduct market operations to adjust the structural position of the Eurosystem vis-à-vis the financial sector⁽¹²⁾.

The Governing Council has decided that the banks must deposit reserves with the Eurosystem corresponding to 2 per cent of selected liabilities. The ECB pays interest on these deposits at the rate of interest for the main refinancing operations. One of the objectives of the minimum reserve requirements is to contribute to stabilising the interbank interest rates.

The euro area member states have transferred a proportion of their foreign-exchange reserves to the ECB. The total transfer of gold, dollars and yen corresponds to around 40 billion euro. The administration of the foreign-exchange reserves thus transferred, i.e. their placement, etc. is undertaken on a decentralised basis by the national central banks, whereas the placement rules are laid down centrally.

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Footnotes