Understanding details. Mark True (T) and False (F) statements according to the text. 40. An EMU is a type of trade block which does not involve a common market

40. An EMU is a type of trade block which does not involve a common market.

41. The idea about the introduction of the common currency first occurred to France’s and German’s leaders.

42. Originally the euro was to be modeled on the frank as a hard currency.

43. The prospect of adopting the euro was not that attractive either to Italy or to Spain as they had less stellar records in keeping the stability of their currencies.

44. Since the year of its introduction the euro has fluctuated quite sharply.

45. The entry of the euro into the USA’s stock market led to this currency fall.

46. Chinese growth allowed Germany to increase its exports to this country.

47. When monetary relations were rather primitive there were only two forms of monetary policy.

48. The modern idea of monetary policy first appeared in China in the 7^th century.

49. The creation of the Bank of England was an important stage in the development of the idea of monetary policy.

50. Monetary policy has been independent of executive action ever since the Bank of England foundation.

51. The role of the central bank as the “lender of last resort” was associated with decision about coinage.

Text I

An economic and monetary union is a type of trade bloc which is composed of a economic union (common market and customs union) with a monetary union. It is to be distinguished from a mere monetary union (e.g. the Latin Monetary Union in the 19^th century), which does not involve a common market. This is the fifth stage of economic integration. EMU is established through a currency-related trade pact. An intermediate step between pure EMU and a complete economic integration is the fiscal union.

Europe’s Single Currency Obsession

The idea for a common European currency had its proximate origins in discussions during the late 1970s between Valery Giscard d’Estaing and Helmut Schmidt, the leaders then of France and Germany. The Germans were sufficiently concerned with the rapid rise of U.S. inflation and the poor prospects for the dollar as a viable store of value that they conceived the idea, as part of a move toward European union, that Europe should have its own currency. The demise of the Soviet Union and fall of the Berlin Wall, just over a decade later, gave strong impetus to the movements toward European political and monetary union. By 1997, European countries were pursuing policies that amounted to a peg of their currencies to each other in anticipation of the introduction of a single currency, the euro, in January 1999.

The euro was clearly to be modeled on the deutschemark as a hard currency, which would be managed in a manner that assured low inflation rates in the euro currency area and thereby low interest rates. The European Central Bank (ECB) was located in Frankfurt, just a few miles from the Deutsche Bundesbank, which oversaw the post-war elevation of the deutschemark to hard-currency status. The prospect of adopting the euro as the currency of Europe was especially attractive to countries like Italy and Spain with less stellar records in keeping their currencies stable. Countries that used the new common currency would, in effect, be able to borrow at the same interest rates that Germans could enjoy as a result of their long history of hard-currency policies.

The euro had its ups and downs after its introduction in January 1999. Initially, the euro traded at a price $1.18 on the expectation that it would command a premium over the dollar as a superior store of value under the management of the stern European Central Bank, which was charged only with maintaining low inflation. That is, it was not to be distracted by concerns about asset prices, growth, and unemployment as was the U.S. Federal Reserve, the steward of the dollar’s purchasing power.

In fact, the euro fell steadily against the dollar during most of the first two years of its existence, reaching a low on October 26, 2000, of about $.82. Just before that, central banks in Europe, Japan, and the United States had purchased euros to stem what was perceived as an excessive weakness of Europe’s new currency.

The primary underlying reason for the euro’s tumble was the rush from Europe into the surging U.S. stock market during 1999 and early 2000. Even though the NASDAQ crashed in March 2000, flows did not begin to reverse in earnest until after it was clear later in the year that the U.S. tech bubble would not reinflate. After October 2000, the euro rose consistently over an uneven path for about four years, reaching a high of about 136 in 2004 amidst fears of a rising U.S. current account deficit.

Yet the strength of the euro during the post-bubble period came at a price. First, Europe’s main economy and often its engine of growth--Germany--entered the currency union at what amounted to an overvalued exchange rate. As a result, German manufacturers squeezed down costs in order to improve competitiveness, relying in effect on falling unit-labor costs as a way to restore competitiveness rather than a falling currency. Growth rates in other parts of Europe also suffered, and by 2003 it was necessary for Germany and France to abandon the fiscal restraints originally imposed as a condition for membership in the European Union. Their budget deficits were allowed to rise above 3 percent of GDP and have remained at that level, sustained by continued outlays under generous social programs and constricted revenues as their economies have underperformed.

Europe, and especially export-oriented Germany, received a reprieve after 2002 from the surge in Chinese growth. Germany’s exports to China rose rapidly, giving its manufacturing sector a boost. Meanwhile, the ECB continued to pursue tight monetary policies, so the euro appreciated further, thereby undercutting Europe’s advantage in its traded-goods sector.

Text 2

Monetary policy is primarily associated with interest rate and credit. For many centuries there were only two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of monetary policy during this time. Monetary policy was seen as an executive decision, and was generally in the hands of the authority with the power to coin. With the advent of larger trading networks came the ability to set the price between gold and silver, and the price of the local currency to foreign currencies. This official price could be enforced by law, even if it varied from the market price.

Paper money called "jiaozi" originated from promissory notes in the 7th century China. Jiaozi did not replace metallic currency, and were used alongside the copper coins. The successive Yuan Dynasty was the first government to use paper currency as the predominant circulating medium. In the later course of the dynasty, facing massive shortages of specie to fund war and their rule in China, they began printing paper money without restrictions, resulting in hyperinflation.

With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them with gold, the idea of monetary policy as independent of executive action began to be established. The goal of monetary policy was to maintain the value of the coinage, print notes which would trade at par to specie, and prevent coins from leaving circulation. The establishment of central banks by industrializing nations was associated then with the desire to maintain the nation's peg to the gold standard, and to trade in a narrow band with other gold-backed currencies. To accomplish this end, central banks as part of the gold standard began setting the interest rates that they charged, both their own borrowers, and other banks who required liquidity. The maintenance of a gold standard required almost monthly adjustments of interest rates.

During the 1870-1920 period, the industrialized nations set up central banking systems, with one of the last being the Federal Reserve in 1913. By this point the role of the central bank as the "lender of last resort" was understood. It was also increasingly understood that interest rates had an effect on the entire economy, in no small part because of the marginal revolution in economics, which demonstrated how people would change a decision based on a change in the economic trade-offs.

Monetary decisions today take into account a wider range of factors, such as: