DP1379 | Out in the Cold? Outsiders and Insiders in 1999: Feasible and Unfeasible Options


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If the third stage of monetary union in Europe begins on 1 January 1999, not all EU countries will participate: two, with opt-out clauses, may choose to stay out; others will have a derogation because they do not fulfil the required conditions. The Maastricht Treaty, while silent on the regime governing the relationships between the single currency and currencies of member states with a derogation, contains contradictory provisions regarding the latter gaining later admission. On the one hand, the Exchange Rate Mechanism of the EMS will cease to exist in its present shape in January 1999; on the other hand later admission to the single currency requires fulfilment of the convergence criteria, one of which is the observance of normal fluctuation margins as provided by the ERM. The paper examines the nature of this ?catch 22? problem. It then surveys the conceivable options concerning the exchange rate relationships between the Euro and the outsiders? currencies. An analysis of political and institutional constraints, and incentives and disincentives for different groups of countries shows that the subset of feasible options is very narrow. Also, building on recent contributions, the paper sketches the economic and legal framework of a possible solution, consisting of a set of bilateral and conditional exchange rate agreements, which may be institutionally feasible and economically viable.