THE LIBERALIZATION OF CAPITAL MOVEMENTS IN EUROPE

FINANCIAL AND MONETARY POLICY STUDIES

Volume 29

The titles published in this series are listed at the end of this volume.
 THE LIBERALIZATION OF
CAPITAL MOVEMENTS IN EUROPE
THE MONETARY COMMITTEE AND
FINANCIAL INTEGRATION
1958-1994

by
AGE F. P. BAKKER
Free University, Amsterdam
Deputy Director of De Nederlandsche Bank

SPRINGER-SCIENCE+BUSINESS, MEDIA, B.V.

Ubrary of Congress Catalogiog in Publication Data
Bakker. Age.
The 11berallzatlon of capital movements In Europe: the Monetary
Commlttee and flnanclal lntegratlon. 1958-1994 I by Age F.P. Bakker.
p. cm. -- (Flnanclal and monetary pollcy studles ; 29)
Inc 1udes 1ndex.
ISBN 978-94-010-4059-4 ISBN 978-94-011-0123-3 (eBook)
DOI 10.1007/978-94-011-0123-3
1.. Capltal movements--Europe. 2. Monetary pOllcy--Europe.
3. Commlss1on of the European Communltles. Monetary Commlttee.
4. European Economic Communlty. Monetary Commlttee. I. Tltle.
II. Serles.
HG3942.B35 1995
332' .042--dc20 95-20404

ISBN 978-94-010-4059-4

Printed on acid-free paper

AlI Rights Reserved

© 1996 Springer Science+Business Media Dord.recht
Originally published by Kluwer Academic Publishers in 1996
No part of the material protecteci by this copyright notice may be reproduced or
utilized in any form or by any means, electronic or mechanical,
including photocopying, recording or by any information storage and
retrieval system, without written permission from the copyright owner.
C' est alors que je me suis demaTUie comment ttablir une r~gle,
puisque je n' acceptais pas de vivre sans r~gle, et que cette r~gle je
ne l'acceptais pas d' autrui.
Andre Gide, Les faux-monnayeurs

In the longing that starts one on the path is a kind of homesickness,

and some way, on this journey, I have started home.
Peter Matthiessen, The snow leopard

For my parents
 Contents

Acknowledgements xvii

1. Introduction 1
1.1 Capital liberalization and monetary unification 1
1.2 Capital liberalization and monetary policy 3
1.3 The tidal movement of exchange control 5
1.4 The role of the Monetary Committee 7
1.5 The purpose of this book 8

2. Capital Restrictions: Classification and General Observations 10

2.1 Introduction 10
2.2 Types of capital controls 11
2.3 The impact on capital flows 15
2.4 Types of transactions affected by capital controls 16
2.4.1 Long-term and short-term capital flows 16
2.4.2 Inflows and outflows of capital 18
2.5 The motives for capital restrictions 19
2.5.1 Exchange rate considerations 20
2.5.2 Monetary policy considerations 21
2.5.3 Saving and investment considerations 21
2.5.4 Tax considerations 21
2.6 Drawbacks of capital controls 22
2.6.1 Low degree of effectiveness 22
2.6.2 Undermining economic discipline 23
2.6.3 Hampering the domestic financial centre 24
2.6.4 Costs of controls 24
2.7 The sequencing of liberalization 24
2.8 Conclusion 26

3. The Treaty ofRome and Capital Movements 30

3.1 Introduction 30
3.2 The Spaak report 32
3.3 The attitudes among the founding member states 33
3.4 The Dutch attitude towards capital liberalization 36
3.5 The Treaty provisions 39
3.6 Subordination to the freedom of trade 42

vii
viii

3.7 Public reactions 44

3.8 Interpretations by the Court of Justice 46
3.9 The involvement of the IMP and the OECD in capital
liberalization 47
3.10 Conclusion 53

4. The Role of the Monetary Commiu(!e 58

4.1 Introduction 58
4.2 The Treaty status of the Monetary Committee 58
4.3 The tasks of the Monetary Committee 61
4.3.1 Liberalization of capital movements 62
4.3.2 Exchange rate policies 62
4.3.3 Balance-of-payments assistance 64
4.3.4 Further tasks 64
4.4 The composition of the Monetary Committee 65
4.5 The chairman of the Monetary Committee 66
4.6 The Alternates of the Monetary Committee 68
4.7 The proceedings of the Monetary Committee 69
4.8 Relationship with the Commission 70
4.9 Relationship with the Committee of Governors 71
4.10 Conclusion 73

5. The 1960s: Lost Momentum 79

5.1 Introduction 79
5.2 The initial attitude of member states 80
5.2.1 Germany in favour of full liberalization 81
5.2.2 France in favour of monetary policy coordination 81
5.2.3 Italy fears speculation 82
5.2.4 Dutch misgivings 83
5.2.5 The special case of Belgium and Luxembourg 84
5.2.6 Assessment 84
5.3 Preparation of the first directive 85
5.4 The First Directive of 1960 87
5.5 Maintaining the momentum 89
5.6 The Second Directive of 1962 92
5.7 The Third Directive: a failed attempt 94
5.8 Further efforts of the Commission 97
5.9 'Les evenements' of May 1968 in France 102
5.10 Conclusion 103

6. The 1970s: Lost Control 109

6.1 Introduction 109
6.2 The Werner report, a doomed attempt 110
6.3 The establishment of the snake 113
 ix

6.4 Capital controls codified in the 1972 Directive 116

6.5 The collapse of the Bretton Woods system and the oil crisis 118
6.6 The German experiment with capital controls 120
6.7 The French response to the currency turmoil 124
6.8 Italy: an economy under siege 128
6.9 The Netherlands: liberalization gaining pace 130
6.10 Comparison of the Dutch and French attitudes 133
6.11 The Belgian-Luxembourg dual market 134
6.12 European integration at a standstill 136
6.13 The liberalization in the United Kingdom 138
6.14 Conclusion 140

7. The 19808: Liberalization and Deregulation 147

7.1 Introduction 147
7.2 Capital liberalization reintroduced on stage 149
7.3 A strategic reorientation in'France 153
7.4 The change of attitude of the Commission 154
7.5 Active gradualism 156
7.5.1 Promotion of the ECU 156
7.5.2 Formulation of a package deal 158
7.5.3 Examination of derogations 160
7.6 Presentation of the White Book 161
7.7 Discussions on the Single European Act 162
7.7.1 Freedom of capital movement 162
7.7.2 A monetary dimension 163
7.7.3 Assessment 165
7.8 Commission proposals for a new directive 166
7.9 A new ambitious initiative of the European Commission 167
7.10 The reception of the Commission's programme 169
7.10.1 The French position 170
7.10.2 The German position 171
7.10.3 The Dutch position 173
7.10.4 The Belgian postition 174
7.10.5 The Danish position 174
7.10.6 The Italian position 175
7.11 The 1986 Directive 177
7.12 Conclusion 179

8. Towards the Full Liberalization of Capital Movements 187

8.1 Introduction 187
8.2 The changing financial environment 188
8.2.1 The role of innovations 188
8.2.2 The administration of controls 188
8.2.3 The effectiveness of controls 188
x
8.2.4 Financial integration 189
8.3 Commission initiatives for full liberalization 189
8.3.1 Reactions of member states 191
8.3.2 1\vo rival schools of thought 194
8.4 The monetary safeguard clause and the erga omnes principle 196
8.4.1 The monetary safeguard clause 196
8.4.2 The 1972 Directive and the erga omnes principle 198
8.4.3 The European credit mechanisms 199
8.5 Transitional arrangements 199
8.6 Questions of competence 201
8.7 The Basle/Nyborg agreement 202
8.8 A European financial area 204
8.8.1 Discussion in the Monetary Committee 204
8.8.2 The Belgian dual market 205
8.8.3 Draft directives 206
8.9 Fiscal questions 207
8.10 Enhanced supervision 209
8.11 Completion under German chairmanship 210
8.12 Conclusion 212

9. Towards Economic and Monetary Union 218

9.1 Introduction 218
9.2 The follow-up to the 1988 Directive 219
9.2.1 Full liberalization in the leading group 219
9.2.2 Gradual progress in derogation countries 221
9.2.3 Effects on capital flows 223
9.2.4 Indirect barriers 225
9.3 The follow-up in taxation and supervision legislation 226
9.4 The Delors report 227
9.5 Preparations under the Luxembourg presidency 229
9.5.1 The erga omnes principle 230
9.5.2 Sanctions 231
9.5.3 Transitional arrangements and safeguard provisions 231
9.6 Finalization under the Dutch presidency 232
9.7 The future of the Monetary Committee 235
9.8 Crises in the European Monetary System 236
9.8.1 The September 1992 crisis 237
9.8.2 The August 1993 crisis 238
9.9 Restrictions revisited 240
9.9.1 Taxation of foreign exchange turnover 240
9.9.2 Reserve requirements on foreign exchange positions 241
9.9.3 Liberalization in Greece 243
9.10 Conclusion 244
 xi
10. Conclusion 249
10.1 General overview 249
10.2 An economic appraisal of the attitudes of member states 252
10.3 A political appraisal 254
10.4 The effectiveness of controls 257
10.5 The opportunity costs of capital controls 258
10.6 Linkages with other policy domains 260
10.7 Will capital controls be reintroduced? 261
10.8 Concluding observations 262

Chronology of major measures with respect to the regime of capital

movements in the member states of the European Community 264

Chronology of general events in Europe 276

Annexes
1. Extracts from the Treaty establishing the European
Communities concerning capital movements and the balance
of payments 279
2. Members of the Monetary Committee 285
3. Statutes of the Monetary Committee 290
4. First Council Directive of 11 May 1960 for the
implementation of Article 67 of the Treaty 294
5. Council Directive of 21 March 1972 on regulating
international capital flows and neutralizing their undesirable
effects on domestic liquidity (721156/EEC) 301
6. Council Directive of 24 June 1988 for the implementation of
Article 67 of the Treaty (88/361/EEC) 303
7. Extracts from the Treaty on European Union concerning
capital movements 308

Literature 314

Index A: subjects 319

Index B: persons 330

 Figures

1. Trends in capital regimes in the EEC 5

2. Cyclical movements in the EEC 6
3. Typical sequencing of capital liberalization 17
4. Main motives for capital restrictions 22
5. Dutch long-term interest rates in the 1950s 38
6. Position of EEC member states under the OECD liberalization
code 52
7. Preparation of EEC directives 63
8. Italy's economic miracle 83
9. Diverging economic developments in the 1960s 98
10. The French dual market 1971-1974 114
11. German interest rates 1971-1979 123
12. French interest rates 1971-1979 125
13. The Netherlands O-guilder premium 1971-1974 131
14. The Belgian dual market 1972-1978 135
15. Inflationary pressures in the EEC 1971-1979 137
16. The EMS 1979-1983: a shaky start 148
17. French and Italian Euro interest rate differentials 1979-1989 152
18. The Belgian dual market 1979-1990 175
19. Denmark's switch-over to a hard-currency policy 176
20. Convergence of inflation in Europe 190
21. Crises in the EMS 236

xiii
 Tables

1. Multiple currency practices in the EEC 13

2. Introduction of a positive exchange control regime 14
3. Official objectives of exchange control 19
4. Financial indicators at the eve of the Treaty of Rome 35
5. Selected judgements of the European Court of Justice 46
6. Acceptance of the Article vm obligation 49
7. The distinctive roles of international institutions 51
8. The regular tasks of the Monetary Committee 65
9. Chairmen of the Monetary Committee 67
10. Chairmen of the Alternates of the Monetary Committee 68
11. Tasks of the Committee of Governors and the EM! Council 72
12. Official reserves of EEC member states 1956-1965 89
13. Public finances in the EEC 1960-1969 100
14. French balance of payments 1968-1969 102
15. The snake arrangement 119
16. The German capital account 1969-1974 121
17. German capital control measures 1970-1974 122
18. The French capital account 1969-1974 125
19. Monetary targets in France and Germany 127
20. French and German economic performance compared 127
21. Spreads between official and financial exchange rates 128
22. Italy: economic indicators 1973-1979 129
23. Fiscal imbalances in the EEC 137
24. Application of safeguard measures 151
25. Third amendment of the 1960 Directive 178
26. A political tally of attitudes towards capital liberalization 193
27. Dutch non-bank capital flows 197
28. The abolition of exchange controls in the EEC 220
29. Stabilization in Ireland 221
30. Disequilibrium in Italy 224

xv
 Acknowledgements

This book is based on a dissertation which I defended in December 1994 at

the University of Amsterdam. But its origins lie much further back in time. On
an early morning in the spring of 1981 my then-mentor J.J. Polak. who at this
time was Executive Director at the International Monetary Fund, handed me
four pages of scribbled notes, jotted down in a wakeful night, with a complete
scheme for a dissertation on an IMF-related subject. I took up the challenge
and started some research. Back in Europe, however, when my work focused
on European monetary cooperation, the project was abandoned. This book,
albeit on a different subject, testifies to the chord Dr Polak then touched.
The choice of the subject matter originates from the intellectual curiosity
which I felt when the process of liberalization of capital movements gained
momentum in the 1980s and eventually succeeded in overcoming the author-
ities' attachment to exchange controls and regulations. This liberalization
sparked off discussions on the form and modalities of monetary cooperation
in Europe and its ultimate goals. What seemed to be a merely technical,
rather esoteric subject apparently contained ingredients which were able to
revitalize Europe's quest for integration and, eventually, unification.
I would like to thank many colleagues and friends who have contributed
with their support and comments to bringing this project to a close. Nout
Wellink encouraged me to start working on this book. Andre Szasz provided
thoughtful comments with respect to the leitmotiv. Henk Jager has stimulat-
ed me throughout my research with his pointed questions and suggestions.
Although we may not have finished our debates on the respective roles of the
monetarist and economist camps in the drive towards capital liberalization,
his comments have helped to keep me on track. Finally, lowe a large debt of
gratitude to Henk Boot who has commented on various drafts of the study.
His sharp analytic mind and his sense of purpose have helped me greatly
in sorting out the main themes from the overwhelming amount of detailed
information on capital liberalization.
A number of experts have provided useful material or have commented
on drafts or chapters. I would like to thank in particular GUnter Grosche,
Wolfgang Kiemel, Emile van Lennep, Philippe Moutot, Jean-Jacques Rey,
Wolfgang Rieke, Carlo Santini, Mario Sarcinelli, Jan Schuijer and Rene Smits
for their valuable suggestions. Ken Lennan of the Directorate General for
Economic and Financial Affairs of the European Commission read the entire
manuscript and provided me with some interesting thoughts on the respective
roles of the Commission and the Monetary Committee in the process of capital
xvii
xviii

liberalization. On the same subject, albeit viewed from a different angle,

Andreas Kees, the former secretary of the Monetary Committee, commented
in his habitual lucid manner. It goes without saying that the author, while
having been receptive to some of the comments, is solely responsible for
the present text. I also thank my colleagues at the Nederlandsche Bank who
assisted me in finding documentation. In naming Raymond Moonen, Olaf
Sleijpen and Wun Vanthoor I thank them all. I am grateful to the Governing
Board of the Nederlandsche Bank for granting me access to the archives. Part
of the research, especially with respect to the proceedings of the Monetary
Committee, is based on internal memoranda. Positions of individual member
states have in most cases been double-checked with other material which is
available in the public domain.
Coen Collee has been so kind as to proofread the entire manuscript and
remove the gravest grammatical errors in the English text. Harmen Warris
provided useful research assistance in the' early stages. Cobie Hogewoning,
Kees de Boer and Kasper van Veen have contributed in assembling the statis-
tical material for the figures and tables. The typescript has been prepared by
Imelda Drubbel, Katja Groeneweg, Martine Hijstek-Weeling and Nicolette
Ligtenberg with much care and dedication. Last but not least, I thank Klara
for her love and understanding. Without her cheerfulness and her unwavering
support this book would not have been finished. And I apologize to Barbara
and Feite who have been deprived of so many hours which could have been
spent so much better playing games, but who one day may understand the
temptations of the quiet seclusion of one's own study.
I dedicate this book to my parents, who have taught me to combine freedom
of thought with consideration for other opinions.
 Introduction

The member states are facing the choice between either reaping
the benefits of increasing integration in a certain area - in this
case the capital markets - attended by a significant reduction in
national powers ofautonomous decision-making and independence,
or retaining this national independence enabling them to pursue
their own policy objectives with the aid of instruments selected at
their discretion. To this question, there is no generally valid answer.
The solution is determined by the weight assigned to the benefits,
on the one hand, and that assigned to the reduction in national
sovereignty, on the other. This, however, is a subjective matter,
which is assessed differently in the various countries.

OnnoRuding, 1969

1.1 CAPITAL LffiERALIZATION AND MONETARY UNIFICATION

In the 1980s Europe made a leap forward towards the liberalization of capital
movements. EEC directives were accepted by all member states obliging
them to abolish all remaining exchange controls. This common objective
of freedom of capital movements has been consolidated in the Treaty on
European Union. Nowadays virtually all restrictions have been lifted. This
stands in striking contrast to the state of affairs only a decade ago, when many
countries still operated a tight regime. Although the Treaty of Rome provided
for the freedom of capital movements, this objective was circumscribed by
the clause that such liberalization should only be carried through to the extent
necessary to ensure the proper functioning of the Common Market. In practice,
for a long time trade liberalization took precedence over capital liberalization.
It is only since the publication of the White Book on the completion of the
Internal Market in 1985 that freedom of capital movements generally has
been accepted as a common goal. Apparently there has been a major shift in
the appreciation of the pros and cons of free capital flows over time.
The move towards free capital movements in the EEC came at a time
of significant progress in the process towards European integration. In the
Single European Act, signed in 1986 and ratified one year later, principles
and procedures were adopted facilitating the removal of the obstacles to the
establishment of the Internal Market. The European Commission considered
the capital restrictions applied in the majority of member states to be such

1
2
an obstacle which needed to be removed. The dynamism displayed by the
Commission in this respect contrasted sharply with the consideration it had
shown earlier for restrictive regimes, which were often in contravention of
agreed Community obligations.
The turnaround in the attitude towards capital liberalization, both on the
side of member states and of the Commission, was boosted by the stabi-
lizing influence exerted by the operation of the European Monetary System
on both economic policies and financial markets. The protective shield of
exchange control was ever less needed since convergence of economic per-
formance improved gradually. Controls moreover were losing their efficacy
in the changed international financial environment, characterized by financial
deregulation and globalization. The negotiations on capital liberalization in
Europe were accompanied by discussions on a strengthening of monetary
cooperation, lest the coherence of the EMS would be sacrificed on the altar
of enhanced capital mobility. These were aimed at creating conditions to
ensure that freedom of capital movements would not jeopardize exchange
rate stability in Europe.
The reorientation of the Commission was motivated by wider-reaching
strategic considerations as well. Freedom of capital movements is a sine qua
non for monetary unification. The objective of a European economic and
monetary union (EMU) had been a recurrent theme ever since the establish-
ment of the European Community. A number of reports on European union
- the Werner report, the Tindemans report, the SpadoliIii report - had been
published in the course of the years. All had been shelved due to the lack
of political consensus and economic convergence, and their precondition,
abolition of exchange control, had not been fulfilled. With the growth of con-
sensus on capital liberalization the chances for a breakthrough on EMU would
increase as well. In 1988, when the negotiations on capital liberalization were
wound up, France took the initiative to put the issue of economic and mone-
tary union again on the agenda. Not much later, on 1 July 1990 the start of the
first stage of EMU was proclaimed with full freedom of capital movements
well established in the core of the Community and with firm commitments of
the lagging member states to bring such freedom about soon. Eventually, the
political will to forge ahead proved to be so forceful that, against all historical
odds, in December 1991 in Maastricht a new Treaty on European Union was
agreed. The traditional inhibitions against the implicit surrender of national
sovereignty had finally been overcome.

Capital liberalization - The easing or abolition of restrictions and administrative

controls on financial cross-border transactions.
Financial deregulation - The easing or abolition of rules with respect to domestic
financial markets and institutions.
 3
1.2 CAPITAL LIBERALIZATION AND MONETARY POLICY

The abolition of exchange controls in Europe prior to the Maastricht Treaty

constituted a tangible expression of member states' willingness to conduct
policies in an open, market-oriented environment. This fitted in well with a
world-wide movement towards increased attention on the part of econom-
ic policy makers for the functioning of markets. Capital liberalization has
been attended by an increased use of market-oriented monetary instruments
by the central banks. Previously, capital restrictions typically went hand in
hand with direct instruments of monetary policy, which imposed limitations
on the growth of commercial banks' assets and, in some cases, liabilities.
Direct control mechanisms were aimed at achieving monetary objectives at
a lower interest rate level than would otherwise have been the case. Capital
restrictions provided the protection needed to conduct relatively autonomous
monetary policies and at the same time maintain exchange rate stability by
preventing capital outflows seeking higher yields. Conversely, such restric-
tions sometimes were needed as a complement to avoid the circumvention of
domestic credit ceilings through capital inflows. Direct monetary instruments
and capital restrictions were considered as two sides of the same coin.
The costs associated with direct monetary instruments, in terms of distort-
ed allocation and risks of bureaucratic manipulation, began to weigh more
heavily in the course of the years. They stifled competition between financial
institutions, gave rise to disintermediation, tended to favour the privileged
financing of governments to the detriment of private enterprise, and were
perceived as standing in the way of the development of an international-
ly competitive financial centre. Market participants demonstrated increasing
ingenuity in finding ways to circumvent credit and exchange controls. The
transition to the use of indirect instruments of monetary policy, which seek to
influence credit expansion through price mechanisms (i.e. changes in interest
rates), and the deregulation of financial markets gathered momentum, first in
Anglo-Saxon countries, later on the Continent. This process can also be under-
stood in the historical perspective of the gradual return to market-oriented
systems in the post-war period, when the immediate focus on reconstruc-
tion and industrialization, necessitating active government involvement, lost
force.
The release of market forces has shifted attention to other policy domains,
notably to the task and position of the central banks. Freely functioning mar-
kets only perform well if price and volume signals are distorted as little as
possible by uncertainty about the future policy actions of the budgetary and
monetary authorities. This is all the more important with respect to the finan-
cial markets, which by their very nature are more prone to vicissitudes than
the commodity markets. In the 'incompatible triangle' of freedom of capital
movements, stable exchange rates and autonomy for domestic monetary pol-
4
icy, a phrase coined in the literature on optimum currency areas in the 1960s,
theory suggests that one of the three angular points has to give in.
The discussions on liberalization of capital movements in the framework of
the EMS therefore have focused attention on the goals of monetary policy. If
autonomy of monetary policy is perceived as supporting government policies
in achieving domestic economic goals, which can shift over time and may
differ among countries, the triangle will remain incompatible. If, on the
other hand, domestic price stability is the primary common goal of monetary
policy an important element of divergence will have been removed. The
chances of combining free capital movements with stable exchange rates will
be increased. Over time, disillusionment with stimulatory monetary policies
and the apparent success of German policies predicated on stability-oriented
policies have fostered the acceptance of price stability as the primary goal of
monetary policy.
A measure of independence of the national central banks is required in order
to enable them to strive for domestic price stability unhampered by short-
term domestic political considerations. After the ratification of the Treaty on
European Union, which provides for independence to be established before
the start of the final stage of EMU, important steps have been taken in this
respect in several member states. Comparable institutional positions of the
central banks in the member states encourage cooperation and facilitate the
coordination of monetary policies. This important shift towards institutional
independence of the central banks reflects the increased attention given to
the need to preserve price stability in economies characterized by freedom
of capital movements. It also reflects the exemplary role of the independent
Deutsche Bundesbank as the central bank which has been most successful in
the fight against inflation.
The case of Europe is an interesting one. Its combined drive for liberal-
ization of capital movements and for strengthening the position of national
central banks has inspired many countries outside the European Community
to follow suit. Although capital liberalization has been a global phenomenon
in the past ten years or so, affecting a number of developing countries as well,
many of these countries practise a relatively high degree of exchange rate
flexibility. EC member states, however, have firm exchange rate objectives
in the framework of the European Monetary System and have even higher
aspirations in pursuing monetary unification. They therefore have to deal with
the allegedly incompatible triangle. In the wake of the EMS crises of 1992
and 1993 a division has become visible, with some countries abandoning
exchange rate fixity and other countries continuing to align monetary poli-
cies. After a brief interlude of experimentation, eventually none has reverted
to exchange controls, despite calls for their reintroduction.
 5

68 73 61 83
General
restrictive tendency

Neutral or diverging
tendencies 74

General
liberal tendency 58 62 87

58 63 68 73 78 83 88 93

Based on observations of the direction of capital measures,

as compiled in the Chronology.

Fig. 1. Trends in capital regimes in the EEC.

1.3 THE TIDAL MOVEMENT OF EXCHANGE CONTROL

The process of the imposition of capital restrictions and their subsequent

liberalization has been a constant ebb and flow in economic history. After the
liberalism of the nineteenth century, the inter-war period was characterized
by severe restrictions on capital and ultimately on trade. The post-World
War IT period in Europe can be divided into three distinct periods. In the
years immediately following the war there was an important move towards
liberalization. As shown in Figure 1, towards the end of the 1960s this trend
was reversed and restrictions were reimposed in a spectacular manner in
European countries, on outward as well as on inward capital flows. This was
followed in the 1980s by a dramatic reversal, eventually leading towards
the full liberalization of capital movements in all European countries for the
first time since the Treaty of Rome had been signed. One important question
addressed by this study concerns the causes which lay behind these regime
shifts and the eventual complete abolition of exchange control in the member
states of the European Community. Another question is whether this state of
full freedom of capital movements in Europe will be maintained or whether
there is a chance that the ebb and flow of economic history will re-take its
due course, opening the perspective of yet another tide of restrictive policies.
The tidal movements of the regime with respect to capital movements run
partly parallel to the cyclical situation of the world economy. In times of
cyclical downturn the authorities tended to avoid through restrictive mea-
sures that the stimulatory effect of lower interest rates on domestic demand
would get thwarted by capital outflows. Exchange controls were particular-
6
Weighted average of annual increase 1)

15 ____________________________________ _

o L lLLLLLL
-5 ____________________________________ _

58 63 68 73 78 83 88 9391

Real GDP Price deflator GDP

1 Average of actual EEC member states.

Source: European Economy no 58 1994. European Commission.

Fig. 2. Cyclical movements in the EEC.

ly favoured if economic downturn went hand in hand with high inflation,

so-called stagflation. In general higher rates of price increases tend to coin-
cide with larger inflation differentials among countries, which in turn spark
off exchange rate tensions. Countries tried to counteract these tensions by
imposing capital restrictions. Indeed, Figure 2 provides prima facie evidence
of a degree of correlation between the direction of price movements and the
general tendency with respect to capital regimes in the EEC. When domestic
stability was endangered - in the final years of the Bretton Woods System
- and policies diverged - the first years of the European Monetary Sys-
tem - restrictive tendencies manifested themselves most forcefully. In times
of cyclical upturn liberalizing measures were in general taken more easily,
especially if inflationary pressures were contained. In those circumstances
pressure groups seeking protection became less vocal. Such groups could
include financial institutions wishing to protect their home market, indus-
trial sectors wishing to preserve privileged financing arrangements, but also
monetary authorities were inclined to maintain the status quo. International
cooperation, which implies give-and-take in negotiations, flourishes during
cyclical upturns, because then authorities are more willing to make conces-
sions involving potential short-term costs but long-term benefits.
The lifting of capital restrictions formed part of negotiations, conferring
obligations upon member states of the European Community. Like trade nego-
tiations, the abolition of restrictions was made conditional on the fulfilment
of demands in other areas, notably as regards the strengthening of monetary
 7
cooperation mechanisms. Liberalization measures thus could be presented
as a compromise deal, with other countries taking measures as well. Capital
restrictions were seen as the lesser evil as compared to trade restrictions.
In fact, it will be argued in this study that capital restrictions by implied
agreement for a long time were tolerated by the Commission and by other
liberally-oriented member states because their abandonment was regarded as
potentially endangering the Common Market for goods and services. There
was another distinguishing characteristic: some member states maintained an
open exchange regime regardless of the practice in other countries. Capital
controls were rarely utilized in order to discriminate between countries. Such
discrimination was circumvented easily anyway. But there was one thing
which trade and capital restrictions had in common: once imposed they were
not easily removed. In this sense capital restrictions shared the ratchet effect
typically associated with trade restrictions.

1.4 THE ROLE OF THE MONETARY COMMITTEE

The involvement of the Monetary Committee of the European Community

runs through this book as a continuous thread. In this rather secretive body
the highest civil servants of the national Treasuries convene monthly with
their counterparts of the national central banks and representatives of the
European Commission. One of the main assignments of this body has been
the promotion of the liberalization of capital movements. All proposals of the
Commission for directives with respect to capital movements have been dis-
cussed at length in this committee. Because of its unique composition it was
well placed to oversee the implications for economic and monetary policies.
At times the committee has played a stimulating role, at other times the polit-
ical obstacles in this field became manifest in the committee's deliberations.
The committee's role was not in the nature of a supporting act. In practice
the Commission proposals with respect to capital movements would not be
presented to the Council of Ministers as long as the committee had not given
its seal of approval.
The main motives for maintaining capital controls were considerations
regarding the exchange rate and monetary policy. All decisions concerning
the EMS, and in particular exchange rate realignments, were prepared in the
Monetary Committee. As the name of the committee implies, it is in this
forum that the institutional checks and balances concerning monetary policy
decisions come together as well. Thus the link which was all along placed
by some member states between the dossier on capital liberalization and the
dossier on monetary cooperation was ideally dealt with in the committee. In
the Monetary Committee the controversies between the 'economist' school,
which proclaimed that monetary integration was dependent on economic con-
vergence, and the 'monetarist' school, which held that monetary integration
8
could move in parallel with progress towards economic convergence, came
to the fore. The monetary cooperation dossiers culminated in the discussions
on economic and monetary union.

1.5 THE PURPOSE OF THIS BOOK

This study takes as its starting point the provisions in the Treaty of Rome with
respect to the liberalization of capital movements. It then follows the ups and
downs in this liberalization process ending with the Treaty of Maastricht. On
the way the study picks up the thread which Onno Ruding, the later Minister
of Finance of the Netherlands, had to leave in 1969 in his magnum opus
'Towards one integrated European capital market?' The question mark he
wisely put in the title could only be removed much later than could be fore-
seen at the time. This book does not seek to describe in detail the precise form
of the liberalization of capital transactions, e.g. by distinguishing between
types of instruments, and the micro-economic impact on market participants.
Neither does it deal with detailed descriptions of liberalization codes of other
international organizations, such as the OECD. Others have done this exhaus-
tively and also the organizations themselves publish heavily. What this book is
about is the apparent shift in the balance between the pros and cons of capital
restrictions in the course of the years, the economic and political forces which
were behind this changing perception, and the implications this has had for
monetary policy cooperation in Europe, in particular for the use of monetary
instruments and the position of central banks. In analysing the discussions
on capital liberalization attention focuses in particular on the attitude of the
European Commission vis-a.-vis the freedom of capital movements and the
involvement of the Monetary Committee. Throughout the attitude of indi-
vidual member states is analysed, starting with the six founding members
and including new members as they joined the Community. Following the
analysis of these factors, tentative answers are formulated with respect to the
question whether the capital liberalization which has taken place in Europe
will prove to be of an irreversible character.
The book is organized as follows. In Chapter 2 capital controls are defined
and categorized and the different motives for imposing restrictions and abol-
ishing them are analysed. Particular attention is paid to the sequencing of
liberaliza.tion measures. Chapter 3 deals with the provisions in the Treaty of
Rome with respect to capital and briefly comments on the involvement of the
OECD and the IMF in capital liberalization. In Chapter 4 the Monetary Com-
mittee is introduced and its main tasks, apart from liberalization of capital
movements, are examined. Many related tasks of the committee concern areas
which were dealt with in parallel in the negotiations on capital liberalization.
Annex 2 contains a complete list of the members of the Monetary Committee
since its establishment.
 9

Chapters 5 through 9 constitute the core of this study. In a largely chrono-

logical order the attitudes of member states and the Commission with respect
to capital liberalization are analysed. The first successful steps towards liber-
alization in a common EEC framework are dealt with in Chapter 5. Gradually
momentum was lost and towards the end of the 1960s restrictions were rein-
troduced. In Chapter 6 the failed attempt towards economic and monetary
union along the lines of the Wemerreport is examined. In the wake of the col-
lapse of the Bretton Woods system and the oil crisis member states went their
own separate ways and European integration came to a stand-still. The decade
of the 1970s, however, ends on an optimistic note with the establishment of
the European Monetary System and the abolition of exchange control in the
United Kingdom. Chapters 7 and 8 examine the negotiations in the 1980s
leading up to the acceptance of the common obligation to fully liberalize
capital movements. Just as for earlier years, related dossiers, such as taxation
and supervisory issues, are touched upon, and the discussions are document-
ed on the erga omnes principle which demands that capital liberalization be
applied to third countries as well. In Chapter 9 the actual implementation of
the liberalization directives is described, as well as the incorporation of the
principle of full freedom of capital movements into the Treaty on European
Union. The chapter ends with a discussion of the crises in the EMS which for
a time seemed likely to reopen the debate on freedom of capital movements.
In a final Chapter 10 some conclusions are drawn, and some tentative answers
are formulated with respect to the questions phrased in this introduction.
For a survey of major measures with respect to capital movements the
reader is referred to the chronology at the end of the book. In annexes the
main relevant Community texts are reproduced.
 CHAPTER 2

Capital Restrictions: Classification and General

Observations

Private financial markets have become internationalized much more

rapidly and completely than other economic and political institu-
tions. That is why we are in trouble.
James Tobin, 1978

There may have been some cases ofunwarranted speculative attacks

on some currencies, although Ifind it difficult to think ofconspicuous
examples, while it would be easy to cite many examples where the
speculators were right and the authorities dead wrong.
Gottfried Haberler, 1976

2.1 INTRODUCTION

Although capital controls have fonned a major instrument for the monetary
authorities in the conduct of economic policy, they have not received the same
degree of intellectual attention as many of the other policy instruments. There
is a substantial range of academic literature on capital controls. Still it is a
mere trifle in comparison to the vast bulk of literature on specialized subjects
such as trade restrictions or tax incentives. One of the explanations may
be that the use of capital restrictions, while having redistributional effects,
generally has not been regarded as having negative allocation and growth
effects of a magnitude in any way comparable to trade restrictions or tax
incentives. I Another explanation may be that capital controls have not been
a generalized phenomenon in industrial countries in the post-World War II
period. Moreover, shaped by tradition and the country-specific institutional
set-up of the financial system, restrictions have taken manifold fonns and
were often camouflaged in complex administrative rules.
The two major reserve currency countries, the United States and Gennany,
have traditionally followed liberal economic policies. The United States, as
the dominant economy with the major world reserve currency, has generally
not availed itself of outright restrictions on capital flows. Nevertheless, it
has in the final years of the Bretton Woods system taken measures with the
aim of discouraging capital outflows. 2 Another reserve currency nation like
Gennany, apart from a brief albeit intensive experiment in the immediate

10
 11

post-Bretton Woods period to curtail capital inflows through exchange con-

trol, likewise has not used capital restrictions to the same extent as the other
industrial countries have done. Switzerland and Canada, too, in general have
adhered to a well-established liberal regime.3 But in most non-reserve cur-
rency countries capital controls have been a major economic tool, although
varying in intensity and taking widely diverging forms. 4 Academic attention
thus mainly focused on the analysis of the merits of specific forms of exchange
regulations in individual countries. In economic models capital controls have
been utilized as constraining variables, enabling the authorities to fix their
exchange rate and to shield domestic interest rates from external influences.
For the purpose of this study, this introductory chapter briefly discusses
the various types of controls utilized and their implications. The motives to
introduce or maintain capital controls are examined. These are of an economic
but sometimes also of a wider-ranging political nature. In the discussion of
these motives it becomes clear that there is a significant difference between the
application of controls on outflows of capital as opposed to controls on inflows
of capital. The drawbacks of controls are commented upon; these drawbacks
have led to liberalization being perceived as preferable to the 'second best'
solution of capital controls. One of the major theories with respect to the
utilization and subsequent dismantling of capital controls is briefly treated:
the theory of sequencing. This theory takes as its starting point the general
axiom that the unhampered functioning of markets yields the best economic
results, but that economic or political circumstances may justify the temporary
utilization of controls. Policies should strive for the abolition of controls in
steps, depending on the attainment of economic equilibrium conditions.

2.2 TYPES OF CAPITAL CONTROLS

The general label of capital controls encompasses a wide range of diversified

and often country-specific measures. These restrictions on and impediments
to capital movements have manifested themselves mainly in four distinct
general forms. 5
a) Administrative controls on cross-border capital movements. These con-
trols usually involve an approval procedure by a governmental agency or the
national central bank for cross-border transfers of capital. Approval can be
based on a judgement as to the character of the underlying transaction or,
alternatively, on rules regarding limits on the permitted amounts of capital
transferred. The responsibility for operating exchange control regulations has
often been delegated to commercial banks.6 Controls generally have covered
the whole spectrum of capital movements, from long-term direct investment
flows and foreign equity transactions to short-term external positions of com-
mercial banks and foreign exchange transactions by residents. By restricting
forward cover operations or regulating the settlement of exports or imports,
12

shifts in leads and lags have been restricted. Administrative controls thus
influenced greatly the room for manoeuvre for cross-border financial transac-
tions, portfolio decisions of non-bank residents and the internationalization
of companies. Citizens were affected in their freedom to travel abroad by
limits on the amount of foreign currency they could take with them. In one
way or another administrative controls were applied at times in all Euro-
pean countries, least in Belgium and Luxembourg which relied on a dual
exchange market. 7 Common features of administrative controls are that they
imply legislation and regulations, and impose administrative obligations on
the banking system in order to control flows. They also necessitate compli-
ance and enforcement procedures. The judicial treatment of offences differed
among European countries, with Italy's treatment of violations as criminal
offences outranging other more lenient regimes. 8
b) Dual or multiple exchange rate systems. In such systems different
exchange rates apply to certain types of commercial and financial trans-
actions. Typically all or a significant part of current account transactions are
settled at a uniform fixed or managed exchange rate, capital account trans-
actions and sometimes selected current account transactions being settled at
another exchange rate. Usually the latter so-called financial rate is allowed to
float and thus is entirely determined by supply and demand on the 'financial'
exchange market, normally without any official intervention. In most cases
the financial exchange rate stands at a discount (Le. foreign currencies carry a
premium) because the room to buy foreign exchange for cross-border capital
transactions is limited by foreign demand for the national currency related
to capital transactions. The latter is likely to be negatively influenced by
the existence of a dual exchange market as long as foreign investors favour
portfolio investment in countries with a liberal exchange regime. 1\vo-tier
exchange markets typically have been established to insulate current account
transactions from speculative outward capital movements which could call for
undesired interest rate adjustments or lead to reserve losses. They can, how-
ever, also accommodate excessive inflows and thus prevent an overshooting
of the exchange rate for current transactions.
Belgium and Luxembourg, tied together in a monetary union since 1922,
were the only countries to consistently operate a dual exchange rate system.
France and Italy briefly operated a dual market in the currency turmoil of
the early 1970s. Some countries experimented at times with specific currency
markets, mainly in the form of a closed-circuit type, where the funds involved
in purchases by residents of securities denominated in foreign currency had
to be matched by the proceeds from sales of such securities by residents
(see Table 1). Like administrative controls multiple currency systems need to
be enforced by compliance procedures and thus imply the administration of
foreign exchange transactions of residents and domestic currency transactions
of non-residents, in order to separate the current (commercial) and capital
transactions.
 13

TABLE 1
Multiple currency practices in the EEC.

Dual markets
Belgium-Luxembourg financial franc market 1955-1990
France financial franc market 1971-1974
Italy financial lira market 1973-1974

Specific currency markets

France devises-titres market 1955-1962
devises-titres market 1969-1971
devises-titres market 1981-1986
Ireland investment currency market 1947-1978
The Netherlands foreign security market 1959-1966
closed bond 'O-circuit' 1971-1974
United Kingdom investment currency market 1947-1979

c) Specific taxation of cross-border financial flows or of income resulting

from external portfolios. Under such a system taxes are levied on external
financial transactions, thus limiting their attractiveness, or on income resulting
from the holding by residents of foreign financial assets or the holding by
non-residents of domestic assets. In principle such taxation only impedes
cross-border flows if it discriminates between domestic and external assets or
between residents and non-residents. In this sense a generalized withholding
tax, which treats residents and non-residents alike, cannot strictly speaking
be considered an impediment to cross-border flows. However, in practice
differences in tax regimes have given rise to substantial capital movements
and, from the standpoint of the authorities, changes in taxation regimes have
been considered as an alternative to direct capital controls. A specific type,
only applied in the United States in the 1960s, is interest equalization taxation
which seeks to eliminate yield differentials, mainly because of diverging
interest rates, between domestic and foreign assets.
Apart from these three types of direct restrictions there is d) a residual group
ofindirect restrictions or regulations. This category includes measures such as
limitations on interest payments on deposit accounts of non-residents, reserve
requirements which discriminate between residents and non-residents, provi-
sions for the net external position of commercial banks, and other measures
which are intended to limit cross-border capital flows, although not explicitly
outlawing them. Some of these provisions at times have not been intended
primarily to regulate cross-border capital flows, but were rather motivated by
domestic monetary policy considerations or supervisory concerns.
14

TABLE 2
Introduction of a positive exchange control
regime.

1961 September Germany

1977 September The Netherlands
1979 October United Kingdom
1988 October Denmark
1988 October Italy
1989 June France
1992 February Spain

Note: Other member states introduced a

positive regime when they abolished all
restrictions in 1992 to 1994. France briefly
introduced a positive regime in 1967,
which was repealed in the wake of the 1968
crisis.

More in general, a distinction must be made between restrictions taken

in the framework of exchange control, which only relates to the import and
export of capital, and those restrictions which are based on national regula-
tions with respect to the domestic flow of capital. Initially EEC provisions
were only applicable to direct exchange control measures. When in the course
of the years the EEC took a gradually less permissive attitude towards dis-
criminatory national regulations indirect capital restrictions were outlawed
as well, especially after the Brugnoni and Ruffinengo ruling of the European
Court of Justice in 1986. The distinction between exchange controls and dis-
criminatory national regulations is an important one in connection with the
erga omnes principle. In the case of exchange control it is technically difficult
to discriminate between countries, as opposed to national regulations where
discrimination is easier to administer, i.e. in the case of establishment or of
issues of securities.
Another important distinction can be made with respect to positive and
negative regimes of exchange control. Under a positive exchange regime
all cross-border capital transactions are permitted unless explicitly restricted.
Germany was the first European country to adopt such legislation in 1961. On
the contrary, under a negative exchange regime all cross-border capital trans-
actions are restricted unless explicitly permitted. Most European countries
operated negative systems well into the 1980s (see Table 2).
 15

2.3 THE IMPACf ON CAPITAL FLOWS

Views have differed as to the merits and demerits of these respective types of
capital controls, and as to whether they impinged in a comparable way on the
activities of economic agents. Administrative controls influence the volume of
flows, either by forbidding them altogether or by capping them off by limiting
the amounts allowed. Administrative controls have been applied as a structural
economic policy instrument, but they have also been utilized on a temporary
basis. Frequently they were meant to last for a limited time. Taxation, on the
other hand, has a direct impact on the price of capital flows. The taxation
of financial transactions or external portfolios most often has been utilized
with the specific aim of limiting short-term speculative flows. Because these
flows were considered to be a temporary phenomenon, the relevant taxes were
also considered to be temporary and thus could be withdrawn. In this respect
authorities could keep alive the fiction of free financial flows. 9 Promises, both
as to taxation and to administrative controls, were, needless to say, not always
kept. As Alworth (1993) has said: 'The taxation of cross-border flows is a
stepchild of conflicting objectives (i.e. raising government revenues as well
as domestic savings) being generally an outgrowth, ifnot an afterthought, of
the domestic tax system.'
Domestic regulations can constitute an indirect barrier to cross-border
capital flows. An important example is provided by administrative rules with
respect to the investment policies of pension funds and other institutional
investors. They typically were required to invest a substantial proportion of
their assets in domestic (government) bonds. Regulations with respect to the
allowed share of foreign assets in their portfolio effectively dampened cross-
border flows. Regulations with respect to foreign ownership of domestic
companies, too, can limit inward investment without formally restricting
it. Apart from the formal restrictions there are thus many hidden ways of
limiting outflows. It is only recently that these hidden barriers have received
more attention once formal restrictions were lifted.
Dual exchange rate systems often have been considered by the authorities
concerned as being of a less restrictive character than the other types consid-
ered above. It was argued that cross-border flows were uninhibited and that
the price for the conversion of national into foreign currency and vice versa
was solely determined by economic forces in a freely functioning market.
This view was contested by others who saw in the separation of exchange
markets for current and financial transactions an infringement of the free play
of supply and demand. Nevertheless, a dual system, because of its market-
oriented approach, probably can be considered as the lesser evil. In practice it
was likely to be the least effective as well, because large differentials between
the financial and the commercial rate were not likely to persist for very long.
The larger the differential, the greater the incentive there is for private market
operators to try to circumvent the regulations separating the two markets. 10
16

Dornbusch (1986), in a discussion of the appropriateness of a dual exchange

system for developing countries, has concluded that such a system works well
if the commercial rate is maintained close to its equilibrium level, i.e. in a
range close to the free rate. The managed rate therefore should be allowed to
shift in response to fundamental macro-economic changes.
This leads to the conclusion that the different types of control more or
less have the same economic impact. Administrative controls primarily influ-
ence the volume of transactions, taxation the price of such transactions. Dual
exchange systems influence both the price and volume of transactions. In
all instances therefore capital flows are affected, either directly (volume) or
indirectly (price). In this respect Adams and Greenwood (1985) have rightly
noted that dual exchange rate systems and capital controls can be thought
of as having equivalent effects to the same extent as the standard trade lit-
erature views tariffs and quotas to have. The discriminatory character of
exchange control systems makes it necessary in all cases to have procedures
for compliance and enforcement, requiring complex sets of rules and admin-
istrative red-tape. In an economic sense all types of capital controls lead to a
separation between the domestic financial market and the external financial
markets. This segmentation of markets through capital controls, if effective,
makes domestic interest rates less dependent on international interest rates.
The types of capital control reviewed here stand in the way of truly liberal
international financial markets because they imply segmentation and discrim-
ination. If liberalization of capital movements is to be pursued, from a policy
viewpoint, therefore, there is no need to distinguish between the types of
control discussed here. In the European context, the policy conclusion has
been drawn that all three types of direct capital controls as well as the indirect
restrictions stood in the way of the creation of the Internal Market and thus
had to be eliminated. But, as we will see, it has been a lengthy process to
overcome ingrained habits. Liberalization has not come overnight.

2.4 TYPES OF TRANSACTIONS AFFECTED BY CAPITAL CONTROLS

In the application of capital restrictions generally a distinction has been

made according to the type of financial instruments or transactions involved.
Typically distinctions have been made between long-term and short-term
capital flows and between incoming and outgoing capital flows.

2.4.1 Long-Term· and Short-Term Capital Flows

Long-term capital flows are more closely related to the real economy, so it
is generally felt, because they involve investment flows and the building-up
of external portfolio positions. In general it has been considered desirable to
obstruct as little as possible such capital movements which respond to long-
term considerations with respect to portfolio preferences or investment and
 17

control of freedom of
long-term flows long-term flows

control of
short-term flows

freedom of
short-term flows

Fig. 3. Typical sequencing of capital liberalization.

profit opportunities. Typical examples are direct investment flows, the buying
and selling of securities, the admission of issues of foreign securities on the
domestic capital market, as well as transactions in real estate. Although these
transactions often have received priority when direct exchange restrictions
were abolished, they frequently remained subject to domestic regulations
because of political sensitivities concerning foreign ownership.
Short-term capital flows are regarded as financial flows and provide the
most common channel for speculative capital movements. Although such
flows can have a macro-economic impact through their effect on interest and
exchange rates, they are easily reversible by their very nature. In the absence
of financial disturbances the influence of short-term capital flows on the real
economy is deemed to be small, because they are only distantly related to
the financing of real activity and trade. Short-term flows typically have been
restricted more frequently because the benefits of freedom were not deemed
to be commensurate with the possible costs associated with speculative flows,
bringing pressure on the exchange rate or complicating domestic monetary
control.!! Typical examples are short-term non-trade related loans, deposits
by residents (non-residents) in foreign (domestic) currencies and the buying
and selling of money market instruments or short-term unquoted securities.
Generally the demarcation line between short and long-term flows is drawn at
a maturity of one to two years. Because travel allowances provided a notable
loophole, foreign exchange entitlements for tourists, while formally being an
invisible transaction, were frequently tightened at the same time as short-term
capital flows were cQrtailed.
18
2.4.2 Inflows and Outflows o/Capital

The distinction between restrictions on incoming and outgoing capital flows

typically reflects different economic policy attitudes on the part of the coun-
tries concerned. A country shielding itself under fixed exchange rates from
inco~ing capital flows can follow restrictive monetary policies more easily
than would otherwise be the case: it can restrict domestic credit expansion
through higher interest rates without having to fear offsetting inflows. On the
other hand, a country which restricts outgoing capital flows can follow accom-
modating monetary policies and force interest rates down, without having to
fear outflows by residents seeking higher yields elsewhere. The distinction
between incoming and outgoing capital flows need not apply in the case of a
dual exchange rate system. In such a system all flows - incoming and outgo-
ing - can be pooled in the market and the exchange rate then is determined
by supply and demand. Nevertheless, some countries have combined such a
system with administrative controls, thus indirectly influencing the balance
between supply and demand, and hence the price. Others, such as Belgium
and Luxembourg, initially targeted the dual market to outflows only, while
capital inflows could be settled in the official market. Only in the beginning
of the 1970s inflows were led through the dual market as well.
From a policy standpoint, the distinction between restrictions on outflows
and those on inflows is a significative one. Restrictions on outflows typically
were used by weak-currency countries. This weakness of the currency in tum
was the outcome of economic policies, which favoured low interest rates and
accepted higher inflation rates in order to reach in the short run a better point
on the Phillips curve, the negatively sloped curve depicting the relationship
between the levels of inflation and unemployment. Such policies typically
resulted in a weak position on the current account of the balance of payments,
which provoked confidence crises. Controls on capital outflows for exchange
rate considerations thus could be considered a sign of weakness on the part
of the countries concerned.
On the other hand, restrictions on inflows were utilized to avoid that
stability-oriented domestic policies in strong-currency countries were thwart-
ed by capital inflows out of countries with more lax policies. Su~h inflows
would enlarge the money supply and thus would frustrate restrictive mone-
tary policies. In the beginning of the 1970s such inward capital controls were
imposed to avert so-called hot' money, speculative flows in the final days of
the Bretton Woods System and thereafter.
These distinctions between types of capital control demonstrate the wide
array of choices open to the authorities. The PatVcular constellation chosen
has been usually inspired by the motives the authorities had for imposing
capital restrictions.
 19

TABLE 3
Official objectives of exchange control.

France to protect the currency, to preserve the autonomy of monetary policy,

and to control the participation of foreign capital in sensitive sectors of
the economy
Germany to counter adverse effects on the purchasing power of the Deutsche
mark and to secure equilibrium on the balance of payments
Ireland to help to safeguard the national external reserves and to regulate the
effects of capital movements on the exchange rate of the Irish pound
The Netherlands to prevent the capital market from being disrupted, to prevent a large
outflow of capital which (threatens to) considerably reduce the gold
and foreign exchange holdings, or to prevent a large inflow of capital
which (threatens to) seriously thwart financial and economic policies
United Kingdom to conserve the United Kingdom's gold and foreign currency resources
and to assist the balance of payments

Sources: France: Galy (1986); Germany; Aussenwirtschaftsgesetz (1961), Article 23.2; Ire-
land: Memorandum of Irish delegation to OECD (1983); the Netherlands: External Financial
Relations Act (1980), based on Articles 4, 7 and 8; United Kingdom: A guide to United
Kingdom Exchange Control (1977).

2.5 THE MOTIVES FOR CAPITAL RESTRICTIONS

Capital restrictions have been a critical ingredient of the set of economic

control instruments of the authorities in the post-World War II period. They
have lain close to the heart of politicians and have frequently been part of the
agenda of political parties. It is only quite recently that these restrictions have
been dismantled in a number of countries under the influence of economic
and political forces. A gradually accelerating process of erosion of the effec-
tiveness of capital controls has precipitated this process. We will dwell on
this process of financial liberalization later. First, it is important to understand
why in the past the authorities were so attracted to capital restrictions and
thus for a long time were extremely reluctant to give up this instrument to
control financial transactions.
Many arguments to justify capital controls have been advanced in the
economic literature. 12 In Table 3 some of the official objectives are brought
together. But there were other motives as well and policy makers have been
quite vocal in their advocacy of control mechanisms. The main arguments
can be grouped in four thematic categories, related to exchange rate policy,
monetary policy, savings and investment, and taxation, respectively.
20

2.5.1 Exchange Rate Considerations

Without any doubt the foremost motive to impose restrictions has been the
wish of the authorities to limit downward or - more rarely - upward pres-
sure on the exchange rate. These restrictions have mainly been applied to
short:-term capital transactions. They were frequently maintained or strength-
ened to counter volatile speculative flows which threatened to undermine the
stability of the exchange rate and to deplete a country's foreign exchange
reserves, especially in times of a balance-of-payments crisis. In many coun-
tries residents have long been forbidden to hold deposits denominated in
foreign currencies, in order to prevent them from quickly converting domes-
tic currency into foreign currency in case of a crisis of confidence in the
economic policies of the national authorities. Sometimes these restrictions
functioned as an alternative to the adjustment of economic policies and thus
helped to 'buy time' for the authorities. At other times they were taken to
avoid the effects of foreign disturbances on the domestic economy. Particu-
larly the excessive exchange rate volatility, caused by the unstable short-term
behaviour of financial markets, has formed a justification for restrictions in
order to insulate the real economy from 'markets dominated by traders in the
game of guessing what other traders are going to think' .13 Once restrictions
were imposed, however, there was a reluctance to abolish them out of fear that
policies would immediately be put to the test again by the financial markets.
Capital controls on short-term inflows became a particular feature of the
late 1960s in Europe, when the earlier process of liberalization was reversed.
This was caused by the underlying strains in the Bretton Woods system of
fixed exchange rates. The loss of confidence in the US dollar resulted in cap-
ital outflows towards low-inflation countries like Germany, the Netherlands
and Switzerland. They either had the choice to revalue their exchange rate
and thus take the pressure off or to accept the inflationary consequences of the
liquidity inflows on their monetary aggregates. Initially, both roads were con-
sidered unattractive. Restrictions on inward capital flows were imposed, while
after the first oil crisis other countries experiencing downward pressure on
their exchange rate imposed restrictions on outward capital flows. Although
most controls on inward flows were lifted in the course of the 1970s and an
appreciation of the currency vis-a-vis the US dollar was accepted, the controls
on outward flows were more sticky. At the time of the establishment of the
EMS it was taken for granted that these controls would remain in place and
would help to beat off speculative attacks. In fact, it was widely believed that
this was the only feasible way to maintain a system of fixed, but adjustable
exchange rates among economies with diverging ..economic performances. 14
 21

2.5.2 Monetary Policy Considerations

A motive closely related to the exchange rate policy considerations has been
the wish on the part of the authorities to increase the room to manoeuvre
for monetary policy. Capital controls enabled monetary policy to be directed
towards domestic objectives, while maintaining the exchange rate irrespec-
tive of external developments, because a wedge was driven between domestic
and international interest rates. In the 'incompatible triangle' of simultaneous
autonomy over monetary policy, freedom of capital movements and stabil-
ity of the exchange rate, the freedom of capital movements was generally
considered to be the intermediate variable which could be dispensed with at
the least costs. Pressures exerted on the exchange rate could be countered by
introducing or tightening capital restrictions instead of relieving such pres-
sures by adjusting interest rates. Interest rate adjustments could be considered
inappropriate in the light of domestic policy goals and exchan~e restrictions
formed a commensurate substitute for monetary policy action. 5
More in general capital restrictions were considered necessary in order
to close loopholes under regimes of direct credit control. Such restrictions
were aimed at avoiding that credit taking abroad was substituted for domestic
credit which was subject to ceilings or penal reserve requirements. Typically,
therefore, as discussed in chapter 1.2, the use of direct monetary instruments
went hand in hand with exchange controls.

2.5.3 Saving and Investment Considerations

Another rationale for the imposition of restrictions has been the wish to use
scarce domestic savings to finance investment at home rather than abroad.
The popular paraphrase of this argument was that national thrift should be
put at work to generate jobs at home. The controls often were disguised
in the form of rules on investments in foreign assets by pension funds and
insurance companies. I6 More outright controls were aimed at limiting access
of non-resident borrowers to domestic capital markets. But there were less
noble afterthoughts in operating exchange control: governments frequently
adopted a negative stance against foreign ownership of domestic industry and
thus subjected inward direct investment flows to cumbersome authorization
procedures. Especially countries conducting active government-led industrial
policies availed themselves of such controls. A prime example is France where
considerations concerning national industrial development inspired a compli-
cated set of permits for the establishment of foreign controlled companies. I7

2.5.4 Tax Considerations

A fourth motive for capital restrictions has been the wish on the part of the
fiscal authorities to be able to tax financial transactions, interest and dividend
22

- short-term long-term

outflows - preserve low - protect domestic

interest rates savings
- avoid downward - protect domestic
pressure on capital market
exchange rate

inflows - preserve domestic - protect domestic

price stability control of key
- avoid upward industries
pressure on
exchange rate

Fig. 4. Main motives for capital restrictions.

income, as well as wealth. Capital is a highly mobile factor of production.

Controls have been imposed to avoid the erosion of the tax base and to limit the
possibility for residents to shift their financial portfolios abroad to countries
with lower tax rates in order to avoid domestic taxes. It was hoped that capital
controls would insulate the domestic tax base from such tax arbitrage and
would prevent the movement of assets to off-shore centres. 18

2.6 DRAWBACKS OF CAPITAL CONTROLS

Although all countries have experimented with capital controls, be it in a

direct manner or indirectly in a disguised manner, there always has been
a strong undercurrent in favour of abolishing them. The arguments of the
proponents of liberalization were related to doubts as to the effectiveness of
controls with respect to the objectives they were supposed to achieve, as well
as to the c.osts of capital controls.

2.6.1 Low Degree of Effectiveness

Capital controls are most likely to form especially a hindrance for legitimate
capital transactions. The latter are easier to restrict than speCUlative or other
unwanted transactions, which by their very nature will tend to be diverted
through unrestricted channels or be camouflaged as other transactions, e.g. in
 23

the current sphere. Controls will induce market participants to find ways of
circumventing them. Bhagwati's study (1978) of exchange control regimes in
developing countries provides sometimes amusing but mostly sad evidence
of the incentives for illegal outflows under control regimes in cases of an
overvalued currency. Ifcontrols lead to an artificially low interest rate and an
overvalued currency, there are particularly strong incentives to find loopholes
in the regulations in order to place funds in higher-yielding external assets. In
its tum this will provoke the authorities to impose new controls. There is thus
an inherent tendency for an extension and cumulation of controls, leading to
increased restrictiveness. In fact, there has been a distinct tendency for control
measures, once taken, to remain in effect. Controls cannot be easily switched
on and off according to the needs of the moment. 19 The technical apparatus
needed for the implementation and control of the capital restrictions tends to
grow all along.
In the economic literature the effectiveness of capital restrictions frequently
has been measured by comparing differentials between domestic and Euro
interest rates. Also the effects on capital flows have been assessed. This
empirical work, which generally observes a certain degree of effectiveness,
will not be redone here. What interests us primarily is the perception from
the side of the policymakers of the effectiveness of capital restrictions to
reach predetermined goals, such as the preservation of the exchange rate
or of domestic monetary stability. In general, experience shows that capital
controls may be effective in warding off speculative attacks in the short run,
but that in the long run the exchange rate has to be adjusted anyway. There is
evidence that the effectiveness of capital controls in this respect has eroded
over time because of the technological and structural changes which have
taken place in the financial markets, making it harder for the authorities to
monitor compliance with restrictions.

2.6.2 Undermining Economic Discipline

The macro-economic costs of capital controls are found in the distortions in

asset prices and interest rates which can lead to a suboptimal allocation of
capital resources. From a policy viewpoint, however, the disturbing effects on
economic and monetary policy have been a more important consideration. By
shielding domestic financial markets from external influences, governments
were enabled to direct policies to suit their own priorities and keep domestic
interest rates artificially low. This may have had temporary economic and
political advantages, especially if the external shock was a temporary one.
However, it led to suboptimal economic solutions if the necessary adjustment
of policies by governments or adaptation of strategies by private economic
agents to changed international circumstances was postponed. The shielding
of domestic financial markets has made it easier for the authorities to fol-
low stimulatory monetary policies, and capital controls typically have been
24
associated with a relative poor inflation perfonnance, as discussed in chapter
1.3. The combination of low interest rates and high inflation, often leading to
negative real interest rates, has induced countries to pursue less sound fiscal
policies as well. In sum, controls on capital outflows enabled the authorities to
follow less disciplined policies, leading to divergence with the perfonnance
of other, more stability-oriented countries. It was especially this aspect which
would became a primary focus of attention in the discussions in the European
context.

2.6.3 Hampering the Domestic FinancitiJ Centre

Other costs are associated with the position of the country concerned as
a financial centre. The banks and other financial institutions in countries
with extensive capital restrictions are handicapped in international financial
transactions. Industry and investment companies are likewise restricted in the
management of their assets and liabilities.

2.6.4 Costs of Controls

Gottfried Haberler has summed up his objections to capital controls in a rather

blunt manner: 'The controls give rise to expensive and wasteful efforts of cir-
cumvention and evasion by legal or illegal means to which the authorities
react with e~ally expensive and wasteful measures to tighten and expand
the controls. ' And expensive the administrative apparatus was. The Belgian
National Bank, over the years an outspoken proponent of the dual exchange
market, later stated that 'the administrative costs entailed by the two-tier sys-
tem were admittedly fairly substantial'. In defence of these costs, however,
it argued that the controls also pennitted the compilation of statistics. 21 The
French technical apparatus was notoriously fonnidable. France had devel-
oped a technique of controls, which rightly could be called 'pointilliste' in
style,22 consisting of checking the balance of payments section by section.
The complexity of the French regulations is illustrated by the fact that in
1985 the total of official texts, instructions and advisory notes made up a
voluminous book, 8 centimetres (3 inches) thick. 23
 25

factors which have been important motives for keeping capital controls in
place. Liberalization therefore often has been conditioned by changes in the
perception of these risks or of the possibilities to raise taxes on capital. It is
generally felt that governments should not undertake all liberalizing measures
simultaneously. In practice, this has meant that countries typically strive for
gradualism in the liberalization of capital movements. However, there are
important exceptions. The United Kingdom (1979), Australia (1983) and
New Zealand (1984) opted for a shock therapy by crossing out all capital
restrictions at one stroke.
Much attention in the literature on economic development has been devoted
to the optimal sequencing of liberalization and deregulation in commodity
and financial markets. The judgment on optimal sequencing depends partly on
the initial macro-economic framework of government policies. Ifthe reigning
ideology is market-oriented, steps towards liberalization can be taken more
easily than in the case of a long-standing history of interventionist policies.
The literature suggests that fiscal control should precede financial
liberalization. 24 Nowadays strict budgetary policies are more necessary than
may have been the case in the 1960s, because of the much less favourable
expectations on the part of governments' creditors, either foreign or domes-
tic, in view of the major fiscal derailments in the past two decades which
resulted in high government debt ratios. Furthermore domestic capital mar-
kets should be liberalized, so that depositors receive, and borrowers pay,
substantial real (inflation-adjusted) interest rates. The pace of deregulation
of banks and domestic financial markets should be 'carefully geared to the
government's success in achieving macro-economic stability. Only after such
successful domestic liberalization and stabilization will there be appropriate
scope for the liberalization of the foreign exchange markets. Otherwise, the
premature abolition of exchange controls could lead to an unwarranted capi-
tal flight or an unwarranted build-up of foreign indebtedness, or both. If, on
the other hand the fiscal deficit is under control and the domestic financial
market is liberalized, the opening up of the capital market may result in large
capital inflows. Such inflows may be triggered by inflation differentials and,
therefore, interest differentials, but also by portfolio adjustments, inspired by
increased confidence because fiscal balance is restored and capital controls
are abolished. The credibility of the continuation of sound macro-economic
policies and the free movement of capital is crucial. The inflows initially cause
a real appreciation. The inflows, however, may have a temporary character
insofar as they reflect once-and-for-all portfolio adjustments. And they may
send the wrong signal to the authorities, who feel official reserve ease and
may be tempted to relax fiscal and monetary policies. Sometimes this cannot
be avoided, because forced interventions lead to a growth of the money sup-
ply. Inflationary capital inflows triggered by the credibility gained through
anti-inflationary policies - the so-called Walters effect25 - would play an
26

important role from 1988 to 1991 when countries like Italy, Portugal and
Spain liberalized capital movements.

2.8 CONCLUSION

The foregoing analysis shows a wide variety of arguments pro and contra
the use of restrictions of capital movements. This has been reflected in an
even greater diversity of practices in individual countries, both with respect
to the advisability of using restrictions in principle and to the type and form of
restrictions actually employed. The analysis further shows that there is a close
interconnection between capital restrictions and a number of important issues
which are at the heart of economic policy-making. Theoretical considerations
would suggest that quite a number of conditions need to be fulfilled before
capital restrictions can be abolished without unduly risking undue pressures
on the exchange rate. In particular, domestic macro-economic stability has
been singled out as an important condition. Domestic price stability, a bal-
anced budgetary position and equilibrium of the balance of payments are
fundamental constituent parts of such macro-economic stability. The dereg-
ulation of domestic markets, or at least the abolition of financial repression,
is another condition for liberalization as is the use of market-oriented indi-
rect monetary instruments. In practice, as will become clear in this study,
these conditions will not always be fulfilled. At the same time, the author-
ities have been aware of these conditions. As was hinted at in Chapter 1.3,
and will be discussed more in detail in the following chapters, the case of
Europe shows a rather well-established correlation between macro-economic
instability and diverging developments on the one hand and the existence
of controls on the other hand. Conversely generalized convergence towards
stable macro-economic conditions goes hand in hand with the abolition or
absence of controls. Therefore, successful policy coordination among coun-
tries is conducive to the process of capital liberalization.
Whatever the theoretical merits of free capital movements, experience
shows that countries could not and did not take a detached attitude towards
exchange controls. Disregard for the external constraints would provoke
instantaneous reactions by the international financial markets. This called
for a quick policy response because either the official reserves of the national
central bank would be depleted or the exchange rate would be devalued. These
were always politically sensitive issues. The imposition of capital restrictions
was a highly visible response. At the same time, their effectiveness always
has been in doubt and has probably decreased in the course of the years. In
Europe this has caused increased political sympathy for the route towards
a common currency. In this study we will follow this hazardous route from
the viewpoint of the governments involved. High stakes were involved. The
issue of capital liberalization never was viewed in isolation because of its
 27

implications for monetary and fiscal policies. All in all, it would seem that the
policy implications have carried a greater weight in the balancing of the pros
and cons of liberalization than the theoretical arguments in favour of optimal
resource allocation.

NOTES

1. Alesina et at. (1993) reject rather strongly the hypothesis that capital controls reduce
growth. Their analysis is based on a dummy variable assuming a value of one when
capital controls are in place and zero otherwise. The simplification, however, notably
ignores the fact that the macro-economic effects of controls differ greatly depending on
the types of transactions affected.
2. In July 1963 the Interest Equalization Tax was introduced with the aim offorcing Europe to
develop its own capital market and find there the capital which hitherto it had raised in the
United States. This measure was followed by 'voluntary' programs aimed at restraining
direct investment abroad and the establishment of a reserve requirement on Eurodollar
borrowing by commercial banks. Eventually these arrangements were not successful in
curbing speculative outflows and they were abolished after the move to floating exchange
rates. For a discussion of the US regulations see Cairncross in Swoboda (1976).
3. Switzerland, which frequently was a magnet for capital flows seeking refuge from currency
turmoil, at times deemed it necessary to take temporary measures to curb such inflows.
Particularly in the aftermath of the collapse of the Bretton Woods system, like other
European countries, it had recourse to banning interest payments on deposits of non-
residents and introducing other disincentives and penalties for increasing such deposits.
This was at a time when the vagaries of the exchange rate of the Swiss franc were
comparable, as Tobin (1978) argued, to those of the prices of 'rare coins, precious metals
and baseball cards.' After intensive experiences with different sorts of administrative
measures, the Swiss authorities seem to have come to the conclusion that they never
produced more than a very temporary brake on the appreciation of the Swiss franc (DECD,
1982).
4. The United Kingdom tried to maintain its reserve currency status in the post-war period
while preserving exchange control. However, when the pound sterling came under repeated
pressure the subsequent tightening of exchange controls in the 1960s and 1970s heralded
the final demise of its reserve currency status.
5. The IMF classification is followed here, see IMP, Exchange arrangements and exchange
restrictions, Annual report, various issues; see also Matthieson and Rojas-Sulirez (1993),
page 4. This listing is not exhaustive but covers the main types. The DECD (1982) uses
a distinct classification of categories of controls, i.e. (a) individual authoriiation require-
ments on the basis oflegal or regulatory prohibitions involving direct controls on quantities
of certain cross-border flows; (b) general administrative regulations which are designed
to limit the volume of certain cross-border flows by indirect means; such regulations can
comprise conditions with respect to operations (eg timing, costs, composition etc); dual
exchange markets, surrender requirements and interest rate controls are also included in
this category; (c) other control measures which at the same time try to achieve other
policy objectives (protection of investors, supervisory considerations) but indirectly influ-
ence the incentives for cross-border flows; such measures may include taxation measures,
minimum reserve requirements on external assets and liabilities, and limits on domestic
credit expansion.
6. Payments with non-residents typically have been centralized with authorized banks
(' intermediaires agrees').
28
7. At times of severe strains, particularly in the early 1970s, the dual market system in
Belgiwn had to be supplemented with administrative controls (see Chapter 6.11).
8. Italy practised its criminal offence regime from 1976 through 1988.
9. Taxation redirects market forces. Cairncross (1976) has argued that the main effect of the
US Interest Equalization Tax, by shifting the financing of outward direct investment by
US companies to foreign sources, has contributed to the rise of the Eurodollar market.
10. Gros (1988), discussing the dual exchange rate system of Belgiwn, argues that' ... dual
exchange rates (as well as capital controls) could succeed only temporarily in dampening
the effects (...) of shocks to financial or other markets (...) a steadily increasing differential
would also lead to a steadily increasing incentive for private operators to circwnvent the
regulations that separate the two markets by buying foreign exchange at the lower rate
(usually the controlled or commercial rate) and selling it at the higher rate (usually the
free or financial rate).' He concludes that 'the use of dual exchange rate regimes to offset
permanently the effects of permanent shocks should therefore not be attempted'. See also
Marion (1994).
11. See OECD (1982) for an elaborate survey of the merits and demerits of restricting certain
types of short-term capital movements.
12. Cairncross (in Swoboda, 1976) distinguishes four main purposes: (a) to influence the
direction taken by inward or outward capital flows, (b) to operate on the long-term balance
between domestic and foreign investment, e.g. in order to increase the proportion of
domestic savings invested at home, (c) to reduce the pressure on the balance of payments,
and (d) to extend the freedom of manoeuvre of the monetary authorities. Matthieson and
Rojas-Suarez (1992) identify four partly overlapping main purposes: (a) to limit volatile
short-run capital flows and avoid balance-of-payments crises, (b) to maintain the domestic
tax base, (c) to retain domestic savings and (d) to help stabilization and structural reform
programs.
13. Tobin (1978), who ascribes such behaviour to the absence of any consensus on fundamen-
tals.
14. Eichengreen and Wyplosz (1993) are still of the opinion that the European Monetary
System will not survive without capital controls and advocate throwing sand in the wheels
of international finance (see for discussion chapter 9.9.2). Gros and Thygesen (1992,
p. 114-126) discuss extensively the use and effectiveness of capital controls in the EMS.
They reach the opposite conclusion that the elimination of capital controls need not threaten
the stability of the EMS.
15. For a further discussion of monetary policy considerations under various exchange regimes
see OECD (1990), p. 24-26, and Gruijters (1992), p. 5-8.
16. Many countries use sector-specific regulations with respect to the investment of assets
abroad by banks and other financial institutions. They are normally not intended to restrict
capital exports, but are designed for creditor protection or for sound, prudent banking
principles. Admittedly, there is a grey area here and there is a tendency, in the framework
of the liberalization of the insurance market in the EC, to relax such regulations.
17. Rather sutPrisingly, few complaints have been made. A case went to the European Court
of Justice in the 1960s, but judgement was not delivered since the restriction subsequently
was abolished. Other countries, too, have erected obstacles to foreign investment in key
sectors deemed of national interest, such as the airline industry or the maritime sector.
18. The importance of off-shore centres is demonstrated by BIS statistics on international
banking and financial market developments (August 1993), which show that as of the end
of 1992 the external assets of reporting banks vis-a-vis the off-shore centres Bahamas,
Bahrain, Cayman Islands, Hong Kong, the Netherlands Antilles and Singapore amounted
to nearly $ 1,000 billion, representing approximately 20% of total external assets.
19. Smz (in Swoboda, 1976) mentions three reasons for the stickiness of exchange restric-
tions: (a) the authorities and the public get used to the measures, (b) the authorities do
not want to take the risk of having to reintroduce restrictions a short while after having
 29
abolished them, and (c) the expanded technical apparatus to administer controls cannot be
easily shrunk.
20. See Haberler's essay on The case against capital controls for balance of payments reasons
in Swoboda (1976).
21. The operation of the two-tier foreign exchange market, The experience and its lessons.
Internal memorandum of the National Bank of Belgium (1992).
22. Jean Peyrelevade quoted in Neme (1986).
23. Neme (1986) enumerates 129 published texts in the Official Journal, 12 general instructions
to the IntermMiaires agr~s, 57 letters of the Banque de France still in force (out of a total
of 262) and 29 advisory notes, compiled in a collection of the Association Fran~aise des
Banques.
24. Edwards (1984) and McKinnon (1991) provide good overviews of the existing literature.
Although their considerations are applied mainly to the context of developing countries,
they may have a more universal application.
25. Walters (1986) argues in his critique of the European Monetary System that a credible
exchange rate commitment leads to a fall in nominal interest rates and an increase in
domestic demand, and hence to upward pressure on prices.
 CHAP'IER3

The Treaty of Rome and Capital Movements

I learned that there is no solution to economic problems without

growth and that growth cannot come from bureaucratic manipula-
tions, but only from the individual efforts ofall, working in freedom
that is as near complete as possible.
Robert Marjolin, 1989

3.1 INTRODUCTION

In the first few years after World War II the attention of policymakers in
Europe was focused entirely on reconstruction and rehabilitation. Foreign
exchange scarcity, in practice a shortage of US dollars, imposed, however,
severe constraints on the pace of economic recovery. Due to a lack of credit-
worthiness European governments had no easy access to private funding from
US commercial banks. Official assistance from the newly founded Bretton
Woods institutions was slow in forthcoming. In these circumstances the US
Administration took the initiative to put the necessary financial resources at
the disposal of the war-tom European countries in order to revitalize their
economies. Behind this Marshall aid was a well thought-out political concept.
The European states were asked to design themselves a common recovery
plan and thus were forced to get organized and cooperate. To this end the
Organisationfor European Economic Cooperation (OEEC) was established
on 16 April 1948. As a complement to its coordinating functions, the orga-
nization was mandated to pursue the liberalization of trade flows and current
payments. Under its aegis the European Payments Union was established in
1950 with a view to gradually restoring external convertibility of the Euro-
pean currencies for the settlement of trade in goods and services. This goal
was achieved at the end of 1958. By that time important steps had been taken
with respect to the dismantlement of trade barriers as well. 1 In most countries,
however, barriers to non-trade related capital flows remained in place.
In the meantime the countries cooperating in the framework of the OEEC
held intensive discussions on the future shape of a more united Europe.
As an initial step, at the instigation of Jean Monnet and Robert Schuman,
the European Coal and Steel Community (ECSC) was established in 1952
by France, Germany, Italy and the Benelux countries, marking the first break
with the tradition of national sovereignty of European states. A year later J.W.
Beyen, the Dutch Minister of Foreign Affairs, launched a plan to expand the

30
 31

existing cooperation to a common market and a customs union. The plan was
targeted towards the free flow of goods and services. It did not yet address the
issue of capital flows, understandably so at a time when external convertibility
had not yet been restored. Actually not many advocated a rapid return to
capital account convertibility with still vivid memories of the destabilizing
speculation in the interwar yeriod, apart from a circle of advisors around
Ludwig Erhard in Germany. Beyen had a reputable economic and financial
background, unique among his counterparts, which he had acquired during
his tenure at the BIS and the IMP. His plan, which was to be the first blueprint
of the later EEC, was designed to complement the existing ideas among the
other ECSC member states to form a European Political Community. All
along views differed about the form and intensity of cooperation between
European countries. For the Dutch government political inteFtation was only
acceptable if it were accompanied by economic integration. Discussions on
political integration broke down after the echec of the European Defence
Community, which was postponed sine die in the French Assemblee on 30
August 1954.
After this set-back in the political field the Benelux ministers attempted to
initiate a European 'relance'. Among themselves the Benelux countries had
made substantial progress in liberalizing bilateral trade, and proposals were
submitted to extend this into other areas, including capital. For the European
relance the original plan for a common market was un shelved. Its practical
goals seemed more likely to be attained. At the Conference of Messina on 1
and 2 June 1955 an intergovernmental committee was established under the
chairmanship of the Belgian Minister of Foreign Affairs Paul-Henri Spaak in
which experts participated from the six ECSC member states. This committee
was asked to examine the methods for the development and progressive
integration of their markets. In the resolution adopted in Messina it was
stated that the integration of the six member states should also encompass the
movement of capital. The Spaak report indeed included freedom of capital
flows as an important element of a common market, because this would
facilitate the efficient deployment of savings for investment purposes in the
member states. But the report was prudent in its recommendations in this
respect. The Spaak report was to serve as the basis for the negotiations on the
Treaty of Rome, which were successfully concluded in the course of 1957.
Various attempts to pull the United Kingdom on board all failed because of
diverging views on the extent of cooperation, particularly between France and
the United Kingdom. Under British leadership a separate organization was
to be formed, the European Free Trade Association, with less far-reaching
goals. Among them, freedom of capital flows did not figure. EFTA's less
ambitious concept of pulling down trade barriers did not require, unlike the
EEC's integration ideal, common undertakings and obligations in the field of
capital movements.
32
The establishment of the European Economic Community coincided with
the collapse of the Nth Republic and the reappearance of General Charles de
Gaulle at the head of the French government. This rekindled fears that France
would not live up to its European commitments. It had not been forgotten
that it was de Gaulle who had opposed the further integration aspirations and
had greatly contributed to the shelving of the plans for a European Defence
Community. De Gaulle had opposed the supranational ideas of his compatriots
Robert Schuman and Jean Monnet. These fears, however, did not come true.
France was preoccupied with solving the Algerian question and was interested
in 'buying time' on other fronts. The impending decolonization process would
necessitate a restructuring of the European economies, for which the EEC
with its social and investment funds could provide an attractive vehicle. At
the same time it was considered useful to retain the OEEC as an umbrella
organization in which the other European countries participated. Membership
of the organization was opened to non-European industrial countries as well
and in 1961 it was rechristened the Organisation/or Economic Cooperation
and Development (OECD). The liberalization of capital movements, which
had advanced considerably since the establishment of the EEC, was to be
an explicit goal of the organization, to the extent that it enhanced economic
cooperation among its member states.

3.2 THE SPAAK REPORT

In the Spaak report the free movement of the main production factors - capital
and people - was considered to be part and parcel of the establishment of a
common market. But they were to be the very last to be achieved - actually
the liberalization of capital made up the concluding chapter of the Spaak
report. The free movement of people and capital was to be conditional upon
progress in three main policy areas: the coordination of economic policies,
the realization of basic investment in the underdeveloped regions of the
Community and the suppression of large-scale unemployment. Therefore,
precise obligations, particularly in the field of capital movements, could
not be written beforehand into the Treaty. Rather, capital liberalization was
to depend on the circumstances and the interaction within the Community
institutions, which could weigh the implications with respect to other common
targets.
The members of the Spaak committee were aware of the reservations of the
member states towards liberalization, which they grouped under four head-
ings: (a) the fear of speculative movements in case of divergent monetary
policies; (b) the fear of outflows to third countries through member states
with a liberal regime; (c) the risk of capital flows motivated by tax evasion;
and (d) the risk that capital would flow mainly to developed areas. As a
practical solution certain types of capital transactions were selected where
 33

liberalization should have priority. Particularly direct investment flows and

transactions in securities were singled out as promising areas. Lastly, the
Spaak report accepted that even in the final stage of the common market
recourse to safeguard clauses should remain possible. Although their effec-
tiveness was doubtful, given the possibilities to camouflage capital transfers
in the form of goods or services, temporary restrictions should remain possi-
ble as long as member states retained autonomy over budgetary and monetary
pOlicies. 4
Beyond this cautious and pragmatic attitude the Spaak committee firmly
held that full freedom of capital movements should be the ultimate goal. Many
experts in the committee were convinced that behind the existing exchange
controls a certain measure of illusion was apparent. It was not self-evident,
so it was argued, that a member state by enforcing exchange controls would
have more capital at its disposal for investment purposes; by restricting the
outflow of domestic capital, foreign capital was discouraged from entering its
territory as well. In short, the issue of exchange controls was deemed to be an
area of considerable prejudices, in which national sensitivities were hardly
disguised.

3.3 THE ATTITUDES AMONG THE FOUNDING MEMBER STATES

The Spaak report was adopted by the Ministers of Foreign Affairs at their
meeting in May 1956 in Venice, although its reception by the French gov-
ernment at best could be considered lukewarm. The latter presented its own
memorandum on the establishment of a common market, which in essence
contained an endless list of French demands and reservations. 5 Nevertheless,
the momentum was maintained and an intergovernmental conference of rep-
resentatives was established which used the Spaak report as a basis for the
design of the Treaty establishing the European Economic Community. French
political support for the European common market idea increased apprecia-
bly after the ill-fated Suez affair, as a means to divert public opinion. On 25
March 1957, less than two years after the go-ahead had been given at the
Conference of Messina, the Treaty was signed by the Ministers of Foreign
Affairs in the Campodiglio, the proud city hall of Rome. In the course of the
year it was ratified in all member states. The Treaty came into effect on 1
January 1958.
The negotiations on the provisions of the Treaty had been held in the
context of the impending restoration of current account convertibility and
the abolition of the European Payments Union. However, some countries still
experienced a shortage of official reserves and monetary equilibrium had not
yet been generally restored. Consequently, the exchange control regimes with
respect to capital movements varied considerably among the six prospective
EEC members. Given the diversity of national positions it was clear that the
relevant Treaty provisions would have to constitute a compromise.
34
Under the influence of the liberal policies of Ludwig Erhard, Adenauer's
Minister of Economic Affairs since 1949, Germany had opened up its borders
at a rapid pace. Erhard's thinking was influenced by the writings of Wilhelm
Ropke on the soziale Marktwirtschaft, in which government interventions
should be aimed at reaching as large as possible free competition of market
forces. Since 1952 Germany had registered surpluses on its current account,
enabling a replenishment of its official reserves. From this healthy external
position the government actively encouraged capital outflows. In line with its
policy of giving free reins to market forces in September 1957 all remaining
controls on outflows were abolished, whereas only a small number of inward
capital controls was retained. The latter were, however, of limited economic
significance. Germany, traditionally liberally-oriented, thus was in a strong
position to favour the inclusion of the free movement of capital as a common
goal in the Treaty. There were no great sacrifices involved either because
Germany's domestic capital market was relatively underdeveloped. Although
non-residents in principle had gained free access to the German capital market,
in practice its use remained limited because of the prevailing relatively high
interest rates in Germany.6 Nevertheless Germany did not push very hard for
its preference of freedom of capital movements. Being a net capital exporter,
it had no great interest in gaining access to the domestic capital markets
in other European countries. Nor did it wish to see its high-interest rate
policy undermined by large capital inflows from third countries. Therefore,
the German negotiators did not attach overriding importarice to the promotion
of their own ideology of free capital movements.
In the course of the negotiations, when it became increasingly clear that the
establishment of a European Economic Community was to be a real proposi-
tion, there was considerable preparedness on the German side to make con-
cessions to the French on a broad front of issues. One of the striking examples
was the common agricultural policy, which would imply that Germany was to
be a net payer to the Community in the years to come. Another plausible area
for compromise was formed by capital movements, where Germany stood
more or less alone in its advocacy of full freedom and the interventionist
attitude of France with respect to capital movements was backed by Italy and
the Netherlands. Against this crowd Germany was ready to compromise and
no longer postulated the free movement of capital. This open attitude reflect-
ed in large part the political agreement Chancellor Konrad Adenauer had
reached with his French counterpart, premier Guy Mollet. Germany, eager to
align itself with its former adversaries, stood ready to back specific French
demands as long as they did not go against vital German interests. The free
flow of capital movements was not deemed to be vitally important, neither
for Germany, nor for the Common Market.
France still was in a weak external position in the mid-1950s. As shown
in Table 4 it had only a limited amount of official exchange reserves at its
disposal. France operated an extensive exchange control system, including
 35

TABLE 4
Financial indicators at the eve of the Treaty of Rome.

1957 Official Current Fiscal Government Long-term

reserves account deficit debt interest rate

% imports %ofgdp %

Belgium 33.7 2.0 -0.4 63.6 6.0

France 11.9 -2.4 -4.9 33.2 5.9
Germany 68.5 2.7 -2.3 9.1 7.5
Italy 40.3 0.1 -1.5 45.0 6.8
Netherlands 25.6 -1.7 0.6 50.8 4.6

approval procedures for direct investment flows. For the French government
it was imperative that the Treaty provisions on the movement of capital would
not obstruct the national economic plans. The dirigistic economic approach,
apparent in the portioning and subventioning of credit to specific sectors
of the economy, stood in the way of allowing complete freedom of capital
movements. The French therefore insisted on safeguard clauses. In their view
these should also imply that governments in case of need autonomously
could take restrictive measures with ex post approval by the Commission
(the so-called clause d'urgence). In his memoirs Marjolin reports that the
French Minister of Economic and Financial Affairs, Paul Ramadier, sent
memo after memo to Guy Mollet to put him on his guard against what he,
Ramadier, regarded as a surrender to Mammon. To introduce freedom of
capital movements would in the French eyes be playing into the hands of the
speculators, who would take advantage of it to attack the franc. 7 The latter
position did not, however, deter the French administration, while operating a
full-fledged exchange control system, from devaluing the French franc twice
in 1958, in June by 20% and in December by 17.5%. These devaluations,
which were accompanied by a substantive financial and monetary reform,
gave the French economy an excellent competitive starting position in the
Community.
Italy operated a mixed system: there was a free market for cross-border
capital transactions, but residents had only limited access. Italy generally
favoured the liberalization of capital movements during the Treaty negoti-
ations because it wished to attract capital for the development of Southern
Italy. It wished, however, to retain the right to control issues on its own capi-
tal market through domestic regulations. Belgium and Luxembourg were in a
special position. Their relatively favourable economic situation enabled them
to liberalize capital movements earlier than most other European countries.
36

With that consideration in mind a dual exchange market was introduced in

1955, consisting of a free financial market, which was separated from the
official exchange market for current payments. The dual market's advantage,
so it was argued, lay in its steering a middle course between full freedom of
capital movements, which was not yet attainable, and the more cumbersome
'formalities' of a direct control system. The Belgian negotiators generally
adopted a liberal attitude with respect to capital movements. 8 Among the
European countries the Netherlands held a position in the middle. Capital
transactions were subject to permissions, which, however, especially with
respect to trade in shares, were granted liberally. Although its general attitude
towards controling capital movements was close to the French dirigistic posi-
tion, in the application of its control system the Dutch authorities were much
more liberally-oriented. Their attitude in the negotiations therefore proved to
be important in determining the extent of the Treaty obligations.

3.4 THE DUTCH ATTITUDE TOWARDS CAPITAL LIBERALIZATION

The attitude of the Netherlands deserves further consideration. Its interme-

diate position could tip the scales in determining the scope of the Treaty
obligations and drawing the line between those capital movements which
would be necessary for the proper functioning of the Common Market, and
those which would not. The Netherlands was opposed to the full liberalization
of capital movements, both on policy and ideological grounds. The Nether-
lands had two main policy motives for a rather restrictive attitude: it wished
to protect its domestic capital market and it wished to control domestic mon-
etary expansion. As far as the first motive - protection of the domestic capital
market - was concerned, there were three arguments in favour of restrictions
on capital outft.ows:
(a) Capital outflows would force up domestic interest rates in countries,
such as the Netherlands, where they were low because of sound fiscal policies.
Holtrop, the central bank's president, argued that the lifting of restrictions in
itself would not guarantee the rational distribution of saving surpluses in
Europe. He essentially took a static viewpoint: ' ... economic integration by
itself does not generate new savings and thus no new capital; therefore the
advantages of free capital movements can only be the displacement of the
utilization of capital from one area to another'.9 Therefore, foreign demand
for credit on domestic markets would crowd out national credit-takers.
(b) Free capital movements wouldfacilitate the financing offree-spending
governments and undermine budgetary discipline. The Dutch concern that
spendthrift governments would borrow in the capital markets of thrifty gov-
ernments had been eloquently voiced by Holtrop.lO 'Should the ant from La
Fontaine's fable open up its store-room to the cricket?', he asked himself.
Would it really be wise policy for the government, which as a good father has
 37

taken care to keep his own house in order, to open up his capital market and
give free access to other members of the Community who take their financing
problems more easily and spare their own taxpayers? Holtrop's answer was
straightforward: this would be irresponsible policy. It might force the domes-
tic government to monetary financing, it might drain the official reserves and
it could put upward pressure on interest rates. Against these drawbacks he
saw no obvious advantages.
(c) Freedom of capital movements could lead to flows from the poor areas
to the rich areas of the Community. Posthuma, the Dutch delegate from the
side of the central bank, when elaborating on this argument which had also
figured in the Spaak report, held that both the speed and the substance of cap-
ital liberalization should be subordinated to the fulfilment of wider-ranging
objectives of the Treaty, such as economic harmonization and a high degree
of employment. Complete freedom of capital movements could only become
mandatory if the economic climate in which entrepreneurs had to work, as
well as the social and economic policies were sufficiently equalized. His main
fear was that the prevailing differences might induce capital movements from
underdeveloped countries to more developed regions, whereas the aim of
balanced growth in the Community and a high level of employment would
require the very opposite. He wrote: 'The liberal economic doctrines of the
19th century, influenced by natural philosophy, took it that with free capital
movements flows would go in a direction which would o~timalize welfare.
Nowadays no economist of reputation shares this notion'. 1 Here economic
ideology was at stake: the Dutch authorities, contrary to their German coun-
terparts, did not have faith in the free play of market forces, which could lead
to undesirable outcomes in terms of welfare. The latter apparently was defined
in terms of equalization of income, production and employment across the
Community.
The second motive - the control of domestic monetary expansion - was
closely related to the influential monetary doctrine which Holtrop had devel-
oped during his presidency of the Nederlandsche Bank. Short-term capital
inflows were regarded as liquidity creation from external sources. There was
no economic reason why this source of liquidity creation, which would come
on top of domestic liquidity creation and thus could have inflationary con-
sequences, would have to be allowed to flow uninhibitedly. Monetary policy
should be able to be geared exclusively to price stability: ' ... only a govern-
ment which accepts stability of the currency as an absolute rule of policy has
the moral right to attract at the lowest p:ossible interest rate savings running
into thousands of millions of guilders'. 2 Monetary control was exercised by
direct means, mainly in the form of credit ceilings for commercial banks.
Exchange controls were deemed necessary in order to prevent credit ceilings
from being circumvented by the taking up of credit in third countries. In theo-
ry, sterilization of such flows could of course dampen the direct monetary
consequences, but it would leave the source of credit expansion uncapped.
38
Per cent per annum

7.0 _________ _

6.5
, , .....
-------r; :---­
, .
6.0 ---"- _ _ _ _ .-L.. _ ---i... _ _
,, ~
,,',
5.5 _~_~~ ___ ~.::"__

5.0 _________ _

4.5

4.0

3.5

3.0 r - I - I - I - r - I - I - I - I - r - I
51 52 53 54 55 56 57 58 59 60

Netherlands European
Community

European Community (excluding The Netherlands)

weighted averages.

Fig. 5. Dutch long-term interest rates in the 1950s.

These two motives for a restrictive attitude were founded in the prac-
tical situation of the day, in which forced savings were generated through
cautious fiscal policies. From the Dutch standpoint the Netherlands, which
in the post-World War II years followed a cheap money policy, stood to
lose from complete liberalization of capital movements. At the time it had
one of the best-developed domestic capital markets, its financial community
was outward-looking and interest rates were relatively low. Therefore, it was
feared that for the foreseeable future the Dutch capital market would be one
of the few sources of capital for the other member states. The serious impli-
cations this would have for the Dutch interest rate level and indirectly for
the level of wages and housing rents explain the dissuasive, cautious Dutch
attitude. Because the Dutch relied solely on exchange controls to regulate
the access to the domestic capital market, their liberalization would leave
the Dutch authorities empty-handed, whereas all other EEC member states
had domestic regulations in place through which they de facto could restrict
foreign issues. The Dutch authorities wished to preclude foreign credit-takers
from financing themselves at low interest rates on the capital market. This
could thwart the cheap money policy.
There was also a systemic vision - with an ideologic Calvinistic under-
tone - in the Dutch attitude: a government which behaves badly should be
punished for its sins and not be provided with easy escape routes or grant-
ed indulgences. In his advocacy of disciplinary incentives for governments,
 39

Holtrop took up a theme which would come back incessantly over the next
decades. The full freedom of capital movements would not satisfy the mone-
tary desiderata that the Nederlandsche Bank under Holtrop cherished. It was a
time in which the Dutch authorities still believed in their ability to determine
their own economic policies. Fiscal policy and monetary policy were both
directed towards internal stability. The rewards in the form of a low interest
rate should not be jeopardized by failing policies elsewhere. Therefore the
Netherlands did not shy away from dirigistic measures in the sphere of capital
flows. Apparently the authorities did not share the German ideology of free
functioning of markets.
Interestingly, the Dutch argument that capital liberalization undermines
fiscal discipline in other countries by allowing easy access to foreign capital
markets, would be contradicted much later, in the 1980s, by the German
argument that capital liberalization on the contrary fosters fiscal discipline.
In the latter view, which would gain widespread acceptance at a time when
international financial markets had expanded in a spectacular manner, the
judgement of market operators on the soundness of pursued policies played a
major role in expectations concerning exchange rates and interest rates, and
therewith in the availability and cost of external finance for fiscal deficits.
The two Dutch motives - to protect the domestic capital market and to con-
trol domestic monetary expansion - fitted in comfortably with the emphasis
in Dutch monetary thinking on the strict separation of liquidity and capital.
This reasoning had as a practical implication that walls of defence were raised
from two sides: restrictions were imposed both on long-term outflows - to
protect the domestic capital market - and on short-term inflows - to control
domestic monetary expansion.
The Dutch preoccupations implied that the Netherlands wished to restrict
the freedom of capital movements through a number of provisions in the
Treaty. In particular the Netherlands demanded: (a) decisions with respect to
capital movements should be taken with unanimity during the entire transi-
tional period; (b) there should be no obligation to liberalize loans of foreign
governments, including parastatal entities, on the domestic capital market;
(c) there should be a safeguard clause which could be invoked for all capital
transactions not only in case of balance-of-payments problems, but also in
case of a threat to domestic employment or the functioning of the domestic
capital market; and (d) a clause d'urgence should enable member states to
take restrictive measures in case of sudden disturbances which should be
authorized ex post by the Commission. I3 On page 44 we will see in how far
these Dutch demands were fulfilled.

3.5 THE TREATY PROVISIONS

In one of the first drafts of the Treaty only three relatively simple articles with
respect to capital were provided for, namely (a) a general definition of the
40

freedom of capital movement as the right to freely take up, transfer and invest
capital within the Community, (b) the time frame and modalities according
to which this freedom should be realized in the transitional phase, and (c)
a general safeguard clause. The Treaty text on capital movements, which
eventually was agreed, was a considerably more complicated one. The final
text has to be regarded as a compromise between the conflicting views of the
member states. Although free movement of capital was intended to be one
of the foundations of the Community, the Treaty provisions in this respect
could not bind the member states to a specific and immediate result because
member states wished to retain their room for manoeuvre.
The Treaty of Rome is based on the principle of the four freedoms: the free
movement of goods, of persons, of services and of capital. The structure of the
text of the Treaty suggests that the founding fathers saw a hierarchical order in
the accomplishment of these freedoms. After the treatment of the Principles
of the European Economic Community (Part I, containing Articles 1 to 8) the
Foundations of the Community are dealt with under 4 separate titles: 1) free
movement of goods, 2) agriculture, 3) free movement of persons, services and
capital and 4) transport. Indeed, for a long time the Community has rightly
been associated with the first two foundations: the free trade of goods and
the common agricultural policy. The accomplishment of the remaining three
freedoms, the free movement of persons, of services and of capital, has been a
more arduous task. As regards the free movement of persons the Community
advanced rather well through the adoption of secondary legislation, but in the
field of services, where progress primarily was based on case-law, domestic
regulations protecting home markets continued for quite some time to stand
in the way of progress in all sectors.
In the following paragraphs the original text of the Treaty of Rome with
respect to the free movement of capital will be dealt with. In Annex I, the
full text of the relevant Treaty provisions is reprinted. Subsequent important
modifications of these texts in the Single European Act and the Treaty on
European Union will be discussed in chapter 7 and chapter 9 respectively.
In the Title on the free movement of persons, services and capital, the
chapter on Capital, covering Articles 67 to 73, is the last. Specific provisions
with respect to capital movements in the context of balance-of-payments
disturbances are not spelled out in this chapter of the Treaty, but are dealt
with later in a special chapter on the Balance ofPayments (Articles 104 to 109)
in the part of the Treaty which deals with economic policy. There, member
states were authorized to impose or tighten capital controls in a crisis situation.
In the same chapter the Monetary Committee was set up which, among other
things, was entrusted with the surveillance of capital movements. Apparently,
there was a serious concern that balance-of-payments disturbances on account
of swings in capital movements could hinder the free movement of goods,
the raison d' etre of the Common Market. Such impediment could either
follow indirectly from forced exchange rate adjustments, which would give
 41

an unwarranted competitive edge to goods traded at the depreciated exchange

rate, or directly through the reintroduction of restrictions in the trade area. 14
At the time capital restrictions were by and large considered to be the lesser
evil, in line with the implicit hierarchical order of freedoms.
The tenet of the Treaty provisions concerning capital is Article 67. The
article deals explicitly with the lifting of impediments to the free flow of
capital within the Community, thus fonning the legal principle for all subse-
quent secondary legislation dealing with the liberalization of capital flows.
The text of Article 67.1 is: 'During the transitional period and to the extent
necessary to ensure the proper functioning of the Common Market, Member
States shall progressively abolish between themselves all restrictions on the
movement of capital belonging to persons resident in Member States and any
discrimination based on the nationality or on the place of residence of the
parties or on the place were such capital is invested'.
The Treaty obligations concerning the movement of capital did not seek to
consolidate the liberalization which had already taken place in some member
states. There was merely the finn obligation in Article 67.2 to bring about
current account convertibility, i.e. free settlement of cross-border current
payments, by the end of the first four-year stage of the transitional period. 1s
In fact, such convertibility was already largely reached by the end of 1958
when the European Payments Union was dismantled. As regards non-trade
related capital movements, member states in essence committed themselves
to endeavour not to introduce new exchange restrictions (Article 71) and
to abolish as much as possible existing restrictions. In practice this weak
standstill clause meant that the Treaty started with a clean sheet and that
directives would have to be issued with a view to obliging member states
to liberalize capital movements in the transitional period, provided that this
was necessary for the proper functioning of the Common Market. Obviously,
a measure of good will on the part of the member states, each operating
different exchange control systems, was needed to bring this about.
Procedures for secondary legislation, which would give legal content to
the Treaty obligations, were provided for in Articles 69 and 70. In Article
69 the legal basis was provided for the Council to issue directives for the
implementation of Article 67 on a proposal of the Commission and after
consultation of the Monetary Committee. Article 70 concerned the movement
of capital between the Community and third countries. The Commission
could come forward with proposals to progressively coordinate the policies
in this area vis-a.-vis non-EEC countries. Measures could also be taken to
prevent residents from utilizing the more liberal exchange regime of other
EEC countries to evade national restrictions. These provisions were clearly
inspired by the desire to prevent long-tenn capital outflows, which were
regarded as a drain on domestic resources. In the same vein, with a view to
protecting the domestic capital market, in Article 68.3, loans of other member
state authorities were explicitly excluded from the obligation to liberalize.
42

The Treaty established a link with the freedom of financial services in

Article 61.2, where it was provided that the liberalization of banking and
insurance services should be effected in step with the progressive liberaliza-
tion of movement of capital. Real progress in this area could only be made in
the late 1980s in the framework of the Internal Market exercise.
In the Treaty exemptions were formulated with respect to certain categories
or circumstances. In case of disturbances on the domestic capital market
(Article 73) and balance-of-payments problems (Articles 108 and 109) a
member could call for derogation from the liberalization obligations. These
safeguard clauses gave assurances to member states that they could take
protective measures in crisis situations. Under the clause d' urgence (in Article
109) a member state could on its own take measures. The Commission and
other member states had to be informed immediately, and the Council, after
having heard the opinions of the Commission and the Monetary Committee,
could by qualified majority decide that the measures should be amended or
abolished. But in practice the Community could not do much about it once a
member state had taken protective measures, beyond exercising peer pressure.
The safeguard clauses confirmed that in the final analysis the regulation of
capital movements remained primarily in the national domain.
The transitional period for the establishment of the Common Market,
foreseen in the Treaty, was 12 years (or at the most 15 years), reflecting
the explicit hope of the drafters of the Treaty - and the commitment of the
governments which had signed the Treaty - that by the year 1970 the Common
Market would be established. The EEC Treaty in essence had the character
of an enabling law, which needed to be given content later. For this purpose
the Commission, as guardian of the Treaty, was given the right of initiative to
see to it that the intentions of the Treaty were fulfilled. With respect to capital
movements the Commission could put forward proposals which went beyond
the explicit, rather minimalistic Treaty obligations. The capital provisions
of the Treaty provided the EEC with real decision-making fowers. But this
required, at least initially, the consent of all member states. l

3.6 SUBORDINATION TO THE FREEDOM OF TRADE

A crucial clause in Article 67 is that the obligation for countries to lift

capital restrictions was limited 'to the extent necessary to ensure the proper
functioning of the Common Market'. Article 67 thus does not contain an
unconditional obligation to liberalize capital movements. There is, however,
an apparent inconsistency with the Principles of the Treaty. In Article 3 it
is stated that for the purposes of the Community 'the abolition, as between
Member States, of obstacles to freedom of movement for persons, services and
capital' shall be included in the activities of the Community. Ruding (1969,
p.199) explains this inconsistency on the ground that the definitive text of
 43

the chapter on Capital was decided upon at a late stage of the negotiations
(February 1957), when agreement had already been reached on the general
principles of the Community. It is only in respect of the freedom of movement
of capital that such an escape clause exists; the other three freedoms are not
subject to any comparable restrictive conditions. 17
The insertion of the clause has to do with the fact that member states
were not prepared to surrender economic and monetary competences to the
supranational level. In Article 104 the drafters of the Treaty entrusted each
member state with taking care of its own internal and external equilibrium.
Elsewhere in the Treaty the obligation to coordinate economic policies l8 -
to the extent necessary to attain the Treaty objectives - was circumscribed
by the provision that the internal and external financial stability of the mem-
ber states should not be jeopardized by the Community institutions (Article
6). These provisions make clear that maintenance of domestic economic and
monetary equilibrium remained in the realm of national authorities. The obvi-
ous conclusion was drawn that the possibility to impose capital restrictions
in case of need should be left open. If the authorities of member states felt
that undesirable capital flows threatened domestic equilibrium, they could
feel vindicated by the Treaty in taking countervailing measures. The incon-
sistency, or rather ambiguity in the Treaty with respect to the freedom of
capital movements therefore underlines the close link between policy auton-
omy and capital restrictions. This connection with the question of national
sovereignty would make it difficult to reach agreement on common obliga-
tions with respect to capital liberalization, or to enforce compliance with these
obligations once they had been agreed upon.
In practice the escape clause has given member states considerable leeway
in the application of capital restrictions. Through this clause the freedom of
capital movements actually is subordinated to the freedom of trade move-
ments as the more immediate objective of the Common Market. The vague
phrasing of the escape clause has left room, as we will see, for various inter-
pretations, which could be advanced by national governments as they saw fit
to suit their own preoccupations. One such typical restrictive interpretation
of the clause was that the drafters of the Treaty only had in mind the free
flow of goods and factors of production. In this view the basic intention was
to free investment flows in the real economic sphere and not other financial
flows of a more short-term character. 19
The reserved, cautious attitude of the Treaty drafters which was revealed
in this clause has to be seen in the context of the time the Treaty was written.
Europe was on the brink of restoring full convertibility of domestic currencies
for current account transactions. The prevailing capital scarcity, especially in
the form of foreign currency (in this particular case US dollars), of the post-
World War II period was just coming to an end. For the rebuilding of Europe all
attention was directed towards the restoration of open markets for goods and
services. The opening up of financial markets was seen as far less important.
44
The provisions with respect to capital movements were the result of a
compromise. The Dutch attitude was important because by aligning itself to
the French dirigistic position it tipped the balance towards an ambiguous text.
The escape clause - to the extent necessary to ensure the proper functioning
of the Common Market - was proposed by the Netherlands delegation and
after having received support from France and Belgium was accepted despite
German protests. 20 It was a formula which succeeded in allaying the French
fears in respect of full freedom of capital movements. Each country was free
to choose its own interpretation and France's interpretation would be more
restrictive than that of other countries. 21 The list of Dutch desiderata, as
discussed on page 39, was more or less fulfilled. The Dutch and the French
had advocated decision-making by unanimity during the entire transitional
period, and had only accepted such unanimity for only the first two stages
after other member states had reluctantly agreed to the inclusion of the clause
d 'urgence. At a Dutch initiative Article 68.3 was inserted at a rather late stage,
in which it was provided that there would be no obligation to liberalize loans
of other EEC governments on the domestic capital market. 22 This article
was regarded by the Dutch delegation as an example of a movement of
capital which was not necessary for the proper functioning of the Common
Market. Finally the Dutch had succeeded in introducing a safeguard clause
for disturbances on the domestic capital market, although the employment
motive was not accepted. In its explanatory memorandum to parliament the
Dutch government, rather than espousing the goal of free movement of capital,
elaborated lenghtily on those categories of capital transactions which in the
Treaty were not deemed necessary to ensure the proper functioning of the
Common Market, including categories for which safeguard clauses could be
invoked. Such a broad interpretation of the general escape clause was a far
cry from the goal of freedom of capital movements.

3.7 PUBLIC REACTIONS

The public reactions to the Treaty on the topic of capital liberalization were
mixed. To the observers of the day it was apparent that in the sphere of
capital liberalization the Treaty mainly consisted of good intentions. Not all
official arguments for maintaining capital restrictions in one way or another
were accepted by commentators. Two examples of such reactions from the
financial and commercial community are the comments of the European
Banking Association and of the International Chamber of Commerce.
The European Banking Association, in a memorandum submitted in July
1958, considered that the European Community would only become a full
success if there would be freedom of capital movements. The right of estab-
lishment in the Community would be an illusion if the transfer of capital,
needed to bring this about, would not be allowed. 23 The bankers did not deny
 45

that disturbing capital flows could occur, but they pointed out that capital
movements, even speculative ones, generally were a consequence rather than
the cause of balance-of-payments imbalances. Nevertheless, they admitted
that diverging policies between member states might continue to call for some
capital restrictions. They concluded that effective coordination of economic,
monetary and financial policies was essential for the total liberalization of
capital movements.
Another interesting comment on the Treaty was given by the International
Chamber ofCommerce. 24 This organization had asked a committee under the
chairmanship of Maurice Frere, the President of the Bank for International
Settlements and former Governor of the National Bank of Belgium, to com-
ment on the monetary provisions of the Treaty, including those on capital
movements. The committee did not accept the lack of coordination of mone-
tary policies, which was used as an excuse for the maintenance of exchange
restrictions, as a given fact. It sought actively to restrain policy autonomy for
member states and so to impose a degree of discipline which would make the
freedom of capital movements a less risky affair. The committee argued that
one of the first measures of harmonization under the Treaty should apply to
the conditions under which the national central banks could provide credit.
It noted that in this respect there were important differences among member
states, which also extended to the relationship between the central bank and
the government. It was of course realized that any change in this relationship
would have serious political implications. Therefore, it confined itself to a
concrete operational proposal: governments should renounce the taking up
of new credits with their central banks, except in exceptional circumstances
to be judged by a third party. Such renunciation would have disciplinary
effects on the public sector. Governments would have to balance receipts and
expenditures in such a manner as not to overburden the domestic money and
capital markets. At the same time it would strengthen the position of the cen-
tral banks and provide them with the independence needed for a satisfactory
operation of the monetary policies of the Community. In this way a truly
'monetary' Community could evolve, which one day, political circumstances
permitting, could have a single currency. Both these public reactions show
that there were genuine pressures in society to force upon the authorities a
greater commitment to free capital movements. The banking community took
issue with the official argument that capital controls were needed to contain
speculation, the commercial community wished to introduce mechanisms to
enforce greater fiscal and monetary discipline as a condition for freedom of
capital movements. The latter gave a visionary advice, which did not go down
well in political circles. Only in the framework of the Treaty of Maastricht
was a prohibition against monetary financing of governments by central banks
agreed upon, effective I January 1994, 35 years after the recommendation.
46

TABLE 5
Selected judgements of the European Court of Justice.

November 1978 Thompson Case 7/78

The term movement of capital is roughly delineated by distinguishing between financial,
real and monetary capital.

November 1981 Casati Case 203/80

Article 67 regarding capital movements does not have the same direct effect as the other
fundamental freedoms of movement of goods (Article 30), persons (Articles 48 and 52)
and services (Article 59).

January 1984 Luisi & Carbone Case 286/82 and 26/83

Further definition of movement of capital as financial operations directed towards depositing
or investing, to be distinguished from current payments as settlement for goods or services
rendered. Safeguard measures under Articles 108 and 109 only to be applied in periods of
crisis. Freedom of payments (Article 106) declared directly effective.

June 1986 Brugnoni & Ruffinengo Case 157/85

Administrative restrictions must be abolished with respect to fully liberalized capital move-
ments under the EC directives.

3.8 INTERPRETATIONS BY THE COURT OF mSTICE

In the course of the years the European Court of Justice has given a number
of judgements on the purport of the Treaty provisions concerning capital
movements. The most important ones have been recapitulated in Table 5.
Some judgements were directed towards defining a dividing line between
current account and capital account transactions, the Treaty itself lacking
a proper definition of capital movements. In the Luise and Carbone case
(1984) the Court ruled that capital movements were to be defined as financial
operations directed towards depositing or investing of means of payment and
not as the settlement of an underlying real transaction. Two years later, in the
Brugnoni and Ruffinengo case, the Court ruled that discriminatory national
regulations concerning liberated capital transactions should be eliminated as
well.
Some judgements elaborated on the philosophy of the drafters of the Treaty
with respect to the freedom of capital movements. Interestingly the Court gave
a rather restrictive interpretation of the Treaty provisions as late as 1981 in
the Casati case. 25 The Court ruled that the freedom of capital movements did
not directly follow from the Treaty and therefore indeed was on a different
footing than the other three freedoms. In its interpretation of the escape clause
the Court stated: 'At present, it cannot be denied that complete freedom of
 47
movement of capital may undermine the economic policy of one of the
Member States or create an imbalance in its balance of payments, thereby
impairing the proper functioning of the Common Market.' Consequently,
the scope of the restriction 'varies in time and depends on an assessment
of the requirements of the Common Market and on an appraisal of both the
advantages and risks which liberalization might entail"'. The Court noted that
there were close links between the movement of capital and the economic
and monetary policies in the member states. Apparently it judged that the
extent of liberalization of capital movements should depend on the degree of
equilibrium in economic and monetary policies among member states. Thus
the Court implicitly argued that satisfactory policy coordination, to which
Article 105 of the Treaty obliges the member states, should precede full
capital liberalization.
The Court's cautious attitude can be understood against the background of
the currency unrest in the beginning of the 1980s. It shied off from reasoning
away the escape clause in Article 67, but the Court reserved the right to
come back to the issue if it felt that the Council backed off from the Treaty
obligations. In later years the Court in practice would merely follow the
political agreement reached elsewhere on the pace of capital liberalization in
the Community. With respect to the freedom of capital movements the Court
of Justice did not play an independent, initiating role.

3.9 THE INVOLVEMENT OF THE IMF AND THE OECD IN CAPITAL

LIBERALIZATION

This study deals with the manner in which the articles of the Treaty were giv-
en content in later years by the secondary legislation adopted by the member
states. This emphasis on the role of the European Community in the process
of capital liberalization has been chosen as it best permits the linkages with
the other policy domains to be illustrated. In the deliberations within the
Community institutions the political and economic quid pro quos prominent-
ly came to the fore, because capital liberalization was part and parcel of a
wider-ranging drive towards integration. This focus on the European Com-
munity, however, is not in any way intended to detract from the contributions
made by other international organizations with respect to the liberalization of
capital movements. In particular the Organisation for Economic Cooperation
and Development has played an important role. Lately also the Internation-
al Monetary Fund is showing a keen interest. As an aside, it is therefore
appropriate to deal briefly with the relevant provisions of these international
institutions.
Although the Treaty is not ambitious in its aims for capital liberalization,
it goes far beyond the detached attitude taken in the Articles of Agreement
of the International Monetary Fund, which had been drafted 13 years earlier,
48
in 1944. Article VI, Section 3, explicitly condones the imposition of capital
restrictions 'as are necessary to regulate international capital movements'.
This was seen by the founding fathers as a necessary instrument in the context
of the Bretton Woods system of fixed parities. In the original proposal of
Keynes for a Clearing Union there was even an outright plea for control of
all capital movements: ' ... control of capital movements, both inward and
outward, should be a permanent feature of the post-war system' .26 Of course
it could be objected that ' ... control, if it is to be effective, probably requires
the machinery of exchange control for all transactions, even though a general
permission is given to all remittances in respect of current trade', but Keynes
argued that effective control of capital movements necessitated controls at
both ends and thus a multilateral control system. The main purpose was that
countries should be able to protect themselves against short-term speculative
movements. International investment flows for legitimate purposes of course
should not be hindered. To this end the control system should distinguish
between investment loans from surplus countries, which should be facilitated,
and flows out of deficit countries, which should not be encouraged if the
country was lacking the necessary financial means.
White in his plan for a Stabilization Fund, in accordance with the official
United States view that trade and capital flows should be interfered with
as little as possible, took a more liberal stance, contemplating the abolition
of exchange control, except when approved by the Fund. At the constituent
meeting the view of other countries prevailed that the postwar world would
require the use of exchange controls. Apparently, memories of the disturbing
role of speculative capital movements in the Interbellum, hot money as these
flows were then called, were still all too vivid. It was believed that authorities
could follow more effectively stimulative policies, aimed at full employment,
behind restrictive walls. In this way fixed exchange parities and a certain
measure of autonomy over domestic monetary policy could be maintained.
Moreover, on the hypothesis that the United States was to remain the most
important surplus country and thus the main financier of the IMF, the drafters
wanted to avoid that Fund resources taken up by deficit countries would be
used to finance capital flows out of Europe into the United States.
Article VI has given rise to controversies in the Executive Board of the IMP.
As early as in 1946 the US Director asked for an interpretation of the article.
It was then decided that Fund resources could only be used to finance a deficit
on the current account. 27 In practice, a more generous attitude was taken and
in 1961 the Board formally reversed this interpretation to the effect that Fund
resources could also be used to finance capital flows, as long as they were
not big and continuous. The IMP never has requested a member country to
impose capital restrictions, neither on outflows nor on inflows, although it was
empowered to do so in case of use of Fund resources. Gold (1977) asserts that
by adopting such attitude the Fund has acknowledged an almost completely
unfettered discretion of members to impose or to refrain from imposing capital
 49
Article VI of the IMF's Articles ofAgreement

Capital Transfers

Section 1. Use of the Fund's general resources for capital transfers

(a) A member may not use the Fund's general resources to meet a large or sustained
outflow of capital except as provided in Section 2 of this Article, and the Fund may
request a member to exercise controls to prevent such use of the general resources
of the Fund. If, after receiving such a request, a member fails to exercise appropriate
controls, the Fund may declare the member ineligible to use the general resourses of
the Fund.
(b) Nothing in this Section shall be deemed:
(i) to prevent the use of the general resources of the Fund for capital transactions
of reasonable amount required for the expansion of exports or in the ordinary
course of trade, banking or other business; or
(ii) to affect capital movements which are met out of a member's own resources,
but members undertake that such capital movements will be in accordance with
the purposes of the Fund.

Section 2. Special provisions for capital transfers

A member shall be entitled to make reserve tranche purchases to meet capital transfers.

Section 3. Controls of capital transfers

Members may exercise such controls as are necessary to regulate international capital
movements, but no member may exercise these controls in a manner which will restrict
payments for current transactions or which will unduly delay transfers of funds in settlement
of commitments, except as provided in Article VII, Section 3(b) and in Article XIY,
Section 2.

TABLE 6
Acceptance of the Article VIII obligation.

15 February 1961 Belgium

France
Germany
Ireland
Italy
Luxembourg
The Netherlands
United Kingdom
1 May 1967 Denmark
15 July 1986 Spain
12 September 1988 Portugal
7 July 1992 Greece
50

controls. Nowadays the article, which in essence remained unchanged in the

subsequent amendments of the IMP's Articles of Agreement,28 does not play
a major role. The IMP has concentrated its efforts on bringing about current
account convertibility among its members. On 15 February 1961 all six
EEC member states accepted, together with some other industrial countries,
ArticJe VIII of the Fund's Articles of Agreement (see Table 6). Under this
article countries assume the obligation to maintain currency convertibility for
current transactions and to abstain from applying any restrictions on current
payments or discriminating vis-a-vis other countries. It was only in 1992
that Greece as the last EEC member state was to acquire Article VIII status.
Presently a little over one half of the IMP membership has accepted the
Article VIII obligations.
Despite the focus of the Fund's Articles of Agreement on current account
convertibility the IMP has in the course of the years taken a more active
stance in the promotion of free capital movements. It was particularly active
in the fight against multiple exchange rate regimes, although it was lenient
with respect to the Belgian dual exchange market type where a distinction was
only made between current and capital transactions. Nowadays, in some of
its programs capital liberalization measures are supported by Fund resources,
since it increasingly has been realized that capital controls are not only inef-
fective in avoiding capital flight - Latin America in the 1980s constituting a
prime example of the powerlessness of comprehensive exchange control sys-
tems - but that they may discourage direct investment and long-term portfolio
inflows. At the Interim Committee meeting in Madrid in October 1994 mem-
ber states were encouraged to remove impediments to the free flow of capital.
The time seems to be ripe to extend the responsibilities of the IMP to the
overview of capital controls in view of the fact that most members now have
eliminated exchange restrictions on most current transactions. This would fill
an institutional gap because presently there is no international agency which
exercises jurisdiction on a global scale on capital transactions.
Right from its start in 1961 the Organisation Jor Economic Coopera-
tion and Development, which has mainly industrialized countries among its
membership, has added the progressive freedom of capital movements to the
continued vocation of promoting the liberalization of international trade in
goods and services taken over from its predecessor the OEEe. In this respect
the OECD has established a separate policy role which distinguishes the
organization from the IMP and the GATT, despite the considerable overlap
in their respective general mission 'statements (see Table 7). In the OECD
Convention member states have agreed that they will endeavour to extend
the liberalization of capital movements. 29 To this end they can voluntarily
undertake obligations resulting from decisions of the OECD Council. These
obligations, once they are accepted, have a binding character. Over time these
obligations have been regularly updated in the Code oJLiberalization oJCap-
ital Movements, which was first drafted in 1961, the year of foundation of the
 51

TABLE 7
The distinctive roles of international institutions.
Institution Primary policy area Provisions with respect
(year of foundation) to capital movements

IMP 1946 international monetary system, members may exercise such

adjustment process capital controls as are necessary
to regulate international capital
movements
OATIl 1947 trade liberalization nil
EEC 1958 common market, economic progressive abolition of capital
integration controls to the extent necessary
to ensure the proper functioning
of the Common Market
OECD 1961 economic cooperation progressive abolition of capi-
tal controls to the extent nec-
essary for effective economic
cooperation

I The World Trade Organization will be mandated to pursue the liberalization of financial
services.

OBCD.30 Interestingly, the OBCD Code, too, contains a conditional clause

for such liberalization. Article 1 spells out that its member countries shall
progressively abolish between one another restrictions on movements of cap-
ital 'to the extent necessary for effective economic co-operation'. Whereas
in the Treaty of Rome the proper functioning of the Common Market is the
leading principle for the extent to which countries undertake liberalization
obligations, in the framework of the OECD, a cooperative organization par
excellence, it is the effectiveness of international cooperation. Admittedly as
vague a notion as the escape clause in the BBC Treaty, but with a different
emphasis. The BBC provisions, as interpreted by the Court of Justice in the
Casati case, postulate cooperation between member states as a preliminary
condition for capital liberalization. The OBCD provisions consider capital
liberalization useful in so far as it contributes to, or at the least does not harm,
policy cooperation. However, this difference of degree did not have a great
practical impact as to the manner in which capital restrictions were treated by
the organizations.
Like the safeguard measures contained in the Treaty of Rome the OBCD
Code provides for exemptions under similar circumstances. The clauses of
derogation may be invoked if a country's economic and financial situation
justifies the taking of measures, if there are serious economic and financial
disturbances, or if the overall balance of payments and the country's offi-
cial reserves deteriorate seriously.31 An important element of the Code is
52

80 _ __

%
~
-----%-
%
60
~
~
!O
~
%

10

~
IIi! 191! 198! IHO 199!

~
Belgium, F,.<lnce, Denmork , Ireland, Greece . Portugol.
Germony. Itoly. United Kingdom Spoin
the Netherlo"-'ds

BoseCl on various OCCO Cloto Pe,ccF\loge oj items 01 the liDerQlizotion

COde covereCl ~y reservations. rhe cove-rage of the code has be-en ex"onde<l
In 1964 , 197:5. 1984 one 1989.
1994' EstImated.

Fig. 6. Position of EEC member states under the OECD liberalization code.

that member states cannot retract from liberalization measures unless they
ask for a derogation from their obligations. There thus is a 'ratchet mech-
anism' which is designed to consolidate the liberalization gains, once they
are achieved. This mechanism is similar to the standstill undertaking in Arti-
cle 71 in the Treaty, which provides that member states endeavour to avoid
introducing new restrictions or making existing rules more restrictive. 32 The
peer pressure exerted in the regular examinations can positively influence
the member states. The Code also sees to it that restrictions are applied in
a non-discriminatory manner. On the other hand, there is no mechanism or
sanction to enforce obligations on the OECD membership. On the whole, the
Code has not been a very powerful liberalization instrument.
Just as the application of controls within the framework of the European
Community has been regularly examined in the Monetary Committee, the
OECD member states have bee,n regularly examined in the OECD Committee
on Capital Movements and Invisible. Transactions (CMIT). In this examina-
tion countries have had to justify any retained restrictions. Apart from the
EEC directives, the OECD Code has been the only multilateral instrument
promoting the liberalization of capital movements. Its content and scope in
general have kept pace with the current state of liberalization, although, of
course, it has been attempted to be somewhat ahead of the common denomi-
nator in order to prevent the pace from being dictated by the most restrictive
countries.
 53
3.10 CONCLUSION

The drafters of the Treaty of Rome had shown vision in their design of a
Common Market. Although the Treaty was less ambitious in its operational
design than the earlier European Coal and Steel Community, the fact that
the six countries could reach agreement on such a goal with far-reaching
implications as to cooperation and coordination was significant. However,
in the field of capital movements it is obvious that caution prevailed. Pro-
gressive liberalization and non-discrimination are guiding principles. But the
subordination of the goal of free capital movements to the higher-ranking
goal of the free movement of goods in the Common Market shows that the
Treaty was indeed primarily designed to achieve a customs union, albeit with
a wider-reaching institutional and cooperative design, and that there were
fears that free trade could be imperilled by destabilizing capital flows. The
main motives for retaining capital restrictions were: the maintenance of a
certain degree of autonomy for economic and monetary policy, the wish to
raise obstacles to speculative short-term capital movements, and the desire to
protect domestic capital markets.
In the prevailing situation of fixed exchange rates under the Bretton Woods
system - which implicitly was taken for granted by the drafters of the Treaty -
the wish to maintain a measure of autonomy in the conduct of monetary poli-
cies seemed to justify for most countries the maintenance of capital controls.
Exchange rate coordination had been one of the weak spots in the Treaty,
where Article 107 stipulated merely that policies with regard to exchange
rates should be a matter of common concern. 33 More in general, the Treaty
follows a minimalistic approach in the monetary area. Monetary coordination
could not properly come off as long as there were no forceful Treaty provi-
sions with respect to coordination of national budgetary policies, the most
conspicuous hiatus in the Treaty. In essence member states were not prepared
to surrender competences in the financial field. It is therefore not surprising
that in the area of capital movements, where potentially supranational powers
are assigned to the Community, with close links to both internal and external
monetary policy, the drafters have been cautious. The majority view was that
short-term, monetary capital flows, which more often than not were associ-
ated with speculation, did not contribute to economic integration and could
hinder monetary policy.
Long-term capital outflows were regarded as a drain on domestic resources.
Allowing non-residents on the domestic capital markets often ran counter to
the desired regulation of those markets. Moralistic arguments were used to
defend this position, such as the fear that productive capital would flow from
poor to rich areas of the Community. Understandable as this fear may have
been at a time of capital scarcity, the Treaty had provided the very instruments
to counter deprivation of underdeveloped areas, such as the social funds and
the European Investment Bank.
54

The overriding desire to ensure freedom of trade, stability of exchange rates

as well as autonomy of monetary policy made it imperative that any obligation
to liberalize capital movements was circumscribed. The more liberal, market-
oriented economies of Germany and Belgium willingly accepted that the more
dirigistic policies - albeit in varying shades - followed in France, Italy and
the Netherlands called for exchange regulations for capital movements. For
Belgium and Luxembourg, the dual market functioned as a shock absorber if
inconsistencies arose between domestic monetary policies and the fixity of the
exchange rate. Germany in principle did not avail itself of market regulation
- although for a long time it would discourage the internationalization of the
Deutsche mark - but it did not press for such liberalization in other countries,
because it did not need foreign capital and its stability-oriented policies could
be undermined if premature liberalization would facilitate speculative capital
fleeing other member states.
All in all the Treaty provisions on capital liberalization, as well as their
later political and legal interpretation, show that in the sequencing of the
whole process of liberalization the freedom of capital movements was given
relatively low priority. Characteristics of sequencing, such as a ranking order,
a time framework, the fulfilment of conditions and linkages with other policy
domains, show up in the relevant Treaty provisions:
- hierarchy - trade liberalization is put first and foremost, before capital
liberalization (Article 3);
- gradualism - a progressive step-by-step approach is to be followed (Arti-
cle 67);
- conditionality - capital liberalization is confined to the need to ensure
the proper functioning of the Common Market (escape clause, Article
67);
- interlinkages - the freeing of financial services, connected with the
movement of capital, shall be effected in step with capital liberalization
(Article 61.2).34
These characteristics of sequencing incorporated in the Treaty implied that
actual obligations with respect to capital movements would be phased in,
depending on progress in other areas. In practice the lack of policy coordina-
tion and, consequently the divergence of economic performance, would prove
to stand more in the way of capital liberalization than the lack of progress in
other domains, including the remaining three freedoms.
Notwithstanding the fact that the actual state of capital liberalization dif-
fered considerably among the six members states, the Treaty made no attempt
to impose a minimum regime of liberalization. In practice, this would mean
that further obligations to liberalize would have to be worked out and would
form the subject of negotiations. The lack of a Treaty provision for a minimum
regime put the countries with a restrictive regime in a stronger negotiating
position: they were the ones who had to give up national control instru-
ments which the countries with a liberal regime already had abandoned. The
 55
position of the latter was already weakened by the standstill provision in
Article 71 which stipulated that countries would endeavour not to introduce
new restrictions nor make existing rules more restrictive, although admittedly
the frequent and continued recourse by the restrictive countries to safeguard
measures had undermined this provision.
Although the liberalization of capital movements within the European
Community is the subject matter of this book, important work in this area has
been done in the framework of the aECD as well. At times this has resulted
in cross-fertilization, each of the organizations taking the lead in turns. The
important liberalization drive in the 1980s, however, primarily had its roots in
intra-EC discussions, in part resulting from a fresh analysis of the effective-
ness of controls in view of the globalization of international financial markets.
Here the European Community took the lead. After European liberalization
directives had been adopted, the aECD Code could be significantly extended
as well. The role of the IMP in the process of capital liberalization has been
a much more modest one, in particular because in its Articles of Agreement
the primary principle with respect to capital is that member countries are
free to control international capital movements. The IMP, however, has been
actively involved in the liberalization of current account payments - at the
foot of the pyramid of capital movements - and in the pursuit of unification
of multiple exchange rate systems. It would be worthwile to explore whether
the IMP's responsibilities could be extended to cover capital liberalization as
well. This would fill a global institutional gap.

NOTES

1. Eichengreen (1993) argues that the EPU had important positive spill-over effects for the
European countries by actively encouraging intra-European trade liberalization.
2. Compare Eichengreen (1993), p. 40. On further consideration Eichengreen argues that
in the post-war years a surge of inward foreign investment would not have materialized
anyway because US private lenders were still demoralized about the interwar defaults (p.
116 et seq.).
3. In its explanatory memorandum addressed to parliament, attached to the EEC Treaty
proposals, the Dutch government takes this principle as a point of departure (Memorie van
Toelichting, zitting 1956-57, no. 4725.3, p. 3 et seq.). The argument had been elaborated
earlier by Beyen in a speech in 1955, reproduced in Hommes (1980), p. 170-182, in which
he concluded: 'economic strength is the necessary foundation for maintaining European
political unity'.
4. In the subcommittee which prepared this part of the report, headed by Verrijn-Stuart, the
question whether the safeguard clauses would remain possible in the final stage had not
yet been decided. Two conflicting views were presented, one arguing the total demise of
capital controls without fall-back postition, and the other arguing the need for an escape
clause in case of balance-of-payments difficulties (Rapport de la Commission du March6
Commun, des investissements etdes probl~mes sociaux, 17 October 1955, Brussels, p. 52
et seq.). Apparently the latter view prevailed (see also note 8).
5. Marjolin (1989), p.288.
56
6. In the Dutch eyes the Gennan interest level was 'extremely' high (Ministry of Finance
memorandum, 15 February 1958). This could in part probably be ascribed to the Bun-
desbank's restrictive monetary policy, but the relatively underdeveloped capital market -
'badly organized' - may also have been a factor.
7. Marjolin (1989), p.3~301
8. The view of the Belgian experts in the Spaak Committee that in the final stage no safeguard
clauses with respect to freedom of capital movements should apply prompted a missive
of the Dutch authorities to their Belgian counterparts, calling on them to display Benelux
solidarity and accept the maintenance of safeguard clauses (letter Ministry of Finance,
dated 10 October 1955).
9. Holtrop (1956), p. 819. For a more general description of Holtrop's line of thought see
Vanthoor (1993).
10. Holtrop (1956), p. 821.
11. Memorandum of 16 May 1959, De Nederlandsche Bank.
12. De Nederlandsche Bank, Annual Report 1957, p. 18.
13. Listing based on various internal memoranda of the Ministries of Finance and Foreign
Affairs and the Nederlandsche Bank, 1956 and 1957.
14. In Article 107, which requires member states to treat their exchange rate policies as a matter
of common concern, member states may be authorized to take countervailing measures
if one of the member states carries through a competitive devaluation. In practice this
provision has not been applied by the Commission.
15. Kapteyn et al. (1987) consider the freedom of payments, as laid down in Articles 67.2 and
106, the fifth freedom.
16. Article 69 provides for unanimity during the two first stages and for decision-making by
a qualified majority thereafter. In the Single European Act, which became effective on 1
July 1987, the provisions with respect to capital movements between member states and
third countries were amended to the effect that decisions in this sphere would be taken by
qualified majority as well (Article 70.1).
17. Articles 30 (free movements of goods), 48 and 52 (free movement of persons and right
of establishment), and 59 (free movement of services). These articles, other than Article
67, are directly applicable and thus extend rights which EEe citizens may invoke against
contrary provisions of national law.
18. Article 2 provides that the progressive 'approximation' of economic policies, together
with the establishment of a common market, is one of two means to attain the goals of
the Treaty; Article 103 provides that member states regard their conjunctural policies
as a matter of common concern; and Article 145, first indent, provides for the general
coordination of economic policies of member states by the Council.
19. Ruding (1969, p. 200) makes a distinction between capital in the real economic sphere
and in the financial sphere. In the latter sense 'financial capital' is closely related to money
(op. cit., p. 7). He concludes that the Treaty contains the obligation that a common market
for 'real capital', such as direct investment or transactions in securities, is established, but
not one for 'financial capital'. In his view capital liberalization is not to be regarded as
an independent obligation under the Treaty itself, but as a complementary obligation with
respect to the Common Market for goods (op. cit., p. 477). There is a certain parallel with
the subdivision given by the Court of Justice in its judgement in the Thompson case (case
7178), where a distinction was made between financial, real and monetary capital.
20. Presentation of country positions based on internal memoranda, De Nederlandsche Bank,
January 1957.
21. Marjolin (1969), p. 301, in describing the French fears, seems to suggest that France was
the auctor intellectualis of the escape clause.
22. See Kapteyn et al. (1987), p. 297.
23. Article 221 provided that as from 1961 all EEC nationals should be accorded equal
treatment as regards participation in the capital of companies. In practice, however, this
 57
article did not play a large role because of its subordination to other provisions in the
Treaty.
24. Declaration of the International Chamber of Commerce on Monetary issues in the Euro-
pean Economic Community, Paris, 6 May 1958.
25. Judgement of the European Court ofJustice on 11 November 1981, case 203/80. Casati, an
Italian citizen resident in Germany, had been arrested for exporting bank notes out of Italy.
He argued that he had taken the bank notes with him out of Germany to buy inventory
in Italy, but that he had to return empty-handed because the factory was closed. This he
could not prove and the Court decided that the EEC provisions would not invalidate the
imposition of a fine on Casati because the export of bank notes did not fall under the
liberalization obligations of the Community.
26. Proposals for an International Clearing Union (April 1943), reproduced in Horsefield
(1969), Vol. III Documents, p. 32.
27. See Gold (1977), p. 23-26.
28. Only Article VI(2), concerning specific IMF-related provisions, has been amended.
29. Article 2 of the OECD Convention stipulates that member states will ' ... pursue their
efforts to reduce or abolish obstacles to the exchange of goods and services and current
payments and maintain and extend the liberalization of capital movements ... '.
30. The Capital Movements Code was expanded in 1964; there were two additions in 1973
and 1984, which dealt with operations in collective investment securities and with direct
investment respectively. Up till the mid-1980s the Code, as a reflection of current practice
in most member states, was confined mainly to long-term capital flows and did not apply to
short-term financial transactions, such as money-market activities. In May 1989 a major
revision of the Code was agreed upon. All capital movements, including cross-border
financial services, money-market activities and financial innovations, such as swaps and
options, were included in the coverage of the Code. See for an exhaustive description
Liberalization of capital movements and financial services in the OECD area, OECD
(1990).
31. Article 7 of the Code of liberalization of capital movements. Articles 13 to 15 provide for
the notification and examination procedures of derogations.
32. The 'standstill' provision has been strengthened through the amendment in the Single
European Act in Article 70.1, where it was provided that measures which constitute a step
back as regards the liberalization of capital movements could only be taken by unanimous
consent.
33. This weakness was demonstrated already on the first occasion of a major readjustment
of exchange rates, in 1961, when the Deutsche mark and the Netherlands guilder were
revalued. In its Annual Report on 1961 the Monetary Committee notes disapprovingly
that these decisions were taken without full ex ante coordination within the EEC.
34. In practice for the liberally-oriented countries, as Germany, the Netherlands and the United
Kingdom, the actual liberalization of capital movements, and not the minimum obligatory
liberalization regime, determined the liberalization of services of banks ·and insurance
companies.
 CHAPTER 4

The Role of the Monetary Committee

1 have always felt that the Monetary Committee has made an

immense contribution to international cooperation by demonstrat-
ing how a small group of people who know each other well can
easily break through the barriers of rigid national positions and
develop new orientations. which are accepted and welcomed by
governments.
Emile van Lennep. 1978

4.1 INTRODUCTION

In the process of capital liberalization in Europe the Monetary Committee

of the European Community has played an influential role. The committee,
where high-ranking officials regularly meet, provides a unique forum for
frank and open policy discussions on issues of common concern and where its
members do not immediately bind their countries' positions. In this committee
the policy aspects of liberalization came to Lle fore in a dialogue between the
Commission, as the guardian of the Treaty, and the member states. Both the
imposition of exchange controls as well as their abolition having significant
implications for other policy areas, the Monetary Committee provided the
natural forum for a thorough discussion of these wide-ranging consequences.
In order to put these discussions into the proper perspective we will investigate
in this chapter the role of the Monetary Committee in its different aspects.
We will allow ourselves a few asides which may be useful in throwing some
light on this rather uncharted terrain.

4.2 THE TREATY STATUS OF THE MONETARY COMMITfEE

The Monetary Committee is the only committee of officials, presently func-

tioning in the Community in the economic area, which is mentioned explicitly
in the Treaty of Rome. 1 Other committees, like the Committee of Governors
of the Central Banks or the Economic Policy Committee, have been estab-
lished by the Council pursuant to relevant provisions in the Treaty. 2 In Article
105(2) the legal basis for the Monetary Committee can be found:
'In order to promote coordination of the policies of Member States in the
monetary field to the full extent needed for the functioning of the common

58
 59

market, a Monetary Committee with advisory status is hereby set up. It

shall have the following tasks:
- to keep under review the monetary and financial situation of the
Member States and of the Community and the general payments system
of the Member States and to report regularly thereon to the Council and to
the Commission;
- to deliver opinions at the request of the Council or of the Commission
or on its own initiative, for submission to these institutions.
The Member States and the Commission shall each appoint two mem-
bers of the Monetary Committee. '

The special Treaty status of the Monetary Committee gives this body an
added significance, which had been the outcome of intense discussions on the
content of economic and monetary cooperation. The burial of the European
Defence Community in the French Assemblee in 1954 had made it clear
that supranational solutions with respect to European integration would be
unattainable. The result was that the Treaty, as enabling legislation, had a
dualistic character: the Treaty declared various policy areas as matters of
common concern, but fell short of declaring those areas as matters of com-
mon competences. Therefore, in practice the coordination of policies between
member states in the areas of common concern was of a non-conmittal char-
acter. There were no ways for the Community to enforce decisions in the
areas of common concern because it lacked the powers to do so. All depend-
ed therefore on the good-will of the member states to coordinate voluntarily
or on the adoption of secondary legislation, which would provide for such
cooperation to be enforceable.
This dualistic design of the Treaty was particularly visible in the phrasing of
the provisions relating to exchange rate policy. In Article 107.1 each member
state is called upon to 'treat its policy with regard to rates of exchange as a
matter of common concern.' But the Treaty does not provide for Community
competences in the area of exchange rates. The latter is hardly surprising
given the feeble provisions regarding economic policy coordination. The
Commission, being denied concrete powers in the field of economic let alone
monetary policies, could not be given competences in the area Of exchange
rates, which are the very outcome of economic and monetary policies.
The caution exercised in the Treaty concerning the coordination in the mon-
etary field and the abolition of exchange restrictions reflected the prevailing
preference at the time for trying to isolate domestic money and capital mar-
kets from international developments. At the same time, this isolation made
it possible to conduct domestic monetary policy in a relatively autonomous
manner. Moreover, the national competences with respect to monetary policy
varied greatly. The newly created Deutsche Bundesbank3 was independent in
the conduct of monetary policy, whereas, at the other side of the spectrum,
the Banque de France in the post-war nationalization had surrendered many
60
of its powers. The Treaty of Rome thus could not provide for any imperative
mechanism for the coordination of monetary policies.
The dualistic approach of the Treaty as regards economic and financial
policies - yes to the coordination of areas of common concern, no to the
surrender of national sovereignty to the Community level -, taken together
with the purpose of the Treaty - 'to the extent necessary for the proper
functioning of the Common market' - made it imperative that mechanisms
were established to ensure that these areas of common concern would be
treated properly and that coordination would not prove to be a dead letter.
Yet, in the economic field, where the need to coordinate figures prominently
in the Treaty, the drafters saw no need to explicitly establish the institutional
framework for this coordination at the level below the Council. Apparently, it
was supposed that the appropriate mechanisms would work out themselves.
Conversely, in the monetary field and as regards exchange rate policy no
explicit powers were formulated in the Treaty.
Nevertheless, there was a wish to fill this void in the monetary policy area.
The drafters of the Treaty chose to set up a committee, with coordinating
powers and, in the interest of the Community, independent expert members
and its own statute. The Monetary Committee thus introduces a Community
element and is shaped to further the goals of the Community. 4 At the same
time the committee has an independent institutional position sui generis within
the Community. It acts independently of the national states, the Commission
and the preparatory bodies of the Council, i.e. the General Secretariat of the
Council and the Coreper. 5 This position sui generis is the natural reflection
of the dualistic character of the Treaty in the economic and monetary field
and of the distinct institutional position of the national central banks in the
member states. In its first Annual Report the Monetary Committee addresses
this dualistic character and describes in passing its raison d'etre in a crystal-
clear manner: 'In Articles 104 and 107 of the Treaty the responsibility of
each member state in determining its own economic and monetary policies is
affirmed. However, in their policy execution member states have to take into
account the objectives of the Treaty; therefore Article 105 provides for the
coordination of economic and monetary policies, because, if such policies
were to diverge too much, they could lead to the application of safeguard
clauses, which would endanger the establishment of the Common Market.'
The progress achieved in restoring external convertibility and liberalizing
trade should not be put at risk. Indeed, it is significant that the article estab-
lishing the Monetary Committee is inserted in the Treaty in the chapter on
the Balance of Payments. Apparently, there must have been strong fears that
exchange rate or balance-of-payments disturbances could lead to a deceler-
ation in the process of trade liberalization or even to the reintroduction of
trade barriers. This may be one major explanation of the Treaty status of the
Monetary Committee: it was of overriding importance that the work of this
committee would create conditions in the monetary and financial field which
 61
would not jeopardize the attainment of the goal of the Common Market. The
further-reaching objective of monetary and financial integration, which would
later come to the fore in the committee, was not yet an issue in a world which
lived in the relative calm of the Bretton Woods system.
However, the creation of the Monetary Committee was not undisputed. In
the Brussels preparatory conference on the Common Market6 the German
delegation unexpectedly opposed the creation of the Monetary Committee. It
considered that the European Commission would suffice. In the background
there was the fear on the German side that the Monetary Committee would
be invested with more than advisory powers and thus would undermine
the position of the Commission. The German delegation stood alone in this
respect and at a later stage joined the majority. As we will see in this study, the
relationship between the Monetary Committee and the Commission indeed
would not always be an easy one. Theirs would be a love-hate relationship,
each quarrel being ended with the confirmation that they needed each other.

4.3 THE TASKS OF THE MONETARY COMMITTEE

The powers of the committee are carefully circumscribed, in line with the
dualistic character of the Treaty in the monetary and economic sphere. The
committee can only 'keep under review', 'report' and 'deliver opinions'.
The promotion of the coordination of monetary policies in the framework
of the committee is limited to the extent needed for the functioning of the
Common Market. From this description of competences it cannot easily be
gauged that in fact this committee has evolved into one of the most influential
policy-making bodies in the Community. The latter can be ascribed to the
wide-ranging areas in which the committee would be called upon to advise
in the years to come, where it acted as the main preparatory forum for the
meetings of the Council of Ministers. Its strength is in part precisely based
on the lack of a supranational common authority in these areas. Kees (1984)
writes that 'throughout the committee's history there has been no example of
the Council taking a decision that went against an orientation expressed by
the committee.' What was true before 1984, remains true until this very day.
Apart from the more general coordinating task mentioned in Article 105,
the committee has a separate task in specific areas where the Community has
some, albeit restricted powers. These tasks are of an advisory nature, but in
the course of time they have expanded and acquired a preparatory status.
Three closely related areas in particular are referred to in the Treaty, where
the committee needs to be consulted by the Commission before decisions or
action can be taken: (a) the liberalization of capital movements (Articles 69
to 73) and (b) the exchange rate policies of member states (Article 107) and
(c) the mutual assistance of member states in case of balance-of-payments
problems (Articles 108 and 109). These articles are reproduced in Annex 1.
62
4.3.1 Liberalization of Capital Movements

Article 69 of the Treaty of Rome specifies that the Monetary Committee

is consulted on directives aimed at the implementation of the provisions of
Article 67 concerning the progressive liberalization of capital movements.
These directives are issued by the Council of Ministers on a proposal from
the Commission after consultation of the Monetary Committee. This three-
pronged procedure - initiative of the Commission, opinion of the Monetary
Committee, decision by the Council of Ministers (EcoFin) - in fact has
become the standard procedure for a number of issues which the Treaty has
assigned to the sphere of competence of the ministries of finance and the
central banks. By means of this provision the Monetary Committee thus
was given an important task in preparing policy decisions concerning the
gradual dismantling of obstacles to the free movement of capital in Europe.
In the Chapter on Capital the committee is given a consultative task in the
monitoring of the regime of exchange controls in the member states. It is to
be consulted if the Commission is to give recommendations concerning the
exchange regime of a particular member state in the framework of Article
71. And it is to be consulted as well if derogations are asked for by member
states which are experiencing disturbances in their national capital markets
because of capital movements (Article 73).
The tasks of the Monetary Committee in the field of capital movements,
extensive as they are, have been broadened in the course of the years by means
of secondary legislation. Of particular importance has been the provision in
the first Directive for the implementation of Article 67 that the Monetary
Committee shall examine at least once a year the existing restrictions on
capital movements with a view to advising the Commission on the possible
abolition of certain restrictions. 7 Although this obligation fell into abeyance
in the late 1960s when many member states tightened their controls, the
provision could be used as an important stepping-stone at a later stage in
order to prompt the Commission to enforce the Treaty obligations.

4.3.2 Exchange Rate Policies

In Article 107 member states have undertaken the obligation to treat their
exchange rate policies as a matter of common concern. If certain member
states nevertheless follow an exchange rate policy which would jeopardize the
goals of economic policy in the Community - eqUilibrium on the balance-of-
payments, high level of employment and a stable level of prices (Article 104)
- and would distort competitive relations within the Community, the other
member states would be allowed, after consultation of the Monetary Commit-
tee, to take countervailing measures. The article apparently was included in
the Treaty for fear of competitive devaluations in case of balance-of-payments
disturbances, as witnessed in the 1930s. Apart from this article, the Treaty,
 63

Commission prepares memorandum

1 with principles or outline of
draft directive

2 Monetary Committee has rounds

of discussion

3 Commission makes final input of working group

proposal for directive of national experts

4 Monetary Committee
gives final advice

5 Council of Ministers decides on

directive

Fig. 7. Preparation of EEC directives.

written in the context of the Bretton Woods system of fixed exchange rates,
confines itself to the general obligation of Article 104 that each member state
shall 'pursue the economic policy needed to ensure the equilibrium of its
overall balance of payments and to maintain confidence in its currency'. 8
The role of the Monetary Committee in the field of exchange rates has
culminated in its active involvement in the functioning of the European
Monetary System and the development ofthe ECU. One of the tasks conferred
upon the committee - some would argue the most important task - has been
the preparation of the decisions by ministers and central bank governors
on realignments of exchange parities within the EMS.9 The negotiations on
exchange rate adjustments largely are conducted in the Monetary Committee
and often Ministers do not separately meet but merely confirm the outcome
of the committee's deliberations. This helps to dedramatize the realignment
negotiations. IO
64
4.3.3 Balance-of-Payments Assistance

The Monetary Committee is involved in the consultation on mutual assis-

tance and accompanying measures for member states which are experiencing
balance-of-payments difficulties (Article 108). In practice the most important
form of mutual assistance has been the granting of credit to a member state.
Under the new Community financing mechanism the Commission and the
Monetary Committee have been given a shared responsibility in controlling
whether the economic policies of the debtor country are in line with the
agreed policy conditions. Article 109 provides that the Monetary Committee
advises whether protective measures taken by a member state experiencing
a sudden balance-of payments crisis shall be amended or abolished. In prac-
tice this article has most frequently been used by member states demanding
derogations from their obligations under the capital directives.

4.3.4 Further Tasks

As Community secondary legislation was enacted, further related tasks have

been assigned to the Monetary Committee. 11 These include the preparation
of the multilateral surveillance of member states' economic policies; the
oversight of economic convergence programs; monetary consequences of the
EEC agricultural policy; surveillance tasks with respect to the EEC credit
facilities; and international monetary relations. 12 After the adoption of the
Treaty on European Union the committee assumed an important role in the
excessive deficit procedure. The listing of subjects the Monetary Committee
deals with is not exhaustive. In the course of the years the committee has
become more actively involved in the preparation of the EcoFin Council
meetings, especially the policy-oriented informal meetings which are attended
by the central bank governors as well. As Kees (1984) has said' ... it is not the
legal framework but the political weight of the committee ... which results in
and provokes the manifold requests for action. '
Through these provisions in the Treaty of Rome and the later secondary
legislation the role of the Monetary Committee in the field of monetary and
economic cooperation has been specified and gradually expanded. They form
the legitimation of the important intermediary role in the decision-making
process between the Commission and the Council. The provisions have been
written in the historical context of the 1950s in which the problem of foreign
exchange scarcity had just been overcome, convertibility of national curren-
cies for external current transactions had been restored and the Bretton Woods
system of fixed exchange rates was in its hey-day. However, the institutional
set-up has proved to be flexible enough to accommodate the changing circum-
stances of the post-Bretton Woods area. The Monetary Committee has played
an important role in shaping the monetary identity of Europe, culminating
in its important contribution to the Treaty on European Union. This Treaty
 65

TABLE 8
The regular tasks of the Monetary Committee

(a) At each monthly meeting in the tour d' horizon recent policy measures and eco-
nomic developments are reviewed, as well as recent exchange rate and interest rate
developments.
(b) Twice a year the monetary policy in the Community is reviewed. The end-year exercise
includes a discussion of monetary targets for the following year.
(c) Two or three times a year the economic and monetary situation ofone member country
is examined in depth. In addition the extent to which a country respects the policy
conditions attached to Community loans is reviewed regularly.
(d) Twice a year the statement to the Interim Committee on behalf of the Community is
prepared.
(e) Once a year bilateral consultations are held by the chairman with the prospective
member states Norway, Austria, Sweden and Finland.
(0 Once a year the existing exchange restrictions and derogations are examined with a
view to recommending possible abolition.
(g) Twice a year a multilateral surveillance exercise of economic policies in member states
is conducted with a view to promoting convergence.
Source: Partly based on the 29th Activity Report of the Monetary Committee, Brussels,
September 1988.

provides that the task and the composition of the committee will change in
the final stage of Economic and Monetary Union. We will come back to this
issue in Chapter 9.

4.4 THE COMPOSmON OF THE MONETARY COMMITTEE

The member countries and the Commission each have the right to appoint
two members to the committee. In tum these members can each appoint one
alternate who can replace them at meetings. Members are chosen from high-
ranking government officials and from the national central banks, normally
the executive director who deals with international affairs. 13
The government officials usually are the Treasurers-General or the Perma-
nent Secretaries at the Ministries of Finance, the exception being Denmark
where the Ministry of Economic Affairs is charged with international policy
coordination. In the case of Germany, where powers are shared between the
two departments the alternate member presently comes from the Ministry of
Economic Affairs. In this way a unique blend of expertise is obtained. The
same officials usually meet also in other international fora, like the IMP Inter-
im Committee, the meetings of the G7 and GIO-Deputies and the meetings of
Working Party 3 of the OBCD, the body which deals with international poli-
cy coordination, balance-of-payments adjustment and the exchange markets.
The central bank members regularly meet in their own circle in the frame-
66

work of the Basle weekends on the premises of the BIS and in the context of
Council meetings of the European Monetary Institute in Frankfurt.
The members of the committee act in a personal capacity and in the
interest of the Community. At times they can adopt positions beyond national
interests and take responsibility for defending concessions at home. The value
of their advice is determined by their knowledge of facts, based on domestic
responsibilities and tasks. Although formally their mandate lasts two years,
in practice renewal follows automatically. In fact many members, particularly
those from central banks, serve very long terms on the Monetary Committee. 14
Thus an influential network of long-standing acquaintances is established.
The Statutes of the committee, reproduced in Annex 3, provide for general
arrangements and procedures as well as for voting procedures. Since their
adoption in 1958 only minor changes have been made to the Statutes, but in
1994 an overhaul of the Statutes, which had increasingly become outdated,
especially after the coming into effect of the Treaty on European Union, was
being contemplated. is According to the Statutes each member has one vote,
but in practice voting is rare, the decision-making process in the Monetary
Committee being driven by the desire to reach consensus. Insofar as the
committee prepares decisions to be taken by the EcoFin Council which require
unanimity, there is a strong urge to agree on compromises which will be
carried in the meeting of the ministers. If conclusions cannot be reached,
deliberations normally are deferred to future committee meetings and no
formal vote is taken. .

4.5 THE CHAIRMAN OF THE MONETARY COMMITIEE

The committee chooses from among its members a chairman who servel> for a
period oftwo years. The role of the chairman of the committee is a momentous
one. He has an important say in the items to be put on the agenda of the
committee meetings and he can set the tone of the discussion. He also takes the
initiative in summing up discussions and advancing compromise proposals. In
the course of the years, the 'chairman's reports' have become more and more
important. In these reports the chairman on his own responsibility outlines
the stance of the meeting for ministers. These reports have frequently taken
the place of the formal advice the committee is asked to deliver. The reports
and opinions of the Monetary Committee are explained by the chairman at
the ministerial EcoFin meetings, in which he has a separate seat.
Although the Statutes provided that the chairman's two-year term of office
could be extended only once, after a Council amendment in 1962 this pro-
vision was dropped and in the first years of the committee the chairman
was routinely reappointed. The first chairman Emile van Lennep, Treasurer-
General of the Dutch Ministry of Finance, served for nearly twelve years,
from 1958 till October 1969, when he was appointed Secretary-General of
 67

TABLE 9
Chainnen of the Monetary Committee.

1958-69 Emile van Lennep The Netherlands MoF

1970-73 Bernard Clappier France Bank
1974-76 CoenOort The Netherlands MoF
1976-77 Karl-Otto POhl Germany MoF/Bank
1978-79 Jean van Ypersele Belgium MoF
1980-82 Jean-Yves Haberer France MoF
1982 Horst Schulmann Germany MoF
1983-84 Michel Carndessus France MoFlBank
1985-87 Hans Tietmeyer Germany MoF
1987-88 Geoffrey Littler United Kingdom MoF
1989-90 Mario Sarcinelli Italy MoF
1991-92 CeesMaas The Netherlands MoF
1992-93 Jean-Claude TIichet France MoF
1993-(present) Nigel Wicks United Kingdom MoF

MoF - Ministry of Finance

the OECD. 16 Thereafter the terms of the chairman approached the two-year
period. Over the years 1958-94,4 Frenchmen served as chairman, 3 Germans
and 3 Dutchmen, 2 Britons, whereas Belgium and Italy provided the chairman
once.
With a few exceptions all chairmen have come from the ministries of
finance (see Table 9). This underlines the important political role the Mone-
tary Committee performs, which calls for a chairman who is in close contact
with the responsible elected authorities. Nevertheless, many chairmen have
also served for the central bank, viz. Karl-Otto Pohl who left the Finanzminis-
terium for the Bundesbank, Michel Camdessus who left the Tresor to become
Governor of the Banque de France before taking the lead at the Interna-
tional Monetary Fund and, recently, Hans Tietmeyer who also left for the
Bundesbank to become eventually its Governor.
The Statutes provide for the appointment of three vice-chairmen,17 one of
whom can replace the chairman in his absence. In practice, however, this rule
is liberally applied. The chairman and vice-chairmen convene together with
other invited members in meetings of the Bureau of the Monetary Committee.
This Bureau is not mentioned in the Statutes and therefore has no official status
nor fixed participation. As a rule the Bureau convenes in informal luncheon
meetings after the morning sessions of the committee. Members of the four
larger countries, in particular those representing the ministries of finance,
seem to be always present. The Bureau meetings are meant to informally
sound out members on the positions taken with respect to agenda items of
68

TABLE 10
Chairmen of the Alternates of the Monetary Committee.

1958-68 A.W.R. baron Mackay The Netherlands Bank

1968-74 J. Mertens de Wilmars Belgium Bank
1974-77 Geoffrey Littler United Kingdom MoF
1977-79 Henry Baquiast France MoF
1980-82 Werner Flandorffer Germany MoEA
1982-84 Jean-Jacques Rey Belgium Bank
1985-88 Stefano Micossi Italy Bank
1988-90 Pieter Stek The Netherlands MoF
1991-92 Henrik Fugmann Denmark MoEA
1993-94 Michael Tutty Ireland MoF
1994-(present) Vitor Gaspar Portugal Bank

MoF - Ministry of Finance; MoEA - Ministry of Economic Affairs

the committee or on other matters of mutual interest (e.g. appointments for

international institutions).

4.6 THE ALTERNATES OF THE MONETARY COMMITTEE

The alternate members of the Monetary Committee frequently convene

among themselves at the request of the Monetary Committee to discuss
technical or administrative details and thus prepare the deliberations in the
full committee. The Alternates have played an important role in the field of
capital liberalization by preparing the yearly examinations and discussing
the technical details of Commission proposals for directives. In recent years
country examinations are routinely prepared by the alternates. Whereas the
attendance of meetings of the Monetary Committee normally is strictly lim-
ited to members and alternates, admission to the meetings of the alternates
is more liberal and thus provides an opportunity for junior civil servants and
central bankers to observe or participate in the decision-making process in
the Community. On technical matters specialists, e.g. tax experts, are called
in to provide advice to the alternates. The alternates normally report to the
full committee by way of a written report or a 'chairman's report'. They also
prepare each year the statement which the country chairing the EC makes
for the annual meeting of the International Monetary Fund on behalf of the
Community.
As can be seen from Table 10 the choice of the chairmen of the Alternates
of the Monetary Committee shows a much larger diversity both with respect
to national background as well as to professional background. Only Belgium
 69
has held the chair twice and the chairmanship has been more or less equally
divided between the ministries of finance and of economic affairs and the
central banks. Obviously the office of chairman of the Alternates has been
regarded as being of minor political importance and as a means to provide
satisfaction to countries which have felt underrepresented.

4.7 THE PROCEEDINGS OF THE MONETARY COMMITTEE

The committee meets generally every month in Brussels. Since its inception
the committee has held over 400 meetings. Each year another EC country
acts as host to the committee members. In the beginning two-day meetings
werd held, but this practice was discontinued in the course of the years. In
case of need meetings can be called at short notice. Preferably the committee
does not meet on Fridays in order to dispel any market expectations that a
realignment in the Exchange Rate Mechanism of the EMS might be imminent.
Such realignments normally take place over the weekend and speculation is
fuelled by rumours of meetings of the Monetary Committee. 18
The Statutes of the Monetary Committee provide that the discussions of
the committee and of its working groups are confidential. The committee
reported on its activities in annual reports up till 1988, when this practice
was discontinued by tacit consent. The principal reason forwarded for this
discontinuation was the lack of resources within the secretariat, the Commis-
sion having tightened the purse strings. These annual reports provided one of
the few published documents of the committee which were easily available
to the general public. In annexes to the report opinions and reports of the
committee were published as well.
The need for confidentiality apparently sometimes has been called into
question and in one of its annual reports some explanations were given. 19 The
committee pointed in particular to the character of the tasks conferred upon
it which called for limited attendance (only members and their alternates)
and confidentiality of its deliberations and reports. The need for confidential-
ity reflected the sensitivity of the issues under consideration and the impact
the decisions in these areas have on the financial markets. The discussions
on exchange rate questions, and in later years in particular on realignments
within the EMS, form a particularly sensitive area. The secrecy surrounding
meetings is resented by journalists who, sometimes in a pack, have to wait
outside the Centre Borschette where the meetings usually are held. The Inter-
national Herald Tribune said sneeringly that 'Since its founding in 1958, the
... committee has taken on the trappings of a clandestine organization. ,20
Confidentiality has been relatively well assured and it has been a major
contributing factor to the effective functioning of the committee. There have
been four other factors which have enabled the committee to proceed in a
pragmatic manner and generally to arrive at consensus: (a) strict attendance
70
rules, (b) opinions and reports under the responsibility of the chainnan, (c)
preparations of the meetings in the Bureau, an~r(d) an independent position
of the secretary.
The strict attendance rules, under which no officials other than the Alter-
nates can attend the committee's meetings, have contributed to the develop-
ment of a 'club of like-minded personalities'.21 In this club understanding
for each other's problems grows and there is no need to play to the gallery.
The instrument of chairman's reports makes it easier for committee mem-
bers to depart from their national standpoint because a committee member
cannot be held responsible at home for the chainnan's report. In the Bureau
meetings representatives of the four major member states are always present.
In an informal manner they can already explore each other's positions and
concoct possible compromises. The independent position of the secretary,
who attends these meetings, enables him to act as a bridge between the Com-
mission and member states. All these organizational procedures, which have
proved their value over the years, have contributed to reaching agreement
among the members.

4.8 RELATIONSInP WITH THE COMMISSION

The relationship of the Monetary Committee vis-a-vis the Commission, as

guardian of the Treaty, is a complex one. The Monetary Committee has a dual
role: it prepares not only the Ecofin Council meetings but also advises the
Commissi<?n. At the same time two Commission representatives are members
of the committee. In practice the deliberations in the committee provide the
Commission with an impression of how its proposals will be received. After
having sounded out the member states the Commission can choose to amend
its definite initiative proposals in order to reach agreement. The attendance
of Commission representatives at the meetings of the committee ensures
that the Commission's standpoint and the considerations behind it can be
well explained. The practical set-up of the Monetary Committee forms the
expression of an intricate set of checks and balances in the interinstitutional
relations between the Commission and the member states. There never has
been any urge for a fundamental change in this set-up, and with good reason.
The efficient proceedings of the committee have proved its worth over time.
Outside the direct context of the Treaty the Monetary Committee has taken
many initiatives and submitted proposals to the Ministers.22 The committee
then provides a platform for intergovernmental consultation and coordination.
This is especially true for the operation of the EMS which is based not only
on a Council Decision but also on an agreement among the national central
banks.
The committee is assisted by a Secretariat, which is financed through the
budget of the European Community. The secretary of the Monetary Com-
mittee, who also participates in the Bureau meetings, traditionally takes an
 71

independent position and is considered to be a servant of a committee of inde-

pendent national experts. The secretary and his staff are responsible to the
committee and, therefore, they work under the instructions of the committee
and not the Commission. At times this has led to strained relations between
the Secretariat and the Commission; the latter has been less than forthcoming
at times in providing the necessary personal assistance for the secretary, even
after an exhortation to this effect by the Council.
There have been repeated attempts on the part of the Commission to nibble
away at the authority of the Monetary Committee. In its initial proposals
on capital liberalization, presented in December 1985, the Commission had
proposed that the Monetary Committee henceforth would only be involved in
a discussion of those restrictions which did not yet fall under a liberalization
obligation. This would give the Commission a free hand in applying and
extending derogations for restrictions, falling under the liberalization regime.
The committee protested, feeling that the Commission had been too lax in the
application of the derogation clauses. The Commission quickly announced
that it would withdraw this part of the proposal.

4.9 RELATIONSIDP WITH THE COMMITTEE OF GOVERNORS

The Monetary Committee provides a unique blend of central bankers and trea-
sury officials. The Ministers of Finance meet in their regular EcoFin Council
meetings. On the side of the central banks, however, it was only several years
after the signing of the Treaty that the Committee of Governors of the Central
Banks of the EEC was established in 1964.23 As early as in January 1958
in the framework of their regular monthly meetings at the BIS in Basle the
five governors of the EEC central banks had discussed the necessity of closer
cooperation. They agreed to seize the opportunity of their monthly BIS meet-
ings for this purpose. Dutch central bank governor and BIS president Holtrop
advanced proposals to formally set up a committee,24 but apparently there
was a certain hesitancy among the Commission services to institutionalize
the central bank cooperation. Had not the Monetary Committee just been set
up ' ... in order to promote coordination of the policies of the Member States
in the monetary field ... '?
The decision to establish the Committee of Governors was taken among
a number of other institutional measures.25 Some of these were designed
to circumscribe the sphere of operation of the newly created committee. In
particular it was provided that the Monetary Committee was to be the body
which would deliberate on all important decisions and positions of member
states in the realm of international monetary relations. 26 Accordingly the
Committee of Governors started on a modest scale and its main purpose was
to set in motion a process of mutual information. 27
In the course of the years the role of the Committee of Governors was broad-
ened. In 1971 a new Council decision mandated the committee to coordinate
72

TABLE 11
Tasks of the Committee of Governors and the EMI Council.
Committee a/Governors!
- hold consultations concerning the general principles and the broad lines of monetary policy,
in particular as regards credit, the money and foreign exchange markets as well as issues
falling within the competence of the central banks and affecting the stability of financial
institutions and markets;
exchange information regularly about the most important measures that fall within the
competence of the central banks, and to examine those measures;
normally be consulted before the national authorities take decisions on the course of
monetary policy, such as the setting of annual :ffioney supply and credit targets;
to promote the coordination of the monetary policies of the Member States with the aim of
achieving price stability as a necessary condition for the proper functioning of the European
Monetary System and the realization of its objective of monetary stability;
to formulate opinions on the overall orientation of monetary and exchange rate policy as
well as on the respective measures introduced in individual Member States;
to express opinions to individual governments and the Council of Ministers on policies
which might affect the internal and external monetary situation in the Community and, in
particular, the functioning of the European Monetary System.

EMICounciP
- strengthen cooperation between the national central banks;
- strengthen the coordination of the monetary policies of the Member States with the aim of
ensuring price stability;
- monitor the functioning of the European Monetary System;
- hold consultations concerning issues falling within the competence of the national central
banks and affecting the stability of financial institutions and markets;
- take over the tasks of the European Monetary Cooperation Fund;
- facilitate the use of the ecu and oversee its development, including the smooth functioning
of the ecu clearing system;
- hold regular consultations concerning the course of monetary policies and the use of
monetary policy instruments;
- normally be consulted by the national monetary authorities before they take decisions
on the course of monetary policy in the context of the common framework for ex ante
coordination;
- at the latest by 31 December 1996, specify the regulatory, organizational and logistical
framework necessary for the ESCB to perform its tasks in the third stage.
! Based on Article 3 of the Council Decision of 12 March 1990 (9011421EEC).
2 Based on. Article 4 of the Statutes of the European Monetary Institute.

monetary policies and to study the harmonization of monetary instruments.

From this time both the Committee of Governors and the Monetary Commit-
tee had a mandate to coordinate monetary policies, a reflection of the different
institutional arrangements concerning monetary policy in the member states.
 73
In practice this shared responsibility did not give rise to frictions because the
monetary coordination in practice retained a noncommittal character.
When in the run-up to the Treaty of Maastricht the coordination decisions
of the Committee of Governors were rewritten, at the start of the first stage of
EMU in 1990, a division oftasks between the two committees was realized. 28
The Committee of Governors was accorded prime responsibility with respect
to the coordination of monetary policies. This gradual shift in the division
of monetary responsibilities between the Monetary Committee and the Com-
mittee of Governors is illustrative of the change over time in the position of
the national central banks. Increasingly their powers to define and execute
monetary policy, independent of government instructions, have been expand-
ed. The role of the Monetary Committee in the monetary area consequently
diminished.
At the same time there have been suggestions to transfer certain respon-
sibilities with respect to external monetary policies to the Committee of
Governors as well. It was suggested in particular that so-called technical
realignments of central rates within the EMS, meaning small adjustments
which would not need to have an impact on market rates, could be dealt with
in the Committee of Governors in the hope that thus the political suspense
which normally surrounds them could be avoided. But even small realign-
ments carried a :E0litical dimension, and therefore there was no follow-up to
this suggestion. 9 Instead, in order to dedramatize exchange rate adjustments,
the committee advised that the usual practice should be for the decision to be
prepared by the Monetary Committee, and be given the approval of Ministers
by telephone, whenever possible. Public statements should be avoided and
a ministerial meeting should be called only if needed. For this procedure to
be workable it would be necessary that negotiating mandates given to the
committee members should not be too narrowly drawn.
In the preparation of the Treaty of Maastricht there has been a sensible
division of tasks between the Monetary Committee and the Committee of
Governors. 30 In the framework of the Delors Committee the governors under
the chairmanship of the President of the Commission presented a blueprint
for Economic and Monetary Union, which would form the basis for the inter-
governmental negotiations. Whereas subsequently the governors prepared the
Statutes of the future European Central Bank and its precursor the European
Monetary Institute, the Monetary Committee concentrated on the economic
part of the Union. In particular it was involved in the design of the conver-
gence criteria and the excessive deficit procedure.

4.10 CONCLUSION

The unique institutional set-up of the Monetary Committee and its pragmatic
proceedings have enabled the committee to live up to the high expectations
74
the drafters of the Treaty had. The committee was left with much room for
manoeuvre with respect to the choice of the policy issues it wished to address.
It had the freedom to give advice or present proposals of its own accord. In
practice this meant that it shifted the focus of its attention in line with the major
economic and political developments of the day. In this respect its members
were affected as much as anybody else by the fits and starts of European
integration. Although its members could not overcome the major political
obstacles which at times have hampered the European integration process,
they have kept the spirit of cooperation alive and have greatly contributed to
a better mutual understanding. What set the committee apart from anybody
else was the institutional continuity, firmly embedded in the Treaty, and the
direct contact which the members had with their political masters at home.
Its influence has increased in the course of the years as it was called upon
to assume other duties, apart from genuine monetary matters, frequently
with a political dimension. After a flying start in the beginning of the 1960s,
when important measures with respect to capital liberalization could be taken,
attention was diverted to the increasing cracks in the international monetary
system. The committee did not have a comparative advantage over other
international fora, such as Working Party 3 of the OECD and the Group of
10 where the major discussions were held, and its influence on the systemic
debate was limited. In the beginning of the 1970s European countries drifted
apart and the proceedings of the Monetary Committee had above all the
character of crisis management.
The Monetary Committee assumed high responsibilities in the preparation
of the European Monetary System. It became much more inward-looking and
the attention given to international developments decreased. The composition
of the committee was upgraded when the EMS started in 1979. The common
procedures for realignment decisions assigned to the committee a central role
in the operation of the system. The participation of central bank members in
the committee assured that the day-to-day management of the system by the
central banks was coordinated. At the same time the Committee of Governors
and its subcommittees had an important role to playas well. After repeated
attempts in the first years to strengthen the institutional structure of the EMS,
which all failed, and to which the committee had a rather skeptical approach,
it redirected its attention to the liberalization of capital movements. Here the
Monetary Committee would play a stimulatory role, as will be extensively
dealt with in the following chapters.
For the purpose of this study, the liberalization of capital movements,
the role of the Monetary Committee has been a central one. It provided
the forum where all interrelated policy areas were discussed as well. There
were simultaneous discussions on capital liberalization in the Committee of
Governors which proved to be a helpful input. The power of the Monetary
Committee was based on the Treaty provisions and subsequent secondary
legislation. Particularly important in this respect was that the committee
 75
needed to be consulted with respect to directives on capital liberalization and
that it annually had to examine existing restrictions. In the next chapters we
will examine how the committee performed this task.
It is deplorable that over the years the accountability of the committee has
decreased. The listing of the membership of the committee was discontinued
in 1986, whereas the last annual activity report was published in 1988. As
a corollary, the valuable recommendations of the committee, which were
frequently annexed to the annual reports, are no longer published and therefore
are not easily available to the interested general public. At a time when
it is generally felt that policy makers distance themselves too much from
the general public, as demonstrated by the cool reception of the Treaty of
Maastricht, it would be useful to resume publication of progress reports.
Powers wielded without informing the outside world evoke counterforces.
With the coming into effect of the Treaty on European Union the coordina-
tion of monetary policy as well as its eventual unification has been enshrined
into Treaty texts. Therewith, one of the raisons d' ~tre of the committee - to
fill the void in the monetary policy area in the Treaty of Rome - has disap-
peared. In the course of the years many related tasks have been taken up in the
committee, to the effect that the present set-up of the committee will continue
to be useful for the foreseeable future. However, when the final stage of EMU
will materialize, there will be a need to overhaul the committee's role. The
Treaty on European Union provides a framework for this new role which will
be discussed in Chapter 9.

NOTES

1. The Treaty provides for the establishment of two other committees, the Transport Commit-
tee (Article 83) and the Economic and Social Committee (Article 193 et seq.). The latter
committee differs in character from the Monetary Committee because of its divergent
composition, comprising professionals from various categories of social and economic
activities. The committee, which has an advisory capacity, was to act as a bridge between
the Community and interest groups from trade and industry. Irreverently put, the com-
mittee was designed to be an institutionalized pressure group. However, in practice its
opinions have not carried much weight.
2. The Committee o/Governors of the Central Banks has been established pursuant to Article
105(1), which provides for the cooperation between the administrative departments and
the central banks in order to attain the objectives of the Community. In the framework of
the Single European Act the Committee of Governors explicitly was included in the new
Article 102 A, where it is stipulated that both the Monetary Committee and the Committee
of Governors shall be consulted regarding institutional changes in the monetary area. On 1
January 1994, at the start of the second stage of EMU, the committee was superseded by the
European Monetary Institute, established pursuant to the Treaty on European Union. The
Economic Policy Committee was established in 1974 (Council Decision of 18 February
1974), merging several committees on economic and fiscal policies.
3. The Bundesbank was established in 1957 as the successor to the Bank Deutscher Ulnder,
which had been set up in 1948 by the Allied forces as an independent central bank system
in West Germany.
76
4. The once-secretary of the Monetary Committee Kees (1984) describes this Treaty pro-
vision as the setting-up of a 'coordinating body which was expected to achieve future
monetary cooperation. The Monetary Committee was left to develop its own momentum
and was given responsibility for preparing the way for the different steps of monetary
integration. '
5. Coreper is the customary French abbreviation of the Committee of the Permanent Repre-
sentatives of the member states. The Coreper, assisted by the General Secretariat, prepares
the meetings of the Council. The Permanent Representatives have the status of ambassador
and report to and are recruited from the national Ministries of Foreign Affairs.
6. Meeting on 27 November 1956.
7. First Council Directive of 11 May 1960 for the implementation of Article 67 of the Treaty,
Article 4.
8. The general obligation of Article 104 was complemented by the proviso that governments
should at the same time take 'care to ensure a high level of employment and a stable level
of prices'. Comparable goals with respect to general equilibrium are formulated in the
statutes of the IMP and the OECD.
9. The Council Decision of 21 April 1980 provides that preparatory consultations regard-
ing the adjustment percentages and the accompanying policy measures take place in the
Monetary Committee, where its members do not act as independent experts, but as repre-
sentatives of their country. The chairman advises the ministers and central bank governors
(i.e. not the Council). If the committee does not reach agreement, the chairman formulates
a compromise proposal.
10. There is a trade-off between on the one hand the danger of overexposure of the Monetary
Committee, which should not take political decisions by proxy, and on the other hand
the additional theatrical drama of a ministers' meeting on Sunday. When following the
September 1992 devaluation of the Italian lira, which in a matter of days was followed
by the withdrawal from the EMS of the pound sterling and the Italian lira, there was
some criticism on the handling of the matter by the committee's chairman, ministers in
unison declaring that next time they would have to convene and take the decisions. Of
course, they would not have done any better. On the next occasion, the September 1992
devaluation of the Spanish peseta, they already had forgotten their intentions and left the
matter to the committee.
11. The EcoFin Council in its meeting on 25 February 1958, in which it approved the com-
mittee's Statutes, added further items (see Annex 3).
12. The Council Decision of 8 May 1964 (64130 lIEEC) provides that' consultations shall take
place within the Monetary Committee in respect of any important decision or position
taken by Member States in the field of international monetary relations.'
13. In general high-ranking officials are nominated, although initially Germany and France
nominated Treasury officials from the second echelon (director's level). After the estab-
lishment of the European Monetary System in 1979, in which the Monetary Committee
had an important role to play, several countries, including Germany and France, upgraded
their representative from the Ministry of Finance. Kees (1994) reports that this move met
with resistance from the Commission services, since it would strengthen the position of
the committee with respect to policy formulation.
14. In Annex 2 a list of the members of the Monetary Committee is reproduced. From this
list it appears that generally central bank members stay longer on the committee than
their counterparts from the Ministries of Finance who more frequently seem to change
career. Among long-serving members are Otmar Emminger, who as vice-governor of the
Bundesbank was a member of the committee from its start in 1958 up till his appointment
as President of the Bundesbank in 1976, and Andre Szasz of the Nederlandsche Bank who
served a record 21-year span as a member of the committee (1973-94).
15. Since 1976 the Statutes were left unchanged, even when new countries joined the Commu-
nity and some operating procedures of the committee were changed. In part this illustrates
 77

the pragmatic manner in which the committee operates. But there was also a politically
inspired preference for leaving things as they were, because amendment of the Statutes
requires the heavy procedure of a decision of the Council.
16. The fact that Emile van Lennep was chosen chairman, apart from his personal qualities,
may have been related to the fact that he was one of the highest-ranking Treasury officials
in the committee (see Note 13). The level of representation had been intensively discussed
in the Netherlands. The Nederlandsche Bank already at an early stage (May 1957) had
decided that it would nominate an Executive Director, prof Posthuma, in view of the
hierarchical level of the central bank nominees of other countries. Governor Holtrop
let it be known to the Minister that the Bank would prefer the Finance representative
to be of equal level so that they could freely confer and take decisions. If the Finance
representative were to be chosen from a lower hierarchical level, this would imply that he
automatically would carry less weight and influence. Then the Bank representative would
have a certain preponderance and would need to have direct access to the Minister. This
argument of Holtrop apparently carried the day. Eventually the Ministry would nominate
Treasurer-General Emile van Lennep.
17. In 1983 it was decided to add a vice-chairman, but there was no formal Council decision.
In later years, the position of vice-chairman has been tacitly dropped; what mattered more
was attendance at the Bureau meetings.
18. Sometimes the agendas of the experts are filled so much that a meeting on Friday has to
be accepted. This was the case when a meeting was planned for Friday, 11 September,
1992. In that week the traditional Basle weekend meetings were followed by meetings of
Working Group 3 of the OECD and the Deputies of the G 10, to the effect that only Friday
was left for a Monetary Committee meeting. This was only one week before the French
referendum on the Treaty on European Union was to be held and the exchange markets
had become more and more nervous about the outcome and the possible implications of
a negative vote. A Friday meeting of the Monetary Committee might get on the nerves
of the markets and fuel speculation. Eventually the meeting was called off. In the end it
proved to be of no avail. The markets had smelt blood and on Friday evening the German
members of the committee took the initiative to call for a realignment in the ERM.
19. Annual Report of the Monetary Committee, 1961.
20. 'At EC, gnomes in shadows; who sets monetary policy? Try to find out', International
Herald Tribune, 24 October 1992.
21. Oort in Twenty years of the Monetary Committee (1978), p. 11.
22. Kees (1994) enumerates a number of proposals presented by the Monetary Committee to
the Ministers and the Council.
23. Council Decision of 8 May 1964 (641300/EEC).
24. Letter from Holtrop of 25 January 1958 to the Dutch Minister of Finance. In his letter
Holtrop suggests to bring about, possibly through the good services of Sicco Mansholt,
the Dutch Commissioner, that the European Commission would make a proposal to set up
a committee of governors of the EEC central banks.
25. At the same date the Committee for Fiscal Policy was established, one of the predecessors
of the Economic Policy Committee (see Note 2).
26. This decision (see also Note 12) confirmed that external monetary policies, in particular
exchange rates, remained in the realm of governments. Through the involvement of the
Monetary Committee a linkage was created with Working Party 3 of the OECD, which
was likewise chaired by Emile van Lennep.
27. Baer (1994) provides a detailed description of the functioning of the Committee of Gov-
ernors till its merger into the European Monetary Institute.
28. Council Decision of 12 March 1990 (90/142/EEC).
29. In its 29th Activity Report (1988, p.19) it was concluded: 'The Monetary Committee is of
the view that there is no such thing as a technical realignment'.
78
30. Less wise decisions were also taken. In 1990 in an attempt to assert the independent
position of the Committee of Governors, its chairman Karl-Otto Pohl kicked out the
secretary of the Monetary Committee who up till then had been allowed to attend the
meetings. In retaliation the secretary of the Committee of Governors no longer was
allowed to attend the meetings of the Monetary Committee. A pacification took place in
1994 when the Director-General of the newly-founded European Monetary Institute was
invited to participate in the meetings of the Monetary Committee.
 CHAPTER 5

The 1960s: Lost Momentum

Large movements of money have been induced by exchange rate

uncertainties because of the need ofprivate business and financial
institutions to protect themselves and even because ofpure specula-
tion. We must face the fact that more often than not the judgement of
the market has correctly evaluated the underlying situation and that
the fault lay with official indecision with respect to the adjustment
process. Direct controls are less effective in these cases because of
the huge shifts offunds that can come about by changes in leads
and lags under present-day business conditions.
lelle Zijlstra, 1972

5.1 INTRODUCTION

After the Monetary Committee had started its work it was some time before
the issue of capital liberalization was taken up. This was largely due to two
factors, a practical one and a political one. The practical factor was that both
the Commission and the committee had to get organized. Priorities had to be
set. They had to take stock of the prevailing situation, make an inventory of
existing restrictions and design a framework for giving content to the Treaty
obligations.
But there was also an important political factor: the change of government
in France. The Algerian question had caused the socialist government under
the IVth Republic to collapse and had cleared the way for a re-entry of
General de Gaulle in government. A new constitution, giving greater powers
to the president, was adopted and in December 1958 de Gaulle was elected
as the first president of the Vth Republic. His attitude vis-a.-vis European
integration remained unknown for some time, until in an accord with the
German Chancellor Konrad Adenauer a definitive choice was made for the
EEC.
Thus the first year of the EEC was marked by a certain wait-and-see atti-
tude. The economic and financial situation in France gave cause for concern
and figured prominently on the agenda of the six meetings held by the com-
mittee in 1958. France had been forced to suspend trade liberalization for
some time. There were fiscal and monetary imbalances; inflationary pres-
sures ran high. In the course of 1958 stabilizing measures were taken, the
exchange rate was devalued and a New Franc was introduced at the end of
1959 (equal to 100 'old' francs). In its last meeting in December 1958 the

79
80
committee for the first time discussed the issue of capital liberalization in
the context of a secretariat's paper on the competences and working methods
of the committee. It was agreed that the committee's role should be inter-
preted widely. In particular it was the Commission's intention to involve the
committee continuously in the formulation of proposals to liberalize capital
movements. The Commission thus renounced its right to ask the commit-
tee's advice only when it had drawn up a concrete proposal. As a first step
the Commission would prepare an inventory of the existing regulations in
domestic capital markets and the restrictions to cross-border capital flows in
the member states for discussion in the Monetary Committee.
In the course of 1959 the deliberations on the liberalization of capital move-
ments gained considerable momentum. The economic climate was propitious
for liberalizing initiatives: the EEC economies enjoyed a cyclical upswing
unhampered, thanks to improved productivity and competitiveness, by exter-
nal constraints. All EEC countries registered surpluses on the current account
of their balances of payments. The two least liberal countries, France and
Italy, recorded sizeable capital inflows which swelled their official exchange
reserves. These favourable developments made it easier to restore external
convertibility for current account transactions and to undertake gradualliber-
alization of capital movements. In 1960 and 1962 two directives were to be
adopted which gave practical content to the provisions of the relevant Article
67 of the Treaty by imposing binding obligations on member states.

5.2 THE INITIAL ATTITUDE OF MEMBER STATES

The preparation of the first directive was preceded by a fundamental debate in

a string of meetings of the Monetary Committee on the merits of the liberal-
ization of capital movements. This discussion was provoked by a voluminous
document of the EEC Directorate General for Economic and Financial Affairs,
which came under Robert Marjolin. The report advocated the greatest possi-
ble liberalization, and considered this to be as urgent as the free movement
of goods, services and persons in the Community. 1
Full liberalization should be the ultimate objective, notwithstanding the
escape clause - 'to the extent necessary to ensure the proper functioning of the
Common Market' - in the Treaty. The crux of the argument of the Commis-
sion was that the eventual freedom of goods, services and persons provided
for in the Treaty would prove to be a dead letter if free capital movements
would continue to be curtailed'by stringent restrictions. At the same time it
was acknowledged that full liberalization could not be carried through at one
stroke and therefore an order of priorities was set. The Commission proposed
to confine liberalization in a first round to (1) direct investment, (2) issues of
securities and (3) certain capital flows in the personal sphere. These types of
transactions roughly corresponded to the capital movements marked out ear-
lier as priorities in the Spaak report. This would have practical consequences
 81
only for France, Italy and the Netherlands. Germany had already liberalized
these capital transactions, whereas under the dual exchange rate system of
the Belgium-Luxembourg Economic Union all capital transactions could be
freely settled in the financial market.

5.2.1. Germany in Favour ofFull Liberalization

The Commission received unequivocal support from the German members of

the committee in its advocacy of full liberalization of capital movements as
the ultimate goal. The representative from the Ministry of Economic Affairs
took an orthodox position in the discussions, arguing that there was no reason
to treat capital flows in a different manner than movements of goods and
services. In line with Erhard's laissez-faire thinking, capital restrictions were
considered as an anomaly in the context of the increasing freedom of inter-
national trade. Although the Bundesbank representatives usually took a more
thoughtful approach to the issues, they too were a firm supporter of free capi-
tal flows. Such freedom should also extend to informal exchange restrictions
such as discriminatory fiscal provisions and regulations concerning foreign
ownership. These should be harmonized and, ifpossible, eliminated.
Right from the start Germany insisted that liberalization of capital move-
ments within the Community should not discriminate vis-a-vis third coun-
tries. The Alternates of the Monetary Committee, who had been asked to
study this matter further, indeed came out strongly against discriminatory
treatment. They concluded that a European discriminatory exchange regime
would impair the pull of the Common Market in attracting foreign capital.
Actual investments in the EEC from third countries (especially those from
the United States, the United Kingdom, Canada and Switzerland) at the time
far outweighed those originating from within the EEC. Furthermore, it was
considered that, technically, effective control of a discriminatory regime was
simply not feasible. Germany throughout the years would remain a staunch
supporter of what later came to be known as the 'erga omnes principle', i.e.
capital liberalization agreed within the European Community should extend
to all countries.

5.2.2 France in Favour of Monetary Policy Coordination

The starting point of the Commission that the EEC territory eventually would
form a unified economic area ('espace economique unifiee') in which all
factors of production, including capital, would flow freely, was instantly con-
tested by the French members of the committee, supported to a certain point
by the Dutch and Italians. It could not be helped, the French argued, that
the Treaty had a dualistic character, blending binding obligations on member
states in some policy areas with national autonomy as regards economic and
monetary policies. But such was reality. Capital liberalization would have to
82
be dependent on and should go hand in hand with improved coordination
of monetary policies. Such coordination should primarily aim at preventing
speculative capital flows. Despite its tight exchange regime France had been
plagued by speculative outflows, which in 1958 had twice forced large deval-
uations. After the monetary reform, culminating in the introduction of the
new franc, the authorities wished to restore confidence and err on the safe
side. Therefore, the strength of the balance of payments would be the deci-
sive factor in the relative tightness of the exchange control system. Moreover,
France was concerned about capital outflows inspired by tax evasion.
Although France acknowledged that liberalization should be of a non-
discriminatory nature, it preferred to leave the door open to 'differentiation'.
This was a subtle distinction: the legal exchange regime should be based
on the principle of non-discrimination, but a certain favouritism through
administrative and other domestic regulations was considered acceptable to
create a 'zone de preference' for the circulation of capital for investment
purposes within the Common Market.

5.2.3 Italy Fears Speculation

The Italian position was close to the French one. Traditionally Italy was
fearful of speculative capital movements, which it felt did not exert an equi-
librating influence. The banking system had been prevented from becoming
a channel through which hot money could easily flow into or out of the
country, because of its disturbing effects on the official foreign exchange
reserves or on domestic monetary conditions. 2 The Italians thus were doubt-
ful whether the complete liberalization of capital movements was advisable.
In any case it was felt that this could not be achieved without prior cooperative
arrangements among the monetary authorities. Among such desired arrange-
ments cross-holdings of each other's currencies in the official reserves figured
prominently. This would enable the national central banks to undertake time-
ly interventions which might counteract undesired capital movements before
they assumed unduly large proportions. 3
As shown in Figure 8, Italy in the first years of the EEC was confronted
with a much higher expansion of economic activity than expected. At the
same time, its current account position was satisfactory. But Italy did not
contemplate becoming a structural c!lpital exporter. It maintained a restrictive
and complicated exchange control system, which, however, was notorious for
its many loopholes. Nevertheless, liberalization of capital movements did not
carry much political priority. It was feared that th-e public at large, which did
not hold shares, would not comprehend liberalization measures. They would
simply be conceived as favouring the interests of the rich and as a vehicle
for tax evasion. For Italy liberalization of capital movements already had
progressed far beyond anything envisaged in the early post-war years.
 83

Per cenl

11 _ _ _ _ _ _ _ _ _ _ _

- ---
---
... ."

-
~ --------
1__ _

o___ L L L__ . - L
-1 _ _ _ _ _ _ _ _ _ _ _

16 Ilia \9 10 61 61 6l 6~ II ..

~-. - - - - - - - - - - - - - _.
Cur ,.e nt account Annual g ro wt h Officiol reserves
( . 01 COP) role 0 GDP (. 0 GDP)

Source: Interne ianol Fin.ancial S totis ics. IMF.

Fig. 8. Italy's economic miracle.

5.2.4 Dutch Misgivings

Although the Dutch authorities were not unfavourably disposed towards fur-
ther liberalization, they maintained the misgivings with respect to the final
objective of full liberalization which had been manifest during the negoti-
ations on the Treaty. In their view the Common Market would not become
equivalent to the 'ideal' type of a freely functioning domestic market within
a country. The main difference was that the Community lacked a coordinated
economic and monetary policy. Therefore, interest rates would differ between
countries, but these differentials need not reflect differences in the produc-
tivity of capital. It could not yet be taken for granted that capital utilized in
countries with higher interest rates would bear more fruit than in countries
with lower rates as long as there were differences in policy priorities. Of
course, a less ambitious concept of a Common Market would make a lesser
contribution to the optimal allocation of resources. But such was reality: 'an
evolution of centuries which had made Europe a split continent could not be
undone within a few decades' .4
Like France and Italy, the Netherlands was opposed to the liberalization of
short-term capital movements. But there was a fine distinction in motivation:
the Netherlands argued on principle that short-term flows did not fall under
the obligations of Article 67. As discussed in Chapter 3, its main objection
concerned short-term inflows which were considered as unwelcome sources
of liquidity creation and thus could obstruct domestic monetary policy. These
84
objections were based on the theory that liquidity (short-term) and capital
(long-term) could be strictly distinguished. This reasoning provided at the
same time the rationale for restrictions on certain types of long-term capital
outflows.

5.2.5 The Special Case ofBelgium and Luxembourg

Belgium had put in place a dual exchange rate system, in which the market for
capital movements was separated from the market for trade-related currency
transactions. Thus, in a formal sense Belgium had a free capital market, albeit
that capital transactions were executed at a different exchange rate than other
transactions. Belgium thus could present itself as a liberal country and could
lean back in the committee's discussions. Its only preoccupation was that it
would not be hampered by EEC directives in the operation of its dual market.
For the rest, it was rather indifferent with respect to the policies in other
countries in this respect.
The other member states disliked multiple exchange rate practices. France
and the Netherlands for example used an exchange control system of indi-
vidual permits, with foreign currency available at the fixed exchange rate.
They felt that the degree of liberalization depended not only on the formal
exchange control system utilized, but also on the material content of the sys-
tem. Ifthe actual free market under a dual market system was not very deep,
the execution of capital transactions might be hindered even more than under
an exchange control regime of permits, so it was argued. For them further cap-
italliberalization was regarded as a sacrifice because it could complicate the
pursuit of domestic monetary or economic objectives. Such sacrifices would
be only acceptable if other countries would take steps as well and would not
hide behind techniques which had the same economic effect,S but could be
presented to the outside world as liberal because of their form. This explains
the irritation which other member states felt with respect to the Belgian posi-
tion that its dual market should be kept outside the liberalization obligations
pursuant to the Treaty.

5.2.6 Assessment

The positions taken in these first discussions by the six founding members
of the EEC with regard to the full liberalization of capital movements were
to be constant themes, albeit in varying shades, in the discussion in the
coming years. Germany stood alone in advocating full liberalization. As a
structural capital exporter it did not fear speculative movements as much
as the other countries. Instead it concentrated on pursuing stability-oriented
policies at home which would gain the confidence of the international financial
markets. Such self-confidence was lacking in France and Italy. Although
their economies and external positions were developing much better than
 85

expected, they were fearful of sudden speculative capital outflows. In their

view monetary cooperation should be strengthened in order to prevent such
speculation. Italy went as far as proclaiming that as long as institutional
arrangements between the central banks were lacking which could provide
ammunition to frighten off speculators, it was not willing to contemplate
the full liberalization of capital flows. The Dutch, in a"balancing act between
their traditional liberally-oriented policies as a major trading country and their
reluctance in principle to ease the channels for undesirable capital flows, were
inclined to adopt a rather restrictive attitude as well. In the course of the years
the balance between pros and cons in the positions of individual member
states would change. But at the time, it was clear that a large majority of the
member states was not willing to consider the unconditional freeing of all
capital flows.
A number of other themes came up as well which would surface more
prominently in later years. Germany made it clear that liberalization obliga-
tions agreed upon in the framework of the EEC should be applied to third
countries as well: the so-called erga omnes principle. Although this formally
was not contested, France and the Commission were instinctively inclined
to allow a certain favouritism towards member states, possibly in the form
of indirect regulations. These positions betrayed the more outward-looking
attitude of Germany versus the increasingly European-oriented attitude of
France. Other themes concerned the link to related policy areas, above all
that of monetary policy, but tax considerations also played a role. This link­
age to other areas would later contribute to the emergence of an attitude that
countries which would liberalize would expect a quid pro quo from other
member states.

5.3 PREPARATION OF THE FIRST DIRECTIVE

In July 1959 the Dutch members presented a memorandum to the Mone-

tary Committee, in which they elaborated on their hesitations with respect
to the full liberalization of capital movements. Countries should have the
possibility to impose restrictions in good time, before balance-of-payments
difficulties would emerge. Unconditional liberalization in their view should
only apply to direct investment. Private issues and loans, as well as trade in
securities could only be conditionally liberalized. 6 More fundamentally, the
Dutch once again tried to substantiate their claim that short-term 'money'
movements did not fall under the provisions of Article 67, which only dealt
with 'capital' movements. Moreover, in their view countries should retain the
possibility, over and above the safeguard clauses of the Treaty, to deliberalize
certain categories of capital transactions if economic and monetary policy
goals were endangered. This was an outright departure from the principle of
irreversibility contained in Article 71. All in all it was a rather ponderous
document which dampened the high hopes of Marjolin's paper.
86
Although the committee shared the Dutch interpretation that Article 67 did
not require full liberalization of capital movements, the majority rejected the
view that short-term money movements were not part and parcel of capital
movements. Although the Dutch members thus did not win their case on
principle, from a practical standpoint this did not matter very much. Other
countries, like France and Italy, were likewise not favourably disposed to the
freeing of short-term flows. Their fear mainly concerned the effects of spec-
ulative outflows on exchange rates, whereas the Dutch feared the inflationary
effects of inflows on domestic monetary policy. So much for the ideological
debate. But as far as the acceptance of concrete liberalization obligations of
other capital transactions was concerned, only Germany and the Netherlands
were prepared to go rather far. The French and Italians hesitated to liberalize
direct investment unconditionally and the Belgians would channel such flows
only through the free exchange market. Others did not consider the latter to
constitute real liberalization because exchange rate fluctuations on this market
might prove to be a hindrance.
In its meeting in September 1959 the committee finalized its report to the
ministers, prepared by the Alternates, on the liberalization of capital move-
ments. In this report a distinction was made between three categories of
capital movements: (1) transactions which were to be liberalized immediately
and unconditionally, (2) transactions which also were to be liberalized imme-
diately but under certain conditions, and (3) transactions for which there
was no obligation to liberalize. Category (1) comprised short and medium-
term trade-related credits and direct investment, category (2) comprised pub-
lic issues, long-term trade-related credits, long and medium-term non-trade
related credits and transactions in securities, and category (3) comprised short-
term capital movements. Liberalized capital transactions in the first category
could only be deliberalized by having resort to the safeguard clauses, the so-
called 'regime severe'. The transactions of the second category fell under the
'regime conditionnel' , and were not deemed to be indispensable for the func-
tioning of the Common Market. This regime implied that countries which did
not liberalize these transactions or wished to deliberalize them had to provide
an explanation to the Commission. The Commission, after having consulted
the Monetary Committee, then could give recommendations to abolish or
relax these restrictions, but these were non-binding. For transactions in the
third category countries were completely autonomous, but there would be a
regular monitoring in the Monetary Committee. The system opened up the
possibilitY that certain categories of capital movements could move up the list
to the unconditional liberalization obligation. In a meeting in January 1960
the Monetary Committee was formally asked for advice on the proposal for
a directive which the Commission had formulated on the basis of the previ-
ous discussions.7 In broad outline the Commission had followed the position
taken by the committee. On some points the Commission tried to go a little
further, notably with respect to transactions in listed shares which the Com-
 87

mission wanted to place under the unconditional liberalization regime. 8 The

committee agreed to this, but there were two reservations. Italy was opposed
to the unconditional liberalization of medium-term trade-related credits, fear-
ing a loophole. And France was opposed to the unconditional liberalization of
transactions in shares of undertakings for collective investment in securities.
These investment trusts had nothing to do with the proper functioning of the
Common Market because they mainly invested in blue chip funds, prepon-
derantly of US companies, so it was argued. The real reason could be found
closer to horne. As part of the French dirigistic financial system the Tresor
actively attracted funds from small investors in order to finance the public
sector deficit. It did not wish to encourage competitors to fish in the same
waters.
The final proposal for a directive was introduced in the EcoFin Council
meeting on 10 March 1960 by Robert Marjolin, vice-chairman of the Commis-
sion. It was finalized in the May meeting of the Council after Italy had dropped
its reservation against the unconditional liberalization of medium-term trade
credits. France, however, held on to its opposition to the unconditionalliber-
alization of transactions in shares of undertakings for collective investment
in securities. At the time it could not be foreseen that it would last more
than two decades before these transactions finally were liberalized in 1985.9
France got its way and the Commission moved this category to the regime
conditionne1.

5.4 THE FIRST DIRECTIVE OF 1960

This first directive, adopted by the Council in May 1960, could be seen as
giving body to the Treaty obligations, although it fell far short of any call
for full liberalization. Member countries were obliged to liberalize uncondi-
tionally short and medium-term trade-related credits, direct investment flows
and transactions in listed shares. These were the financial transactions which
could be considered as having the most direct influence on the physical
creation of the Common Market and thus were most directly linked to the
clause of Article 67, 'to ensure the proper functioning of the Common Mar-
ket'. Trade in goods and services had to move unhampered by restrictions
concerning trade credit. And the freeing of direct investment would enable
companies to gain a foothold in other EEC markets through the operation of
subsidiaries and thus stimulate competition, both through cross-border trade
and through intra-EEC production. Finally, cross-border transactions in list-
ed shares, i.e. securities quoted on official stock exchanges, would enable
investors to acquire an interest in other European companies.
Short-term financial transactions, however, did not fall under any obli-
gation to liberalize. The preparedness of member states to abolish capital
restrictions had generally decreased as the categories had a more short-term
88
character. lO The discussions held in the Monetary Committee brought out
clearly that a major reason was the wish to retain control over domestic
monetary policies, and especially for France and Italy, the fear of capital
flight.
The provisions of the First Directive only applied to intra-Community
flows. There was no attempt to coordinate policies in respect of capital move-
ments between member states and third countries, as provided for in Article
70. However, the wish was expressed that liberalized categories would apply
to third countries as well. In practice this erga omnes principle generally
was adhered to. II The directive consolidated to a large extent liberalizations
which had already been undertaken or were in the process of being undertaken
in some countries. Now it would become more difficult to go back on these
liberalization measures. In the course of 1960 all member states had adjusted
their exchange regime in order to be in compliance with the new directive. 12
As regards the dual exchange market of Belgium, the directive allowed
transactions which had to be unconditionally liberalized to be channelled
through the free financial market, as long as the exchange rates did not
appreciably and lastingly diverge from the rates on the official market. 13 The
Monetary Committee would monitor this and report to the Commission. There
were further tasks for the committee. The Commission would consult the
Monetary Committee when making recommendations to member countries
with respect to their exchange regime. More importantly, the committee was
required to hold annual examinations with a view to exploring whether further
progress could be made in abolishing capital restrictions, in line with the
preamble of the directive which stated that the attainment of the Treaty
objectives required' ... the greatest possible freedom of capital ... and therefore
the widest and most speedy liberalization of capital movements.' Whether
this was only a matter of harmonious presentation or of hard commitments of
the member states would become clear in the coming years.
The adoption of the directive showed that good results could be reached
through cooperation between the Monetary Committee and the Commission.
Although the Commission had wished to go further with respect to capital
liberalization, it was slowed down in its drive for action by the committee
members who took the interests of their country into account as well. The
supranational interest of full capital liberalization, defended by the Com-
mission, had not yet found sympathy in the intergovernmental forum of the
Monetary Committee. The committee members rather tended to espouse the
views of their political masters at home. In general the opinion of the commit-
tee members was the decisive factor, but there was a certain give and take. In
this way the Commission got a good impression of what was politically and
economically feasible. Subsequently, in its final proposal it pushed a little
harder on specific components, and all in all was not dissatisfied with the
end-result. So, a common understanding and sense of direction had grown.
In a note to the Council on its consultation of the Monetary Committee, the
 89

TABLE 12
Official reserves of EEe member states 1956-1965 in billions of US dollars.
1956 1957 1958 1959 1960 1961 1962 1963 1964 1965

Belgium 1.2 1.2 1.6 1.3 1.5 1.8 1.8 2.0 2.2 2.3
France 1.3 0.6 1.1 1.7 2.3 3.4 4.0 4.9 5.7 6.3
Germany 4.2 5.2 5.9 4.8 7.0 7.2 7.0 7.7 7.9 7.4
Italy 1.3 1.5 2.3 3.1 3.3 -3.8 4.1 3.6 3.8 4.8
The Netherlands 1.1 1.1 1.6 1.4 1.9 2.0 1.9 2.1 2.3 2.4

Note: Gold valued at US dollar 35 per ounce, end of period figures.

Source: International Financial Statistics, IMF.

Commission wrote: 'Now that the proceedings with respect to the first direc-
tive concerning capital movements have been concluded, the Commission
considers itself fortunate to have involved the Monetary Committee already
at an early stage in the proceedings without having waited until the formal
consultation. The Commission is convinced that this cooperation has led to
a good result.,14 A good result it was and some member states might have
wished to stop there. The directive provided a good basis for ensuring the
proper functioning of the Common Market. But the Commission wanted
more. It wished to maintain the momentum. Soon the Commission would
come forward with new proposals.

5.5 MAINTAINING THE MOMENTUM

In 1960 the economies of the BEe prospered: there was a strong economic
expansion, prices remained stable and there were no balance-of-payments
problems. The Common Market was off to a good start and had fostered an
accelerated pace of expansion of intra-EEC trade. France had experienced a
favourable evolution of the balance of payments and a large rise in its official
reserves (see Table 12). This provided room to slowly, but with determination,
relax its remaining exchange controls. 15 Italy, which was lagging behind as
far as its exchange regime was concerned, had succeeded in combining strong
economic growth with monetary stability and liberal external relations. Thus
it was well-placed to take further capital liberalization measures as well.
Yet, there were some warning signals. The relaxation of exchange con-
trols, even though mainly limited to long-term capital flows, had facilitated
speculation, which was directed at the strong economies of Germany and the
Netherlands. Monetary tightening by the Bundesbank, matched in a 'trag-
ic coincidence' by an easing of American monetary policy, led to sharply
increased interest rate differentials, which fueled 'hot money' flows. In March
90
1961 the Deutsche mark and the Dutch guilder were revalued. This devel-
opment was viewed with concern. The Banca d'Italia, noting the enormous
transfers of funds, commented: "These displacements put the spotlight on the
perils to which all currencies are exposed in a world from which administra-
tive controls have gone, one after another. This situation is full of dangers for
the orderly functioning of international payments.' 16 They had led Germany,
whose members of the Monetary Committee had advocated the merits of full
capital liberalization, to reimpose in June 1960 restrictions on the purchase
by non-residents of money market paper and to prohibit the payment of inter-
est on Deutsche mark deposits held by non-residents. Both measures would
remain in place until 1969 when the Deutsche mark again was revalued. The
near-complete freedom of capital flows in Germany, established in 1959, had
lasted only one year! Emminger in his memoirs vividly describes this dra-
matic episode: 'the spell was broken.' 17 The German economy had soon left
the 'magic triangle."
In May 1961 the Monetary Committee held its first annual examination
of the state of affairs concerning capital liberalization, as provided for in
the 1960 Directive. The Commission had prepared a memorandum for this
meeting in which it advanced suggestions for further liberalization beyond
the 1960 Directive in three areas: direct investment flows should be excluded
from the free financial market (in practice only existent in Belgium) and
transferred to the official exchange market for current payments; individual
permits for capital transactions under the unconditional regime should be
replaced by general permits; and transactions in shares of undertakings for
collective investment in securities (unit trusts) should be placed under the
unconditional regime. Furthermore, it advocated that further progress should
be made towards the admission of foreign issuers of shares and bonds on
domestic capital markets. Mindful of the exchange rate tensions earlier in the
year the Commission refrained from advocating the liberalization of those
(short-term) channels which were preferably used for speCUlation.
The Commission's suggestion to transfer direct investment flows to the
official market in Belgium led to heated discussions in the committee. The
Belgian members did not wish to give in, because they felt that making a
hierarchical order in capital movements would undermine the fundamental
concept underlying the dual market. The Commission was supported by
chairman van Lennep who pointed to the fact that exchange rate differentials
had been of such a size (between 2.2 and 3.6%) and so sticky that one could not
escape the conclusion that they were both 'appreciable and lasting'. Against
this the Belgian members argued that the exchange rate differential was due
to the political upheavals in Belgian Congo (later Zaire) and that actual direct
investment flows did not seem to be much affected by the differential. The
French and Italian members of the committee, apparently fearing that they
would also be put under pressure to liberalize, came to the support of the
Belgians. Later in the year, they were saved by the bell, when the tensions
 91

in Belgian Congo subsided and the differential quickly diminished to less

than 1%. The Belgian delegation promised to examine the possibility of
transferring certain categories of capital movements to the current exchange
market, without committing themselves to any fixed time schedule. In its
report to the Council the Monetary Committee left the issue open. IS
As to the suggestion of the Commission to bring all unconditionally liber-
alized transactions under a system of general permits, there was opposition
from France and the Netherlands which still practised a system of individual
permits. The Dutch system, so it was argued, was only meant to permit a check
whether the transaction in fact was a liberalized one. In practice authoriza-
tions were granted generously. The French used the system for preliminary
control reasons as well as for statistical purposes in order to ascertain the
origin or destination of capital flows. Both countries would go no further
than examining whether authorization could be facilitated by simplifying and
shortening procedures.
The French continued to oppose the liberalization of transactions in shares
of undertakings for collective investment in securities. They had not allowed
such institutions in France because the Treasury, which drew heavily on the
savings of small investors, feared the competition for funds. France was equal-
ly reluctant to allow the issuance of shares by third countries on its domes-
~c capital market. In this respect it was lagging considerably behind other
countries. Germany had already completely opened its market for issues by
non-resident companies. But even Italy, which operated the tightest exchange
regime within the Community, had allowed issues of international institu-
tions. Also the Netherlands, which had voiced such misgivings about seeing
its hard earned savings withering away to less frugal countries, in practice
took a ~ragmatic viewpoint and had allowed foreign issues on its capital
market. 9 An important consideration was that, like Germany, the Nether-
lands was confronted with speculative inflows. It slowly began to realize
that the difficult post-war years of reconstruction had ended and that it was
necessary to change gear and retake its prewar position of a structural capital
exporter.
The committee also briefly discussed a Commission paper on taxation
of capital transactions, which showed that the absolute level of taxation in
some countries was a hindrance to truly free capital flows. The committee
generally favoured the harmonization and possibly the abolition of such
taxes, but acknowledged that this was within the competence of other bodies
(a special working party of taxation experts having been established).
All in all, the Commission proposals received a cool reception in the com-
mittee. The cooperative spirit which had prevailed during the negotiations on
the 1960 Directive seemed to have evaporated and the committee members
entrenched themselves in their national positions, apparently each waiting for
the other to move. Although all countries adhered to the liberalization obli-
gations under the 1960 Directive, apart from a minor deviation in Italy, they
92

apparently did not wish to accept further common obligations, but wished to
retain the right to set their own pace. The committee's report to the Commis-
sion thus did not contain any proposal for concrete steps forward, but confined
itself to good intentions and further examinations. In its annual report on 1961
the committee would repeat that further coordination of policies would be
needed in order to make progress. The time elapsed since the 1960 Directive
had been too short to initiate further measures.

5.6 THE SECOND DIRECflVE OF 1962

Late 1962 the Monetary Committee resumed its discussion of capital lib-
eralization on the basis of a new Commission paper which dealt with the
unresolved issues of the discussion of the previous year. Yet, again not much
progress was made. Considerable pressure was brought to bear on Belgium
to merge its two exchange markets, or at least to transfer direct investment
flows to the regulated market, but to no avail. The Belgians pointed out that
the exchange rate differential since the settlement of the Belgian Congo affair
had been very small and that therefore no action was needed. Belgium was
willing to reconsider the matter if a large differential were to re-appear. The
argument exasperated chairman van Lennep: when the differential had been
large the Belgian members had advocated that the discussion be resumed in
more quiet times. Now that the situation had been normalized it was asked
to postpone the discussion until problems would re-emerge. In this way the
matter would never be thoroughly discussed. But it did not help. The Belgians
would not budge. 2o
As to foreign issues on domestic capital markets there were some conces-
sions: France and Italy would allow issues on a limited scale by international
organizations (such as the European Investment Bank) and thus followed the
example set by the Netherlands. However, the French stuck to their opposi-
tion to liberalization of transactions in shares of undertakings for collective
investment in securities (unit trusts).
There was a new proposal of the Commission to liberalize non-trade related
medium-term and long-term credit by banks. The Netherlands, France and
Italy, however, did not move, although their considerations differed. The
Dutch authorities continued to be fearful of large-scale demand for capital
on their domestic market because of the relatively low Dutch interest level.
As long as guilder issues of non-residents were authorized only in individual
cases, they considered it undesirable that this regime could be circumvented
by the taking up of bank credit by non-residents. In the French case the
argument was phrased differently: France wished to shield its domestic capital
market and be able to follow its own interest and credit policy, as long as
there was no monetary unification in Europe. For Italy similar considerations
prevailed.
 93
There was not much of substance left to be included in a new directive.
Yet, the Commission wished to maintain the momentum. In its final proposal
for a new directive all small steps to which countries had agreed were insert-
ed. These included some new relatively unimportant categories of capital
transactions which more or less had been forgotten in the 1960 Directive
and now were placed in the nomenclature attached to the directive. Thus
the Second Directive, adopted by the Council on 18 December 1962, merely
served as a supplement to the 1960 Directive. Short-term and medium-term
credits, which had been liberalized only for trade-related transactions, now
were unconditionally liberalized for services as well. This curious inclusion
was an answer to the specific problems posed by the Belgian dual market.
Various cross-border payments for services had to be executed in the free
financial market, because Belgium considered them to be of a capital charac-
ter. In discussions on a directive on trade in services other member states did
not want to accept this and thus implicitly sanction Belgium's dual market.
As a pragmatic solution it was decided to include these payments for services
in the capital directive. 21
All in all, these changes were not impressive and they did not fundamental-
ly change the state of liberalization obligations achieved in the 1960 Directive.
Apparently the political and economic limits to unconditional liberalization
had been reached. Whereas the 1960 Directive to a great extent had consoli-
dated liberalization measures which the authorities had already autonomously
decided to effect, the pain threshold had now been reached for further steps
which would impose obligations on member states. The level of economic
integration still was relatively low, as was the degree of policy coordination.
Despite their favourable balance-of-payments situation, France and Italy did
not wish to take further common steps as long as monetary policy coordination
was not strengthened. At the same time they were gradually dismantling their
controls on an individual basis. France had abolished its devises-titres market
in April 1962 and thus had considerably eased transactions in shares.22 The
Netherlands had progressively opened up its well-organized capital market by
allowing issues of non-residents. But it wished to keep its authorization pro-
cedures in place. The Belgian-Luxembourg dual market formed the rallying
point where all other member states could unite in their objections. Indeed,
in the discussions in the Monetary Committee a disproportionate amount of
time was devoted to the dual market system.
The focus on the dual market was not so much inspired by economic as
by political motives. The Belgians combined a de facto restrictive system
with the claim to be liberal. Because of this position they did not support the
restrictive member states in their opposition to certain liberalization propos-
als of the Commission. This provoked the latter to denounce the restrictive
character of the dual market, just as the truly liberal countries would do. In
an atmosphere where the original cooperative spirit had been lost and quid
pro quos were asked in exchange for liberalization, for them it was not accep-
94
table to undertake further obligations if the Belgian-Luxembourg Economic
Union (BLEU) could back out because of its supposed liberal system. Quid
pro quos implied equal pain for everybody. Under this pressure the Belgians
nevertheless held on to their position.23 The underlying cause must be found
in the demands of the BLEU. The position of the Belgian franc could just as
much fall victim to speculative pressures as other potentially weak currencies,
particularly because of the unbalanced fiscal position in Belgium. However,
for Luxembourg direct capital restrictions were not acceptable because this
would frustrate the development of a specialized financial centre. As the sys-
tem implied the segregation of stocks (foreign currencies held by residents
and Belgian francs held by non-residents) and not only flows, the dual market
could not possibly be reinstated under a safeguard clause once it was dis-
mantled. The maintenance of the dual market therefore must be regarded as
a compromise between the two BLEU partners for which there was no viable
alternative.
The drive towards common liberalization ground to a halt. Political consid-
erations, such as in the case of Belgium, domestic regulations, for France and
the Netherlands, and tax considerations, particularly for Italy which suffered
from lax fiscal ethics, all were put forward as obstacles to further liberal-
ization. Member states more and more were inclined to demand quid pro
quos from others. In short, the political will to arrive to a common accord
dissipated. All in all countries wished to determine the pace of liberalization
of their own accord and were not willing to be forced by further common
obligations. The members of the Monetary Committee, who had so enthu-
siastically started their deliberations as advocates of European integration,
had entrenched themselves in their national positions. In these circumstances
the good atmosphere of cooperation between the Commission and the Mon-
etary Committee deteriorated. The 1962 Directive generally was perceived
by the public at large as a modest achievement in which the ambitions of the
Commission were not fulfilled.

5.7 THE TInRD DIRECTIVE: A FAILED ATTEMPT

The 1962 Directive having been a modest exercise, partly designed to deal
with the Belgian problem, the Commission wanted to press ahead. Before
the adoption of the Second Directive, the Commission had already prepared
a memorandum on the still existing capital restrictions, which, so it hoped,
would form the basis for a Third Directive. The Commission wished to
liberalize three categories of capital transactions: a) issues of foreign securities
on domestic capital markets; b) the introduction and quotation of foreign
securities on domestic stock exchanges; and c) investments in foreign shares
by domestic institutional investors.
Moreover, the Commission wished to tackle 'hidden' restrictions by abol-
ishing administrative and legal domestic regulations which formed a hin-
 95
drance to the free movement of capital. To this end the Commission devel-
oped some general principles which should apply in the EEC, such as non-
discrimination of domestic regulations vis-a-vis non-residents, openness in
criteria used for issuance calendriers and for the introduction of foreign
securities on domestic stock exchanges. It also suggested improvements and
possibly harmonization of the presentation of financial company data, e.g. in
annual reports. Although domestic regulations in a formal sense often did not
discriminate, they restricted de facto capital movements. They were, in vary-
ing forms and with varying intensity, applied in all EEC countries on varied
grounds. Some of them, such as the investment regulations for pension funds
and insurance companies had been designed to protect the interests of small
savers and policyholders. Others were part and parcel of a country's industrial
policy. It was clear that the Commission had trodden on delicate ground. This
immediately became clear when it consulted the Monetary Committee.
The Monetary Committee's advice, prepared by the Alternates, gave a hint
of the problems to come. It was acknowledged that discriminatory regula-
tions concerning the domestic capital market indeed were against the spirit
of the Treaty of Rome. However, it was stressed that these were difficult and
delicate matters as long as the harmonization in other sectors, in particular
with respect to taxation, had not progressed. The committee therefore called
for a gradual and cautious approach. Although there was some sympathy for
the proposal to abolish restrictive regulations with respect to the issuance of
foreign securities in EEC member countries - this would give meaning to
the unconditional liberalization of the trade in securities -, there were great
hesitations with respect to changing regulations for investment in foreign
shares by institutional investors. The rationale of these regulations was the
protection of the small savers who had entrusted their savings to the insti-
tutional investors from transfer and exchange risks. As long as there was
no economic and monetary unification such risks were deemed to be real.
However, a step in the right direction might be the liberalization of issues
of securities in domestic currency by - or guaranteed by - foreign govern-
ments. In such cases both the transfer and exchange risks would be negligible.
Even here, however, the Dutch member Posthuma referred to the right under
Article 68.3, included on a Dutch initiative, to exclude foreign government
loans from the liberalization obligation. With these discouraging reactions
the committee had set the pace for further liberalization measures. But the
Commission did not resign itself to such a cautious wait-and-see policy.
In August 1963 the Commission presented a draft proposal for a Third
Directive which went considerably further than the committee's advice. 24 In
particular, the draft proposal provided for the abolition of regulations which
would limit investment in foreign securities by instutional investors, as long
as they were provided with an exchange-guarantee clause. The Commission
felt that thus the exchange risk had been taken care of. The intra-European
transfer risk could not in its eyes be considered very large. Sound as the
96
economic reasoning of the Commission might have been, it seriously under-
estimated the judicial and competence problems in member states. Several
supervisory authorities - with respect to the stock exchange, insurance com-
panies, commercial banks, etc - were involved, all with their own philosophy
of supervision.
The proposals did not go down well with the committee. The resistance
must be ascribed in the first place to the fact that the Commission had gone
further than the committee's advice. 25 The committee did not want to be
kicked around and this was an opportunity to show the Commission who
would call the tune. Apparently, irritations had grown over time. It was the
first time that the committee had expressed itself in such no uncertain terms.
Opposition came from all sides. But first and foremost from France and the
Netherlands.
In the French eyes the Commission ran ahead of a situation which as yet
did not exist and perhaps never would arise, that is a unified capital market
in a full economic union. As long as the member states conducted their
economic policies in an autonomous manner, harmonization of policies in
these delicate areas could only come about in a cautious and gradual manner.
In France a wide variety of investment regulations was applied with respect
to different financial institutions, because some, such as pension funds, had
to be placed under a stricter regime than others. If the Commission wished
to proceed further it should perhaps come up with a differentiated scheme.
The Dutch found it a wrong course on principle to create at the level of the
EEC the conditions for the free movement of capital before a certain degree
of uniformity was reached with respect to those aspects of economic policy
which influenced domestic savings and their channelling.
It was noteworthy that even the German members, up till then staunch
supporters of the Commission initiatives, also reacted with pique. The Com-
mission was reminded that Germany had no exchange restrictions in place
and that it could not be expected to dismantle domestic administrative regu-
lations before the other EEC countries had fulfilled their Treaty obligations
of - in the German view - abolishing all exchange restrictions. With this
reasoning Germany, which up till then had defended- capital liberalization
as a case of enlightened self-interest, now also brought the quid pro quo
argument into the discussion. Politically logical, this attitude impeded further
common progress and brought the subject of capital liberalization more than
ever before in the arena of negotiations. Up till then the Commission had
prodded member states in bilateral talks to make progress. Now countries
watched each other to see who would move first. Negotiations could only be
concluded in a package deal.
The reception in the Monetary Committee had been disastrous. The com-
mittee concluded that a gradual liberalization of domestic regulations which
hindered the free movement of capital, in parallel with further liberalization
of exchange restrictions on the one hand and further progress in economic
 97
policy coordination on the other hand, was logical and useful. At the same
time these complex matters, which threatened to impinge on their autono-
my as regards economic and monetary policies, deserved a more thorough
and balanced preparation than they had been given up till now. In short, the
committee seemed to have buried the Commission's proposals in an elegant
manner. The committee having given its disapproval, there was no chance
that the Council would go along with the Commission's proposals. But was
the burial elegant? In the annual reports of the Monetary Committee the
subject of capital liberalization had always figured prominently. But in the
committee's Annual Report on 1963 not a single word was devoted to capital
liberalization. This silence was unelegant towards the Commission, if not
ominous.
What caused this disappointing attitude of the committee? Institutional
clashes apart, a real problem figured in the background. The economic climate
was deteriorating. The first five years of the EEC had been exceptionally
favourable: the annual average rate of increase of gdp in the period 1958-62
had been a little over 6%, whereas the annual rate of increase of consumer
prices remained relatively well contained at a level under 4%. This situation
changed towards the end of 1962. As shown in Figure 9 inflationary pressures
rose and, especially in France and Italy, increasing signs of overheating were
attended by a deterioration of the balance of payments. For the first time
economic developments within the Community began to diverge significantly.
On the international front as well the sky became clouded. The United
States and the United Kingdom experienced substantial capital outflows which
in continental Europe threatened to undermine domestic monetary stability.
After Germany had already taken measures in 1960 to ward off short-term
inflows, in 1963 for the same reason France also had to ban the payment of
interest on non-resident accounts. 26 Moreover, in order to prevent evasion
of the direct credit restrictions, the taking-up of loans abroad by residents
was restricted. For the fitst time France applied the same motive - control
of domestic monetary expansion - to capital restrictions as the Dutch had
done, who operated a similar monetary control system of domestic credit
ceilings. The Commission wisely had not proposed to liberalize short-term
capital transactions. But in the increasingly unstable international climate the
member states did not wish to tinker with other capital regulations in Europe
either.

5.8 FURTHER EFFORTS OF THE COMMISSION

In subsequent years the Commission made several attempts to get the Third
Directive accepted in amended forms. In January 1964 a new draft was sent
to the committee, which to a considerable extent met the earlier objections
of some countries. The committee advised that this proposal went in the
98

Annual rate of increase consume r prices

Percentot}e chon~e
B __ _______ _
france

Itoly

0 ___ ___ __ _ _

-2 r - r- - r- - r - r - r- - r- - r- - r - r - I
60 6' 62 63 64 65 66 67 58 69

Cu rrent account
Percentage of COP
6 _________ _

F'ronee

1 __ -- ---- - -

·1 _ _ _ _ _ _ _ _ _ _

60 !1 61 6J 6' 61 61 61 61 69

So urce:
Consumer prices: Inte rnational Financ ial Statistics. IMF.
Current acco unt : Eur opean Economy no 58 199 4. European Co mission.

Fig. 9. Diverging economic developments in the 196Os.

desired direction; some modifications were proposed. 27 The Commission

went back to the drawing board and then submitted on 9 April 1964 a new draft
directive directly to the Council. 28 This proposal, however, was shelved by the
ministers. There could be no other conclusion than that in those circumstances
there was no way to reach agreement on further liberalization obligations.
Germany, Belgium and Luxembourg did not want to move in the sphere of
domestic regulations as long as the other countries kept exchange restrictions
in place. France wished to consider changing its domestic regulations only
in the framework of a wider development towards economic integration.
Italy was dragging its feet as well. So was the Netherlands, which, however,
possibly under the inft.uence of chairman van Lennep, was willing to accept
 99

the directive. In practice it was already moving towards a much more liberal
regime.
An underlying consideration was that further liberalization would not be
opportune in the prevailing cyclical phase characterized by overheating. 29
Germany was trying to curtail demand by raising interest rates and this might
be frustrated if German industry could finance itself freely on other markets.
France and the Netherlands were operating a system of credit restrictions,
which they did not wish to see circumvented by their industry taking up
credit in third countries. It was thus felt by the Monetary Committee, in its
third annual examination of capital restrictions since the adoption of the 1960
Directive, that further capital liberalization would be counterproductive to
efforts underway to rebalance the overheated European economies. 30
In an attempt to bring the discussion to life again the Commission entrusted
a group of experts, headed by Claudio Segre, to study the complex issues of
integration of national capital markets. The Segre report,31 published in 1966,
underlined the linkages between freedom of capital movements and progress
in other domains, such as monetary and economic policies. It forcefully
advocated the removal of obstacles which different domestic regulations and
fiscal regimes posed to capital movements.
Mid-1965 the Commission tried to speed up the treatment of the Third
Directive by adding some new obligations for the countries which still oper-
ated exchange restrictions: France, Italy and the Netherlands. It thus hoped
to have a more balanced proposal, acceptable to the 'liberal' countries Ger-
many, Belgium and Luxembourg which had made it clear that they were only
willing to soften their domestic regulations after the other countries had taken
steps to dismantle part of their existing exchange restrictions. Inter alia the
Commission proposed that foreign issues and financial credits, up till then
falling under the conditional regime, should be liberalized unconditionally up
to certain amounts. The Commission also proposed to abolish the possibili-
ty of reintroducing restrietions on transactions under the conditional regime
which had been liberalized.
These proposals met with objections from the Italian and Dutch members. 32
However, on the initiative of chairman van Lennep who wished to make
progress, a Dutch alternative plan was developed which provided for the
parallel placement of foreign bonds on all European capital markets in order
to prevent these bonds from being issued only on the capital market with the
lowest interest rate (the Dutch capital market). This showed that the Dutch
were willing to take liberalizing measures as long as they could rest assured
that this would not in practice mean that the Dutch capital market would
become overburdened.
In the subsequent meetings of the Monetary Committee the discussions
dragged on without much progress. 33 A situation was finally reached where
the Netherlands and Italy were willing to open up their markets up to certain
limits (foreign issues up to 1.5% of their gross domestic savings), but France
100

TABLE 13
Public finances in the EEC 1960-1969 as percentage of GDP.

Average
1960/1963 1964 1965 1966 1967 1968 1969
Belgium -1.9 -0.8 -1.6 -1.0 -1.3 -2.6 -1.8
France 0.4 0.7 0.7 0.6 0.0 -0.8 0.9
Gennany 1.9 0.7 -0.6 -0.2 -1.4 -0.8 1.1
Italy -1.0 -0.8 -3.8 -3.8 -2.2 -2.8 -3.1
The Netherlands -0.3 -1.5 -0.8 -0.9 -1.3 -0.9 -0.5
BEC 0.5 0.2 -0.9 -0.8 -1.1 -1.3 -0.1

Note: Net lending (+) or net borrowing (-); general government. BEC-
weighted average of 5 countries. .
Source: European Economy no 58, 1994, European Commission.

was not even willing to go this far. On the other hand, Belgium and Germany
were firm in their opinion that these concessions were not enough to make the
Third Directive acceptable to them. The negotiations had become completely
bogged down in haggling over details. A desperate attempt by the Commission
in 1967 to get the Third Directive in an amended form accepted in the Council
failed. 34
It was generally felt that the lack of a sound and well-coordinated policy
mix in the EEC was one of the fundamental reasons why time and again the
proposals of the Commission failed and the capitalllberalization process in
Europe was getting nowhere. The divergences between the economic perfor-
mances of the European countries had increased and public finances in many
countries started to deteriorate (see Table 13). The burden of adjustment and
the fight against inflationary pressures thus increasingly came to rest on mon-
etary policy. In particular France and the Netherlands were concerned that
further liberalization would add to this burden by increasing the demand for
capital, causing upward pressure on the interest rate. In its Annual Report
on 1965 the Monetary Committee suggested that other countries, too, should
consider the introduction of a system of direct credit controls, as was operated
in France and the Netherlands. Capital liberalization had reached a deadlock
also because of the increasing concern over international monetary develop-
ments. The Bretton Woods system started to show cracks. The United States
had taken steps in the mid-1960s to curb its continuous capital outflows,
which had met only with limited success. 35
In the meantime, on the initiative of chairman van Lennep, a discussion
was started on the opening-up of the European capital markets to the less
developed countries. Capital outflows which would finance investment in
 101

less developed countries would form a useful counterpart to the surplus on

current account registered by the EEC as a whole. The practical outcome of
this discussion was that the regional development banks gained access to the
domestic capital markets on the same conditions as the World Bank. However,
this was more of a gesture, which did not have much practical impact.
While the discussions in the framework of the EEC were deadlocked, on
an individual basis countries did take steps to gradually liberalize capital
movements. After France had abolished its devises-titres market as early as
1963, the Netherlands followed suit in 1966 with the abolition of the com-
parable closed-circuit market for cross-border transactions by residents in
securities. End 1966 Michel Debre, the French Finance minister, took the
radical step of liberalizing most capital movements and switching to a posi-
tive system, implying that all capital transactions were permitted unless they
were explicitly prohibited. 36 Most remaining restrictions on short-term capital
movements were abolished. The switch to a positive system was accompa-
nied with the introduction of a system of minimum reserve requirements.
Actually the whole range of monetary policy instruments was under active
consideration with a view to moving to a more indirect s~stem, which would
operate through movements of short-term interest rates. 7 This resulted in a
period of relative liberty for capital movements in France which was to last
only 16 months, until May 1968.
The French transition to a positive system was an important, daring step.
The law's declaration of intent was simple: 'Les relations financieres entre la
France et l'etranger sont libres.' In parliament Debre argued that the French
franc having become a strong currency, the relaxations of exchange control
which had already taken place could now be codified. An important fur­
ther argument was the development of Paris as a financial centre. For this
freedom of capital movements was rightly considered a precondition.38 But
the introduction of a positive system was heavily contested by the technical
apparatus. 39 The Banque de France initially was hesitant as well, arguing that
as long as monetary cooperation in Europe was inadequate capital movements
should be regulated in one way or another. Moreover, the French central bank
needed time to undertake the monetary reform which would have to accom-
pany capital liberalization. 40
The switch to a positive system implied a considerable easing if not aboli-
tion of administrative permissions. Now the French domestic capital market
- no longer governed by exchange controls - could be gradually opened up
to foreign issues through an easing of domestic regulations. The waiting-list
on the French calendrier was a long one - 12 months! - and there was thus
a certain scepticism as to the practical openness, the more so because the
calendrier was determined by the Minister of Finance on the basis of priori-
ties of the national economic plan. The system of administrative controls for
direct investment flows, both incoming and outgoing, remained in place as
well. A situation now had developed where France had abolished nearly all
102

TABLE 14
French balance of payments 1968-1969 in
billions of francs.

1968 1969
Trade balance -0.4 -4.8
Current account -5.3 -8.7
Long-term capital -5.9 -1.6
Short-term capital -1.0 4.4
Net errors and omissions -5.7 0.5
Official reserves -17.9 -5.4

Source: International Financial Statistics,

IMP

exchange controls with respect to short-term capital movements, while main-

taining some domestic regulations which in practice could curtail long-term
capital flows. The main purpose of these regulations was, as it always had
been, the furtherance of domestic economic priorities and the avoidance of
the taking over of French companies by foreign, in particular US interests.
Nevertheless, the French intentions constituted a sensational departure from
the previous system and must be regarded as part and parcel of the Fifth Plan
which envisaged opening-up the French economy to foreign competition. The
traditional fear of speculative capital movements had been set aside.

5.9 'LES EvENEMENTS' OF MAY 1968 IN FRANCE

The ultimate blow to any move forward in Europe was given when France was
forced to reintroduce capital restrictions in the aftermath of what the French
authorities preferably called 'les evenements' of May 1968. Social unrest,
which started at the universities but quickly spread to labour, led to widespread
strikes causing serious disruptions of economic activity. The troubles were
accompanied by an enormous flight of capital which the authorities tried
to stem through the temporary closing of the exchange and gold markets
and the reintroduction of severe restrictions on short and long-term capital
flows (see for balance-of-payments figures Table 14). The provisions of the
January 1967 decree introducing a positive system of exchange control were
suspended. For the first time since the signing of the Treaty of Rome the
safeguard clauses had to be invoked by a member state. France availed itself
of the possibility of Article 109, the 'urgency clause'. which provided that
in case of a sudden crisis in the balance of payments a member state may
take the necessary protective measures. France took, in agreement with the
 103

Commission, temporary emergency measures in the trade sphere as well.

Rumours of an impending devaluation of the French franc increased, but the
authorities continued to resist this despite the loss of competitiveness as a
consequence of the generous wage settlements agreed upon in order to end
the strikes. Thus, in an attempt to regain confidence, the government tempted
fortune by lifting all exchange controls early September 1968, while at the
same time tightening monetary policy.
The resistance to adjusting exchange rates was formidable despite fresh
waves of vast amounts of speculative flows. The exchange market again
had to be closed. In an emergency meeting of the Group of Ten on 20-
22 November 1968 in Bonn pressure was exerted upon Germany, which was
confronted with large current account surpluses, to revalue the Deutsche mark.
But Germany, too, preferred taking regulatory measures, like raising border
taxes and imposing direct restrictions on speculative flows, to contemplating
revaluation. Capital inflows into Germany were further discouraged by the
imposition of a 100% reserve requirement on the growth of Deutsche mark
deposits held by non-residents. After the Bonn meeting General de Gaulle
declared that the French franc would not be devalued. Instead, exchange
controls were reintroduced. The brief experiment with free capital movements
in France had definitely come to a close. The restoration of the French external
situation took more time than initially foreseen and when a new wave of
speculation occurred in the spring of 1969, Germany intensified its controls
on speculative short-term inflows, while France tightened monetary policy
further. It was to no avail. France devalued in August by 11 %, the first
adjustment of the exchange rate of the French franc since 1958, and Germany
revalued the Deutsche mark one month later by a little over 9%.
The Monetary Committee, for the first time since the establishment of
the European Community, was consulted on the parity changes. A large
part of the deliberations was devoted to the consequences for the common
agricultural policy. France, which after the frustrating events did not wish to
risk again a crisis of confidence in the exchange rate, kept the capital controls
in place after the devaluation. This was not challenged in the committee.
Germany, on the other hand, abolished all restrictions after the revaluation
of the Deutsche mark. However, the restoration of full freedom of capital
movements in Germany, as it had existed in the early part of the 1960s, was
not to last long either. The intra-European speculative capital flows in 1968
and 1969 were small compared to the tide which would flood Europe from
across the Atlantic early in the next decade.

5.10 CONCLUSION

The start of the EEC had been promising. Rather soon secondary legislation
had been enacted which gave a meaningful content to the Treaty obligation
104

to liberalize capital movements to the extent necessary to ensure the proper

functioning of the Common Market. Those types of capital transactions were
affected which had a clear link with trade or direct investment. The two
directives which were agreed upon constituted largely a consolidation of the
status quo in the member states. Nevertheless, they could be regarded as a
step forward, because the provisions in principle saw to it that restrictions
would not be reintroduced unless by way of a common procedure. This
exerted some restraining influence on member states. The fact that countries
liberalized further on a unilateral basis but were not yet prepared to codify
this in obligations underlines the importance of the common obligations to
which they had agreed in the first decade of the EEC.
After this promising start it became increasingly difficult to make further
progress. Short-term capital movements were not brought under the liberal-
ization directives, even though some countries on an individual basis began
to abolish restrictions at the short end as well. The wish to remain in control
of domestic monetary policy as well as the fear of speCUlative capital flows
forged a powerful alliance. Countries for the time being wished to retain the
powers to maintain or impose restrictions on short-term flows without having
to go through cumbersome Community procedures, although a majority of
member states acknowledged that in due course also short-term capital move-
ments would have to fall under Community obligations. Even Germany, the
strongest advocate of the freedom of capital movement, had imposed restric-
tions on short-term capital inflows for the larger part of the decade. There was
no attempt on the part of the Commission to include them in the liberalization
obligations.
The Commission trod on difficult terrain when it tried to bring other types
of capital transactions under the liberalization directives. It struck upon objec-
tions closely related to the three motives for maintaining exchange control,
which had come up during the negotiations on the Treaty of Rome and
discussed in Chapter 3: (a) Member states were not yet prepared to open
up domestic capital markets. Foreign demand on domestic capital markets
was a politically sensitive issue, being regarded as a drain on national sav-
ings and leading to potentially upward pressure on domestic capital market
rates. Further unconditional liberalization in the medium and long-term sphere
impinged on national regulations concerning domestic capital markets, where
countries wished to determine their own marching pace. (b) Member states
followed a different monetary philosophY, with some, notably France and
the Netherlands, needing capital restrictions as a complement to domestic
monetary policy instruments. (c) The fear for disturbing speculative capital
movements was still present. Although the fear for speCUlative outflows 'had
diminished as European economies flourished, there remained a latent fear.
Later in the decade it was rather speCUlative inflows which were perceived as
a problem.
 105

The attempts of the Commission to broaden the liberalization obligations

were mainly directed towards the opening-up of domestic capital markets. In
the view of the Commission this could lead towards the development of a truly
integrated European capital market which, so it was felt, would strengthen the
functioning of the Common Market. The Commission targeted areas such as
the admission of foreign issues on domestic markets, the quotation of foreign
securities on domestic stock exchanges and the liberalization of unit trusts. In
doing so the Commission became increasingly attentive to domestic regula-
tions, such as investment rules for institutional investors which discriminated
between domestic and EEC assets.
These Commission attempts towards a common approach failed because of
institutional and structural obstacles, notwithstanding the substantial progress
towards deregulation and liberalization in individual member states. Partic-
ularly in France, before the 1968 events, there was a courageous effort to
liberalize capital movements far beyond the agreed obligations and mod-
ernize monetary policy instruments. For a short while French and German
exchange control systems approached each other closely and plans were
developed in France to move towards an indirect monetary control system
as well. This alignment, however, proved to be short-lived when the French
'evenements' caused a major set-back. When the economic and international
climate worsened towards the end of the decade and tensions in the exchange
markets increased the authorities became disinclined to further liberalization.
So, ten years after the start of the EEC, at the very time when the customs
union between the six EEC members was completed, restrictions on the free
movement of capital had to be reimposed. At the time these measures were
taken, it was thought that they would be of a temporary nature. It could not
be foreseen that it would take another 15 years before attempts toward capital
liberalization could be resumed.

NOTES

1. La liberation des mouvements de capitaux en application de l'Article 67.1 du Trait6 de

Rome (1959), European Commission.
2. Banca d'Italia, Annual Report 1961, p. 77.
3. Banca d'Italia, Annual Report 1960, p. 87-92.
4. Memorandum of9 April 1959, Ministry of Finance.
5. See discussion in Chapter 2, p. 15.
6. In an earlier internal draft of the memorandum it was argued that for transactions in
securities a separate, free exchange market should be established which could absorb the
shocks which were likely to occur in this sector. However, the idea of a dual exchange
market (trade and investment-related capital transactions through the fixed exchange
market, finance-related capital transactions through a free market) met with opposition
from Governor Holtrop and eventually was abandoned.
7. Note concernant la proposition de directive sur la liberation des mouvements de capitaux,
dated 17 December 1959.
106
8. The Commission had split the unconditional liberalization regime into two parts (lists
A and B) in order to accommodate a different treatment of certain categories of capital
transactions in multiple exchange rate systems. 'fi'ansactions on list A - mainly direct
investment and trade credits - should be executed at an exchange rate which was not
allowed to diverge appreciably and lastingly from the official rate for current transactions.
As regards the transactions on list B - mainly listed shares - the authorities merely
should 'endeavour' to avoid appreciable and lasting divergences. The motive for this
different formulation was that the list A transactions were deemed most essential for the
functioning of the Common Market and therefore should not be hampered by the exchange
rate fluctuations on the free market. For list B transactions this was felt to be less urgent.
The regime conditionnel was put in list C and the third category, where there was no
obligation to liberalize, in list D.
9. Directive on the liberalization of transactions in shares of undertakings for collective
investment in securities (851583), dated 20 December 1985. See chapter 7, p. 167.
10. There was one exception: long-term trade credits were not unconditionally liberalized as
opposed to short and medium-term credits. The Commission had wished to liberalize all
trade credits, whereas the committee initially wished to limit the liberalization obligation
to trade credits shorter than one year. Eventually a compromise was struck and medium-
term trade credits were included in the liberalization obligation (see also Chapter 7, Note
39).
11. Monetary Committee, Annual Report 1960.
12. Since the beginning of 1959 France had gradually liberalized its extensive exchange
controls. On 1 January 1960 the Office des Changes, established in October 1940, had
been closed because of its diminished activities. The remaining tasks had been partitioned
between the Banque de France and the Ministries of Finance and Economic Affairs. When
the directive was published on 20 July 1960 in effect no French exchange regulations had
to be amended (Banque de France, Annual Report 1960, p. 25). As regards the Italian
exchange regime, there was, however, a difference of opinion between Italy and the
Commission whether the treatment of shares was in conformity with the directive.
13. Articles 1.2 and 2.2 of the First Directive. Italy, too, was confronted with multiple exchange
rates because exported bank notes, a notable source of illegal or tax-inspired capital out-
flows, could not, after being re-imported, be credited to non-resident accounts. Therefore,
there was an unofficial lira exchange rate quotation which differed from the official
exchange rate. In January 1962 this restriction was lifted. France and the Netherlands
both operated closed-circuit free markets in shares. Because these fell under the less strict
regime of Article 2.2, these markets were not affected.
14. Addendum to the proposal of the Commission to the Council for the First Directive, 1960.
15. Banque de France, Annual Report 1960, p. 24.
16. Banca d'Italia, Annual Report 1960, p. 88.
17. Emminger (1986), p. 98.
18. Conclusions du premier examen annuel des restrictions applicables aux mouvements de
capitaux entre les Etats membres, report of the Monetary Committee to the Commission,
dated 7 July 1961.
19. The Netherlands proceeded cautiously. The issues were allowed 'provisorily' on the basis
of an 'exceptional' authorization and for limited amounts.
20. The Belgian authorities were to propose that in case of large differentials special permits
could be given to conduct direct investment transactions in the regulated market. They
wished to define this as 'on average 2% over the last 90 days or 3% over the last 30 days',
but this was not acceptable to the Commission which did not want to go further than 2%
over the last 15 days.
21. The inclusion of payments for services in the EEC directive implied a deviation from
the OECD code which treated all services payments as current payments, in line with
established practice. However, so it was argued in the Monetary Committee, the OECD
 107

had not taken a strict line against the dual market system: transactions were considered
liberalized ifthey were channelled through the free market. The EEC was taking a stricter
line.
22. The devises-titres market, started in April 1955, implied that proceeds from sales of
foreign securities expressed in foreign currencies and owned by French residents (so-called
devises-titres) might be sold in a free market to other residents, who in turn could use
them only to purchase securities quoted in foreign markets. This system was comparable
with the Dutch system of special investment accounts ('herbeleggingsrekeningen'). The
Banque de France intervened in the devises-titres market in order to exercise a moderating
influence on exchange rate fluctuations. Actually the exchange rate differentials since
end-1958 had been relatively small. In an internal memorandum of the Banque de France
(1 February 1962) its abolition was advocated: 'Ie r6gime de la devise-titre est un h6ritage
d'une p6riode oi) la balance franyaise des paiements se soldait avec persistance par de
lourds d6ficits, oh les reserves officielles de change 6taient manifestement insuffisantes,
oh Ie franc 6tait attaqu6 sur tous les fronts' . All these were bygones and its abolition would
satisfy the IMF, its European partners, the US and the French citizens, who would now
no longer be incited 'to export their capital illegally or buy gold on the Paris market'. The
latter was regarded as undesirable. The abolition of the devises-titres market implied that
transactions in shares by residents could now be channelled through the official market.
23. In the 1960s preparations had been made to abolish the dual exchange market, but they
were cancelled at the last minute when a crisis showed it could still playa useful role.
24. Projet de troisieme directive pour la mise en oeuvre de l'article 67 du Trait6, dated 23
August 1963.
25. In a report by the Dutch members of the meeting of the Monetary Committee in November
1963 there is an undeniable sense of irritation: the committee had carefully considered its
advice, but the Commission had felt that it could brush away these considerations. The
Commission's proposals moreover showed signs of poor preparation.
26. Decision of 21 April 1963 by the Conseil National du Cr6dit. The payment of interest on
accounts held by central banks and international institutions was exempted. The prohibition
was lifted on 9 November 1966, only to be reintroduced during the crisis in the Bretton
Woods system.
27. Avis du Cornit6 Mon6taire, dated 16 March 1964.
28. Proposition de Troisieme Directive pour la mise en oeuvre de l'article 67 du Trait6,
COM(64)128, dated 9 April 1964.
29. There was a serious concern that inflationary impulses might be transferred from one
member state to the other. In its meeting on 15 April 1964 the Council had adopted a
recommendation which called upon member states to adopt measures in order to restore
internal and external equilibrium. A concrete measure proposed was that all countries
should limit the expansion of government outlays to 5% in order to curtail inflationary
pressures. Countries indeed took deflationary measures which met with some success.
30. Meeting of the Monetary Committee in May 1964.
31. Le d6veloppement d'un march6 europ6en des capitaux (1966), European Communities,
Luxembourg.
32. The French members were not present because of the empty-chair policy France conducted
from July 1965 until January 1966. However, had they been present, doubtless they would
have voiced objections as well.
33. Meetings of the Monetary Committee in December 1965, and February and April 1966.
34. See Ruding (1969), p. 212 et seq., for an elaborate discussion of this modified direc-
tive. He attaches much importance to the distrust felt by Germany, Luxembourg and the
Netherlands, that in practice the required liberalization would take place at an equal scale
in France, and to a lesser extent in Belgium and Italy. The latter countries made much
more use of domestic regulations for admission to the domestic capital market, e.g. prior
authorization of issues by the Minister of Finance in France. The lack of transparency of
108

these regulations fueled the fear that the capital markets of those countries which hitherto
relied primarily on exchange controls would after the liberalization become overexposed
to foreign demand for capital.
35. See Chapter 2, Note 2.
36. Law of28 December 1966, which entered into force on 31 January 1967.
37. Icard (1994) reports that these considerations resulted in the publication in June 1969 of
the Report on the money market and credit conditions, written by Marjolin, Sadrin and
Wormser (Rapport sur Ie marcM monetaire et les conditions de credit). They criticized
the selective credit policy at subsidized rates and recommended an active monetary policy
with interventions on the money market to influence short-term interest rates. Icard judges
these proposals as 'very far-reaching and also quite modern for an economy that was still
largely regulated.' Some of the recommendations were implemented, but they had to be
suspended in the economic turmoil which followed the oil shock in 1973.
38. Debre quoted in Teyssier (1973), p. 270.
39. In his memoirs Teyssier (1973, p. 265), one of its administrators, decries the transition
to a positive system in vivid terms: 'Un pays doit etre maitre de son destin. A quoi bon
une armee, une marine, une aviation, et meme des bombes atomiques, si l'aneantissement
peut venir d'ailleurs!', meaning speculative capital outflows.
40. Banque de France, memorandum dated 5 May 1966.
 CHAPTER 6

The 1970s: Lost Control

All diese Fortschritte in Richtung auf gro,Pere Freiheit in der

WeltwirtschaJt, die uns heute so selbstverstiindlich erscheinen,
erforderten jahrelang eine unendliche Kleinarbeit.
Otmar Emminger, 1986

6.1 INTRODUCTION

At the tum of the decade the strains in the international monetary system
had become very pronounced. The large balance-of-payments deficits of the
United States had cast doubts on the sustainability of the fixed exchange rates
and engendered vast speculative capital outflows out of the US dollar. But
the European economic and political situation, too, was full of uncertainties.
The political troubles in France in 1968 - 'les evenements de mai' - had been
followed by repeated speculative attacks on the intra-European exchange rate
relationships. Following a defeat in the referendum held in April 1969 Gener-
al de Gaulle had resigned. The new administration under president Pompidou
was defining a new, less intransigent course for French external policies,
including the possible lifting of the French veto on EEC membership of the
United Kingdom. The continued upward pressure on the Deutsche mark, both
vis-a-vis the US dollar and most other European currencies, had provoked
a crisis atmosphere in Germany. There was widespread reluctance to let the
currency appreciate out of fear of a deterioration of the competitive position
of German industry. When in the face of continuous capital inflows such
appreciation could not be avoided in the end - the Deutsche mark was reval-
ued by 9% in October 1969 - the 'great coalition' (christian-democrats and
socialists) headed by chancellor Kiesinger had already been forced to step
down, reflecting the serious differences of opinion within the administration
as to how to handle the crisis situation. But when the speculative inflows
from across the Atlantic contined to swamp the German money market, the
new socialist-liberal government under Willy Brandt also struggled with the
question whether the Deutsche mark should be allowed to float or whether
controls on capital inflows should be imposed. Opinions on this issue were
sharply divided within the Zentralbankrat of the Bundesbank as well. The cri-
sis in the international monetary system prompted the European Community
into action. Numerous meetings of the Monetary Committee were devoted
to discussing possible measures to cope with the voluminous cross-Atlantic

109
110
speculative capital movements. The exchange control measures taken by the
US administration to stem the continuous outflows had little effect. When it
increasingly became clear that no international agreement on more fundamen-
tal measures could be reached, the European countries were driven into each
other's arms. Gradually consensus emerged on a twofold European reaction
to the turbulences in the exchange markets: (1) closer intra-European cooper-
ation in the economic and monetary field would be pursued, in order to reduce
uncertainty and restore confidence among market operators, and (2) capital
controls would be re-established in order to ward off remaining speculative
capital movements. Faced with the new situation the Commission completely
reversed its earlier position in favour of capital liberalization. Anything was
preferable to floating which was considered to undermine the foundations of
the Common Market and to complicate the common agricultural policy.
The wish to cooperate more closely in the economic and monetary field
had been a constant theme in the deliberations of the Monetary Committee.
In its Annual Report on 1966 the committee had evaluated the functioning of
the EEC in the first ten years since the signing of the Treaty.l One of the main
findings was that the gravest threat to the accomplishment of the goals of the
Common Market had not been the restoration of trade or capital restrictions
- as had been the main fear of the drafters of the Treaty -, but rather the
internal imbalances within the member countries themselves. Thereby the
maintenance of price stability had been jeopardized. The problems caused by
inflation differentials had been compounded by major cyclical divergences
among member states. These had prompted policy reactions which in tum
had repercussions on the policies of other countries. The main lesson to
be drawn from this was that the conditions for internal macro-economic
and financial eqUilibrium of the individual member states deserved much
more policy attention of the Monetary Committee. Economic and monetary
policy coordination should be strengthened with a view to minimizing these
negative repercussions. These considerations and the emergence of exchange
rate tensions prompted a major political initiative at the end of the 1960s to
deepen the institutional and procedural commitments of the member states.
It was felt that this should be done before new member states would be
admitted to the Community. In an enlarged Community the risk of negative
repercussions of uncoordinated economic policies would be even larger.

6.2 THE WERNER REPORT, A DOOMED ATTEMPT

In the breakthrough Hague European Summit meeting in December 1969

an attempt was made to breathe new life in the European integration ideal.
Under its new president Pompidou, France took a more outward-looking
attitude. Its negative demeanour within the EEC, evinced by the empty-
chair policy, was now left behind and the French veto on EEC membership
 111

of the United Kingdom was lifted. From now on the Community would
open itself to new members. However, before initiating negotiations with
prospective new members the Community's goals and institutions should
be strengthened. In their communique, the Heads of State or Government
expressed the wish 'to see the Community develop into an economic and
monetary union through the implementation of a phased plan'. To this end
an Ad Hoc Group, under the chairmanship of Pierre Werner, Premier and
Minister of Finance of Luxembourg, was established to elaborate such a plan.
On 8 October 1970 the group finalized its report. 2
The Werner report took as its starting point the anomaly that due to the
increasing linkages between the European economies autonomy over national
policies had weakened, while no compensation for this loss of national auton-
omy had been created at the Community level. The lack of effective coordi-
nation of economic policies in the Community, prescribed in the Treaty, and
a continued bias towards particularism among member states were seen as
lying at the heart of the insufficient progress towards further liberalization of
capital flows and financial integration. Therefore all attention should be direct-
ed towards strengthening policy cooperation between member states, with a
view to reaching the final objective of economic and monetary union. Such a
union, to be achieved in three stages, would 'realize an area in which goods
and services, people and capital will circulate freely and without competitive
distortions, without thereby giving rise to structural or regional disequilib-
rium', as well as 'the total and irreversible convertibility of currencies, the
elimination of margins of fluctuation in exchange rates, the irrevocable fixing
of parity rates and the complete liberation of movements of capital' .
The main elements of economic and monetary policy-making would have
to be centralized. 3 This would require the creation of new institutions to which
national powers would have to be transferred:
- a Centre of decision for economic policy, which would formulate eco-
nomic policy of the Community and would monitor national budgetary
policies; this institution would be responsible for the external exchange
rate policy of the Community and would be politically accountable to a
European Parliament;
- a Community system for the central banks, which could be based on the
structure for the Federal Reserve and which would execute the internal
monetary policy in the Community, as well as the commonly agreed
exchange rate policy through interventions on the foreign exchange
markets. 4
The aim of the first two stages, the second stage being essentially a rein-
forced first stage, was to progressively strengthen the coordination of eco-
nomic policies with a view to both stabilizing the exchange rates and to
enabling the gradual liberalization of capital movements as necessary steps
towards the final stage of economic and monetary union. National decisions
on budgetary policy were gradually to be taken in the light of Community
112

guidelines. To this end there would be prior consultations among Community

member states and their performance would be closely monitored with the
help of a system of indicators. In these preparatory stages the coordination
of general economic policy-making was to be principally the responsibility
of the Council of Ministers. The Committee of Governors of the EC central
banks would play an important role in both internal and external monetary
policy-making, but the general guidelines of monetary and credit policy were
to be determined in the Council as well. The central banks were requested to
work towards a progressive narrowing of the fluctuation bands.
The Werner report noted with concern that both exchange restrictions as
well as domestic regulations hampered the free movement of capital. The
resulting differences in the costs and conditions of credit among countries
were contrary to fair competition and the eventual establishment of an eco-
nomic and monetary union. In the envisaged first stage the Werner report
took up the earlier proposals of the Commission to abolish restrictions in a
somewhat amended form. It advocated the liberalization of issues of securi-
ties by EEC residents on all EEC capital markets (subject to ceilings which
could be gradually raised), of short and medium-term non-trade related cred-
its, and of the quotation of shares originating from member states on all EEC
stock exchanges. The report furthermore called for the abolition of domes-
tic regulations for institutional investors which limited investment within
the Community. Finally, the Werner report advocated the coordination and
harmonization of domestic regulations concerning the capital market.
A number of observations can be made with respect to these proposals. In
the first place the proposals again fell short of full liberalization of capital
movements. It was envisaged that efforts in the second phase primarily should
be directed towards the establishment of an integrated European capital
market. Apparently the freeing of short-term capital movements was to be
left to the final stage of economic and monetary union. Secondly, the proposals
considerably diverged from the erga omnes principle. They were explicitly
directed towards the establishment of an exchange and regulatory regime
which discriminated between EEC and non-EEC capital movements. Finally,
there was no reference to the desirability of abolishing the Belgian dual
market. In the face of the international exchange turmoil the spreads between
the financial franc and the official Belgian franc rate had increased to as much
as 10%. This omission was all the more remarkable because at the same
time the Werner report called for the progressive narrowing of the fluctuation
bands for the official intra-EEe exchange rates.
The report stopped short at a rather general description of the institutional
set-up of the final stage of the economic and monetary union and did not deal
in detail with the institutional structure and the division of responsibilities
between the system of central banks and the political executive. It was left
unclear whether the system of central banks could operate independently of
government or Community instructions, an institutional feature which gained
 113

a prominent place in the Delors report and subsequently in the Maastricht

Treaty twenty years later.
The institutional vagueness of the Werner report, especially in the monetary
field, and the non-committal character of the economic policy coordination in
the transitional stages formed inherent weaknesses of the report. The Werner
report was rich on the need for cooperation, but was short on the targets to
be achieved through this cooperation. It did not prescribe the objective of
price stability for the national central banks, nor did it provide for indications
of the acceptable size of national budget deficits. Its grandiose concept of
economic and monetary union was not yet supported by a common economic
philosophy among the member states. The compromise formulations used
could barely hide the fact that there were underlying fundamental differences.
The disagreements would become manifest rather soon. When on 22 March
1971 the Council adopted a Resolution on the attainment of economic and
monetary union in stages, the definition of the Werner report's final objective
was accepted, but the relinquishment of national sovereignty in the non-
monetary field was described in much vaguer terms. The proposal for a Centre
of decision for economic policy was not taken up by the Council, without
any provision being made for alternative constraints on national budgetary
policies. The institutional set-up of the economic part of the union thus was
weakened considerably.
At the same time the Council adopted a Decision on the strengthening
of the cooperation between the national central banks. But also here there
were underlying divergent views on the objectives of monetary policy. The
initiative towards economic and monetary union therefore soon would fail
when, despite all good intentions and strengthened cooperation procedures,
economic and monetary developments within Europe increasingly started
to diverge. Thereby the opportunity for liberalization of capital movements
slipped away as well.

6.3 THE ESTABLISHMENT OF THE SNAKE

In the Council Resolution of 22 March 1971 it was provided that in the

framework of the ultimate goal of the introduction of one European currency
the mutual exchange rate margins would, by way of trial, be narrowed,
as suggested in the Werner report. 5 This plan had barely been conceived,
when in May 1971 the speculative capital movements again swelled after the
pUblication of a study by the five German economic institutes, in which either
floating or a revaluation of the Deutsche mark was advocated. The Deutsche
mark had become the safe haven for funds moving out of the US dollar
and the continued capital inflows threatened to blow up the money supply.
Monetary policy, which had been tightened following the 1969 revaluation in
order to curb inflationary pressures, had become completely overstretched. At
114

$/FF

6.00 _ _ _ _ _ _ _ _ _ _ _

.
5.75 _ _ _ _ _ _ _ _ _ _ _
5.50 ---''''''''''~
5.25 _

4.50 _ _ _ _ _ _ ----'=0,,_

4.00 _ _ _ _ _ _ _ _ _ _ _

~75rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrl
j Q a 0 "d j , ma mj j a $ 0 n d jf ma mj j Q son d j f m
71 n n ~

Official Financial
franc exchange franc exchange
rate rate

Source: Quarterly bulletin, DNB.

Fig. 10. The French dual market 1971-1974.

times measures had been taken to discourage short-term capital inflows. These
measures had affected capital movements only in an indirect manner and were
not in contravention of the EEC directives, nor of the OECD Liberalization
Code.6 They were, however, not successful.
There were serious differences of opinion among the monetary authorities
as to how to react to the continuing inflows. At stake was the issue whether
the Deutsche mark should be allowed to float or whether direct controls on
capital inflows should be imposed. The Bundesbank favoured the imposition
of direct capital controls on inward flows, although it was unlikely that at
short notice adequate exchange controls could be introduced which would
effectively discourage further capital inflows. For the German government
the step towards a generalized system of direct controls was not yet acceptable
for reasons of economic philosophy. The government, loath to abandon its
market-oriented approach, decided to float the Deutsche mark unilaterally on
10 May 1971.7 Nevertheless, ~e reintroduction of the prohibition against the
sale of German money market pape~ to non-residents, only lifted in 1969, as
well as a ban on interest payments on bank deposits held by non-residents,
constituted a prelude to an increasing willingness towards interventionism. 8
The Dutch monetary authorities, which likewise found it impossible to draw
up strict excpange controls in time, let the guilder float in tandem with the
Deutsche mark.
The speCUlative capital movements out of the US dollar implied a shift
in the fortunes of the French franc, which up till then primarily had been
 115

prone to speculative capital outflows, but now was attracting inflows. In the
course of the year several measures were taken to curtail these inflows. After
the suspension of the convertibility of the US dollar on 15 August 1971 the
upward pressure on the European currencies was such that direct restrictions
on inflows were considered to be unavoidable. France tried to avert the risk
of an appreciation of its currency vis-a-vis the US dollar by introducing a
dual exchange market with similar characteristics as the Belgian dual market,
while at the same time further strengthening its restrictions on capital inflows.
Current transactions could be settled in the official market, where the Banque
de France intervened, whereas all other transactions, including those for
tourism and travel, had to be led through the free market, where the 'franc
financier' floated (see Figure to). At the same time the authorities were
reluctant to abolish the heritage of the 1968 crisis - controls designed to curtail
capital outflows - although there were some relaxations. The security currency
market ('devises titres') initially was maintained,9 as were maximum foreign
exchange allowances for French travellers. This anomalous situation was
characteristic of the activist, fine-tuning attitude of the French authorities in
using exchange controls. Whereas the Belgian two-tier market was vindicated
by the lack of direct capital controls, France utilized both. In the Monetary
Committee the French members indicated that France intended to leave long-
term and intra-EEC capital movements as much as possible unaffected. A
brave face was put on it, but in practice it proved to be impossible to separate
intra-EEC and extra-EEC flows. Moreover, there was a pull on the French
franc from two sides: against the tendency to appreciate vis-a-vis the US
dollar, there was the tendency to depreciate vis-a-vis the Deutsche mark.
France was the only European country to maintain an effective dollar
parity. Belgium and Italy no longer kept their exchange rates within the agreed
margins. Belgium had provided that capital inflows could only be executed
on the free market where the Belgian franc carried a premium. Previously
market operators had had a choice to settle a number of capital receipts from
abroad either in the free or in the official market and thus could select the most
advantageous exchange rate. Italy, which was not confronted with large-scale
inflows and thus did not have to fear an appreciation, decided to let the lira float
freely. In the Netherlands the so-called O-circuit was established, a closed
bond circuit which was intended to curtail foreign demand for Dutch guilder
paper. In March 1972, as a complement to the reserve requirements for banks,
Germany introduced the Bardepot, which called for a non-interest-bearing
deposit of part of the proceeds of credits taken up by residents abroad.1O In
many countries there were accompanying measures to limit the growth of
domestic liquidity as well, mainly in the form of reserve requirements.
In the currency turmoil of the beginning of the 1970s the Benelux countries
actively tried to maintain a measure of exchange rate fixity within Europe.
In August 1971 they had agreed on narrow fluctuation margins against each
other's currencies in the hope that this would set an example which might
116

be followed by other European countries. 11 These attempts to persuade the

other member states to proceed to a joint floating of the EEC currencies
failed because of diverging economic developments and policy goals, France
wishing to maintain its parity.12 Only in the framework of the Smithsonian
agreement, where on 18 December 1971 new parities were fixed, implying a
devaluation of the US dollar vis-a-vis the Deutsche mark of 13%, could the
European countries reach agreement to establish an exchange arrangement,
which would become known as the snake. Starting on 10 April 1972 the
arrangement functioned as 'the snake in the tunnel' , intra-European exchange
rate fluctuations being limited to narrower margins than the fixed margins
(the tunnel) vis-a-vis the US dollar. The establishment of the snake was
the most concrete left-over of the recommendations of the Werner group. It
was, however, to operate under conditions diametrically opposed to monetary
integration, capital controls having been tightened considerably. Technically
it was not possible to differentiate between intra and extra-EEC capital flows,
despite weak attempts to this effect by France. The snake therefore was not
so much a first step on the road to economic and monetary union as well as
a defensive move to preserve a measure of internal exchange rate stability
within Europe.
European countries had stumbled over one another to close the lock-gates.
However, the plethora of measures did not end the exchange crisis. The impo-
sition of capital controls was merely a symptom of the shaken confidence in
the international monetary system, the seriousness of capital flight out of the
United States and the resistance of European countries to a revaluation of
their currencies. Actually, the dramatic events brought about an evolution in
the thinking of European authorities concerning capital restrictions. Before
this time, in some countries capital controls were regarded mainly as a com-
plement to domestic financial and monetary policies, the Dutch monetary
authorities providing a striking example of this attitude. In other countries
the monetary authorities had been mainly concerned with the risk of specu-
lative capital outflows and the consequent undue downward pressure on the
exchange rate. Now, after the suspension of dollar convertibility, there was a
new motive: to avoid upward pressure on the exchange rate. Appreciation of
the European currencies vis-a-vis the US dollar would cause an unwarranted
deterioration of their competitive positions, so it was felt. Capital controls
were imposed out of fear of a loss of European jobs.

6.4 CAPITAL CONTROLS CODIFIED IN THE 1972 DIRECTIVE

The blow wnich the 1968 events in France had dealt to the process of capital
liberalization in Europe had been magnified by the problems surrounding
the collapse of the Bretton Woods system. The suspension of official inter-
ventions and the subsequent floating of the Deutsche mark and the guilder
 117

in May 1971 had raised serious problems for the Community. The tempo-
rary abolition of fixed exchange rates and the consequent disturbance of the
common agricultural policy were undermining the foundations of the Com-
mon Market. The speculative capital movements were driving the member
states apart. France, which already had an elaborate machinery for exchange
control at its disposal, had tried to maintain the par system in combination
with stringent exchange controls. Germany, which in the 1960s had been the
staunchest supporter of capital liberalization, was not yet ready to revert this
position, both in an ideological and a practical sense, but it was showing signs
of weakening resolve.
In this changed atmosphere the Commission, in a complete reverse of its
earlier drive for liberalization, had presented in June 1971 proposals which
would require member states to have at their disposal the necessary instru-
ments to ward off undesirable capital inflows.!3 These proposals followed
inconclusive discussions in the Monetary Committee on measures to deal
with the speculative flows, which disturbed the monetary situation in some
member states, especially in Germany, and were hindering the pursuit of
the steps provided for the first stage of economic and monetary union. An
important motive for the Commission, which was decidedly against any move
towards floating, was that capital controls might contain speculative move-
ments and thus preserve the system of fixed exchange rates. Although most
member states had the instruments alluded to in the Commission proposal at
their disposal, it was indicative of the disarray within the Community that
no quick agreement could be reached. All member states had taken different
countermeasures in the face of speculative capital inflows. Another factor
was that the German authorities among themselves were not yet clear as to
what the appropriate response should be. Later in the year, after the sus-
pension of dollar convertibility and the subsequent Smithsonian agreement,
thoughts had developed. Consensus among the member states had grown
that indeed measures were called for to curtail the speculative capital flows
which continued to disrupt the exchange markets. It was acknowledged that
the restrictive measures which individual member states had already taken
detracted from the obligations under Article 67. The Monetary Committee,
which held numerous debates on the monetary problems, concluded that the
serious international disturbances and their repercussions on internalliquidi7
justified such a departure from the liberalization obligations of the Treaty.!
In a final discussion of the draft in the Monetary Committee it was decided
to have regular discussions in the committee with a view to coordinating the
exchange controls of member states. This was a far cry from the obligation,
both under the First Capital Directive as well as under the committee's own
statutes, to examine yearly whether existing exchange regulations could be
abolished. The last such examination had taken place in December 1965.
Afterwards it was relegated to oblivion. It suited the committee members
quite well, so it seemed. The mood had changed dramatically.
118
In the directive, which ultimately was adopted by the Council on 21 March
1972, IS the member states were obliged to have instruments available which
could curtail undesirable capital flows and neutralize their effects on the
domestic monetary situation. These instruments should include regulations
governing money market transactions by non-residents. In order to neutralize
the monetary effects of capital inflows, countries were obliged to have rules
in place for the net external position of credit institutions as well as minimum
reserve ratios for holdings by non-residents. Furthermore, a general deroga-
tion from the First Capital Directive was extended with respect to financial
loans and credits by non-residents to residents.
Restrictions under the directive would have general application; there was
no differentiation between capital movements within the EEC or with third
countries. The erga omnes principle thus was upheld. Opinions had differed as
to whether capital controls should discriminate between EEC member states
and third countries. In the eyes of the Commission Europe should manifest
itself as a bloc. In meetings of the Monetary Committee, the Commission rep-
resentatives had taken the position that member states should harmonize their
capital controls vis-a-vis third countries, while simultaneously liberalizing
intra-EEC capital flows. Most other members opposed this, on the grounds
of the erga omnes principle as well as for technical reasons. It was tech-
nically nearly impossible to distinguish between intra-EEC and extra-EEC
capital flows. Ifat all possible, such discriminatory regulations could be eas-
ily circumvented. Moreover, the lack of consensus on policies within Europe
triggered intra-EEC speculative capital movements with equal force. 16

6.5 THE COLLAPSE OF THE BRETTON WOODS SYSTEM AND THE OIL
CRISIS

In the beginning of 1973 yet another wave of speculative capital movements

foreboded the final demise of the Bretton Woods system. On 22 January
1973 Italy, following the example of France, established a dual exchange
market in order to stem considerable outflows of capital. Germany took
further administrative measures to stop capital inflows, but they proved to
be largely ineffective. Finally, it was decided to close the exchange markets.
After a devaluation of the US dollar of 10% the exchange markets were
reopened on 14 February. Within a fortnight the exchange markets had to
be closed again after another'tide of speculation. The failure of massive
interventions by the Bundesbank to change the sentiment had convinced
the German monetary authorities that continuation of the fixed parity would
undermine monetary policy beyond repair and thus would threaten domestic
price stability. The European countries decided to maintain the snake, but to
abolish the fluctuation margins vis-a-vis the dollar (the 'tunnel'), thus marking
the end of the Smithsonian agreement. On 19 March 1973 the exchange
 119

TABLE 15
The snake arrangement.

% change vis-h-vis Gennany Belgium Denmark The Netherlands

European central
rate (UCME)

1973 19 March +3
29 June +5.5
17 September
+5
1976 18 October +2
-4
1977 4 April
-3
29 August
-5
1978 16 October +4 +2
+2

Note: The United Kingdom withdrew from the arrangement on 23 June 1972. Italy withdrew
on 13 February 1973. France withdrew on 21 June 1974, re-entered on 10 July 1975 and
withdrew again on 15 March 1976. Norway and Sweden were temporarily associated with
the snake arrangement.

markets reopened, marking the start of the era ofjloating exchange rates. At
the same time controls on capital inflows in several Community countries
were tightened further in order to prevent or mitigate upward movements of
the exchange rate.
Later in the year the oil crisis erupted, causing a dramatic change in the
fortunes of major currencies. Oil-importing industrial countries experienced
a sharp deterioration in their terms of trade and consequently were faced with
large ex ante deficits on the current account of their balances of payments.
The oil crisis gave the final blow to the project of European economic and
monetary union. The snake had been the only substantive, visible left-over of
the attempts of the Werner Report towards monetary integration. Already at
an early stage, in June 1972, the United Kingdom had been forced to leave the
snake, as the first European country switching over to a full-fledged float (see
Table 15). When in early 1974 France and Italy had to withdraw as well from
the arrangement in the wake of the oil crisis, the aim of achieving a monetary
union had to be regarded as completely illUSOry. Herewith, also the issue
of capital liberalization was pushed into the background. In fact, there was
widespread agreement that 'the regulation of capital flows by direct (restric-
tive) means is of great importance in the current situation in preventing, as far
120
as possible, disequilibria occurring as a result of the differences in preference
that funds from the oil producing countries seeking investment show for the
currencies participating in the scheme (i.e. the snake agreement)' .17
Many countries quickly dismantled the controls on inward capital flows,
which they had installed during the previous years, in order to facilitate the
financing of the expected current account deficits. Furthermore, in coun-
tries with serious balance-of-payments problems capital controls on outward
capital flows were intensified. An even more serious threat to the Common
Market ensued when Italy, which was suffering from high inflation and ris-
ing balance-of-payments deficits, took restrictive measures in the trade field.
Developments in Europe thus had taken a serious turn. Not only had capital
movements been curtailed substantially, but with the Italian measures even
the raison d'~tre of the Community - the free trade of goods - was jeopar-
dized. European member states drifted apart and the coordination of economic
and monetary policies remained a dead letter until the establishment of the
European Monetary System in 1979.
Since the anchor that the fixed exchange rate system had provided was
lost, a new policy orientation had to be chosen. In some countries the con-
viction had grown, partly stimulated by the vivid academic debate on the
pros and cons of fixed and floating exchange regimes, that monetary policy
under a floating regime, possibly supported by exchange restrictions, could
be conducted in a more autonomous manner. But views differed about the
primary aim of monetary policy and thus about the way this increased auton-
omy should be put to work. In Germany, monetary policy was set by a strong
independent central bank which regarded the maintenance of price stability as
the main target for monetary policy. This primary objective was written into
law. But in countries like France and Italy monetary policy, being a shared
responsibility of the Treasury and the central bank, was one of many instru-
ments to support the general economic objectives of the government. These
objectives typically concerned economic growth, the provision of employ-
ment as well as price stability. It was precisely the trade-off which was seen
to exist between these objectives which detracted from the pursuit of price
stability. The 1973 oil crisis had sparked off an exceptional severe cost push
inflation and cyclical downturn which revealed inexorably the diverging pol-
icy priorities of European member states. For a time the ways of member
states would part.

6.6 THE GERMAN EXPERIMENT WITH CAPITAL CONTROLS

Since the mid-1960s Germany had increasingly felt the impact of capital
inflows. It had only reluctantly allowed the Deutsche mark to appreciate in
1969. When afterwards the tight monetary policies, aimed at curbing infla-
tionary pressures, attracted speculative inflows, in tum blowing up the money
 121

TABLE 16
The German capital account 1969-1974 in billions of Deutsche Marks.

1969 1970 1971 1972 1973 1974

Current account 7.5 3.1 3.3 3.7 13.9 27.5

Long-term capital -19.3 0.9 4.5 14.5 14.0 -6.0
- Securities -6.7 1.2 5.1 14.6 6.3 -2.4
- Other -12.6 --0.3 --0.6 --0.1 7.7 -3.6
Short-term capital 4.3 16.2 3.3 -6.2 -3.6 -22.2
Net errors and omissions -3.1 1.8 5.7 2.6 1.0 -1.2
Official reserves -10.6 22.0 16.8 14.6 25.3 -1.9

Source: International Financial Statistics, IMP.

supply which the Bundesbank precisely tried to control, it was clear that some-
thing had to give. Initially the choice was being seen as between letting the
exchange rate appreciate, either through a revaluation or by a float, and the
establishment of exchange controls. When in 1971 it was decided to rely
primarily on an appreciation of the exchange rate and to take only indirect
control measures, this still could be regarded as a victory of those officials
who believed in the free functioning of markets. The market orientation of
the post-war German administrations and the abstinence from direct controls
had contributed to the Wirtschaftswunder. There was great reluctance, espe-
cially in the Ministry of Economic Affairs, to throw this successful legacy
overboard.
When in mid-1972 there was a replay of events with domestic monetary
stability being undermined by another wave of capital inflows, prompted
by the withdrawal of sterling from the snake, the free-marketeers were out-
numbered by the proponents of taking measures to curb the inflows. Now
the German cabinet after a heated debate decided to support Bundesbank
president Klasen in his demand for the imposition of further direct capital
controls. Minister Schiller, who was in favour of introducing a common float
of the European currencies vis-a-vis the US dollar, was outvoted. This clash
caused the downfall of 'super' minister Schiller who was to be succeeded by
Helmut Schmidt, also combining the economics and finance portfolios. The
German cabinet seemed to be convinced by the reasoning of the Bundesbank
that these controls would be able to stem the inflows and thus stabilize the
exchange rate. This was all the more welcome because the cabinet feared the
fall-out of a possible loss of competitiveness on the parliamentary elections
which were to be held at the end of 1972.
If the measures taken up till then to curb inflows could with some indul-
gence be regarded as still being of a market-oriented nature - inflows not
122

TABLE 17
German capital control measures 1970-1974.

April 1970 Reactivation of a minimum reserve requirement of 30 per cent on the

growth of external liabilities of banks.
May 1971 Prohibition of payment of interest on bank deposits of non-residents and
requirement of prior authorization for all purchases by non-residents of
German money market paper.
March 1972 Imposition of a cash reserve requirement CBardepot') of 40 per cent for
liabilities incurred vis-~-vis non-residents. Raising of the reserve require-
ment on the growth of external bank liabilities to 40 per cent.
July 1972 Requirement of prior authorization for all purchases by non-residents of
domestic fixed-interest securities. Raising of the Bardepot to 50 per cent
and of the minimum reserve requirement to 60 per cent.
February 1973 Extension of the prior authorization requirements to all types of credit
instruments, such as securities and mutual fund shares, and borrowing
above DM 50,000.
June 1973 Further tightening of the Bardepot and minimum reserve requirements.
January 1974 Abolition of the marginal reserve requirement.
February 1974 Reduction of the Bardepot to 20 per cent and abolition of authoriza-
tion requirements for credit instruments other than domestic fixed-interest
securities with a maturity of less than 4 years.
September 1974 Abolition of the Bardepot provisions.

being forbidden. but merely being made more expensive -. now a thresh-
old was passed (see Table 17). Further measures would by necessity have a
dirigistic character and would imply an outright ban on certain categories
of capital inflows. The effectiveness of the Bardepot, introduced in March
1972, was eroding through the diversion to other instruments without Barde-
pot provisions. In order to close the loopholes, the sale of fixed-interest bonds
denominated in Deutsche marks to non-residents was restricted. A similar ban
had already been imposed by Switzerland and it was feared that speculators
now would concentrate on Germany. Later on the restrictions needed fur­
ther tightening because new loopholes were continuously found and actively
exploited. Mter the transition to the floating rate regime Germany maintained
its capital restrictions. In a short period Germany had moved from a situation
in which there were almost no controls (in the late 1960s) to a situation by
the middle of 1973 where as regards capital inflows one of the most extensive
sets of restrictions was operated.
Initially, the main German motive had been to avoid an undue appreciation
of the exchange rate. At a later stage, the wish to insulate domestic monetary
developments from the outside world became the preponderant objective.
Domestic interest rates were raised to unprecedented levels in order to wring
out inflationary tendencies (see Figure 11). Capital controls were aimed at
 123
Quarterly overages, per cent

15 _. _ _ _ _ _ _ _ _ _

12

°'_'_'_'-'-'-'-'-'-1
71 72 73 74 75 76 77 78 79

Short term Euro-DM Inflation

domestic 3-months

Short term domestic: 3-months inter bonk rate.

Inflation: 12-months increase.

Fig.l1. German interest rates 1971-1979.

preventing short-term inflows from undermining these stabilization efforts.

All these measures, however, were not capable of resisting speculation at
times of currency unrest. The restrictions were evaded on a large scale. The
so-called 'Koffergeschiifte' (illegal physical cross-border transactions) for
the year 1973 were estimated at DM 4 billion and the illegal taking-up of
credit abroad at DM 7 billion. I8 Although measures were taken to curtail
shifts in leads and lags, their effect was limited because of the large impact
of only minor shifts in payment patterns, which could not be controlled.
The authorities were particularly discouraged that ever more measures were
needed to close unrestricted channels and other loopholes. The Bundesbank
initially relied on cooperative behaviour of the commercial banks. I9 In this
respect it was to be disappointed. German industry and the commercial banks
did not cooperate in accordance with the spirit of the capital control measures,
but were actively engaged in the search for loopholes.
Within a short period the Bundesbank reversed its attitude with respect to
capital controls. Whereas in 1971 the central bank had actively encouraged the
government to impose capital controls, in the course of 1973 the Bundesbank
had come to the conclusion that these controls did not significantly influence
the size of capital inflows in the face of the high level of German interest rates
relative to US interest rates. Against purely speculative capital movements
restrictive measures were ineffective. In a system of floating exchange rates,
where the Bundesbank was freed from the obligation to intervene in support of
124

the US dollar, they could be only of secondary importance. 20 The government

nevertheless decided to keep them in place throughout 1973, proving the
stickiness of controls once imposed. Apparently, there was a fear that their
release would precipitate the appreciation of the Deutsche mark. However,
they were to a large extent dismantled when the oil crisis changed the fortunes
of the European currencies, including the Deutsche mark. Only minor controls
on short-term inflows were kept in place with a view to discouraging the
development of the Deutsche mark into an international reserve currency. In
this respect the controls would not be effective either, as will be discussed
further in Chapter 7. Soon, the Bundesbank developed its own range of
instruments for the setting of monetary policy in a medium-term framework.
In 1974 it announced a target for the growth of the monetary aggregate (central
bank money) which had shown the best correlation in the transmission to
inflation and had shown a stable demand function. Interest rates were used
to influence monetary growth, up to a point regardless of the short-term
consequences for the domestic economy as well as for the neighbouring
countries. This new focus came to be known as the 'new assignment'. In
the course of the 1970s the German traditional preference for freedom of
capital movements again would come to the fore. Its brief experimentation
with direct capital controls had been a dramatic failure. 21

6.7 THE FRENCH RESPONSE TO THE CURRENCY TURMOIL

France had supplemented its extensive exchange control system with restric-
tions on inflows in the wake of the dollar crisis. During 1972, when the
exchange markets were relatively calm, some control measures were sus-
pended, only to be reintroduced with greater force in 1973, when a new bout
of speculative inflows occurred. The exchange controls were complemented
inter alia through the introduction of a marginal cash reserve of 100% on
incremental French franc deposits of non-residents. 22 As in Germany, the
controls were largely ineffective in warding off speculators as inflows con-
tinued to pour in and to swell the official reserves of the Banque de France.23
However, it was considered that in their absence the situation might have
even been worse, and the controls were tightened further after the collapse
of the Bretton Woods system in order to prevent an excessive appreciation of
the French franc. With the oil shock later in the year there was yet another
change in the fortunes of the French franc. The prospect of sizeable balance-
of-payments deficits exerted downward pressure on the exchange rate and
immediately led to a plethora of further controls on capital outflows. The
authorities believed that these controls were more effective than those on
inflows. This discrepancy was partly explained by the fact that in outflow
crises it was mainly residents who should be kept under control- the French
franc not being a widely held international reserve asset - whereas in inflow
 125

Quarterly averages. per cent

25 ________ _

20 ---------ti-----
,,,1 ,
•I I

15 _ _ - - : +-_1\'<-_ - - - -
,,
10 "
5

°'_'_'_'_'_'_'_'_'_1
71 72 73 74 75 76 77 78 79

Short-term Euro-franc Inflation

domestic 3-months

Short term domestic: 3-months inter bank rate.

Inflation: 12-months increase.

Fig. 12. French interest rates 1971-1979.

TABLE 18
The French capital account 1969-1974 in billions of French francs.

1969 1970 1971 1972 1973 1974

Current account -8.7 -1.1 0.9 -0.5 6.4 -18.6

Long-term capital -1.6 0.6 0.1 -3.3 -11.0 -1.3
- Securities 0.4 1.5 1.3 0.8 -3.0 -1.0
- Other -2.1 -1.0 -1.2 -4.0 -B.O -0.2
Short-term capital 4.4 8.6 14.4 6.7 -3.0 12.6
Net errors and omissions 0.5 2.0 2.8 5.2 -0.8 5.5
Official reserves -5.4 10.1 18.2 8.1 -8.4 -1.7

Source: International Financial Statistics, IMP.

crises the whole outside world jumped on the French franc. A contributing
factor was that French banks were responsible for proper execution of the
exchange control measures and that a large control apparatus was available.
Unlike the private German commercial banks, which were prepared to help
clients circumvent controls, the French banks stood under firm government'
control and were more compliant with the rules.
126

The capital controls were not only intended to prevent the exchange rate
from depreciating, but also, and increasingly so, to maintain a margin of
manoeuvre for expansionary monetary policy. Unlike the restrictive mon-
etary stance in Germany, the French authorities were unwilling to follow
deflationary policies. Instead it was believed that the downward impact of the
rise of oil prices should be counteracted by expansionary budgetary policies
and a monetary policy directed towards low interest rates (see Figure 12).
In these circumstances France in January 1974 decided to withdraw from
the snake. In doing so, France confirmed that it would give priority to fos-
tering economic growth over other policy goals. Whereas Germany and the
Netherlands from the beginning of 1974 started to dismantle their capital
restrictions, France on the contrary chose to further restrict capital move-
ments while abolishing the dual market which had not been very effective.
Nevertheless, a substantial depreciation of the French franc followed. The
extensive control system established in 1974 remained in place more or less
unchanged until the beginning of the 1980s.
In the French economic policy setting the Banque de France was subordi-
nated and, although admittedly its advice was sought, it could only execute the
monetary policy as decided by the Treasury. Monetary control was not direct-
ed towards restriction of the growth of the monetary aggregates, but rather
continued to be directed to the provision of cheap credit to targeted sectors
of the economy. The crisis situation at home, with substantial inflationary
pressure, resulted in the mothballing of the earlier monetary reform plans of
Marjolin, Sadrin and Wormser.24 Although some elements were implemented
in the beginning of the 1970s, giving greater room for market influences on
interest rates, the oil shock provoked a reorientation of monetary policy. In
fact a step backwards was taken by reverting to the use of direct instruments,
such as the encadrement du credit, combining credit controls with different
credit windows for chosen industrial sectors. There was reluctance to use
increases in interest rates as an instrument to curb monetary growth, also
since the subsidized, selective credits were not very sensitive to changes in
interest rates. As a substitute, capital controls were used to insulate domestic
interest rates from those prevailing in Germany or the United States. France
re-entered the snake arrangement in 1975 but the general reluctance to follow
restrictive monetary policies in case of need forced France again out of the
snake. French policies generated a relatively high inflation rate and conse-
quently downward pressure on the exchange rate. The use of differentiated
credit ceilings made the monetary control system prone to political pressure
from influence groups, which were all the more difficult to resist because
institutional opposition was lacking in the absence of an independent central
bank.2S
For the whole period of the 1973 oil crisis until the end of the 1970s
French real interest rates were negative (see Figure 12). In an attempt to
boost confidence - both internally as well as externally - the Banque de
 127

TABLE 19
Monetary targets in France and Germany.

France Germany
In % Target Outcome Target Outcome

1975 ±8 10
1976 8 9
1977 12.5 13.8 8 9
1978 12 12.2 8 11
1979 11 14.4 6-9 6
1980 11 9.8 5-8 5
1981 10 11.4 4-7 4
1982 9 11.5 4-7 6
1983 12.5-13.5 11.0 4-7 7

Target: France - M2; Germany: Zentralbankgeldmenge.

TABLE 20
French and German economic performance compared.

1972-1975 1976-1979 1980-1983

France Germany France Germany France Germany

Average in %
Inflation rate 10.9 6.4 10.9 3.7 13.5 5.1
GDP growth rate 2.7 1.3 3.5 3.8 1.5 0.5
Average in % GDP
Current account 0.0 1.5 0.3 0.6 -1.1 -0.2
Fiscal deficit -0.2 -1.6 -1.1 -2.7 -2.0 -3.1

Fiscal deficit: Net lending general government.

France followed the example of the Bundesbank in publishing monetary

targets, beginning in 1977. However, without any change in the conduct of
monetary policy these targets were set much higher than in Germany and
generally were overshot (see Table 19).
From 1976 until 1979 French annual money growth on average was 13.5%,
domestic credit expansion nearly 12%, inflation 11 % and the depreciation of
the French franc vis-a-vis the Deutsche mark ran at an annual rate of7% (see
Table 20).
128

TABLE 21
Spreads between official and financial exchange rates (May
1971-March 1974).

% Maximum Mean spread Standard deviation

Belgium 2.5 0.04 0.67

France 5.5 -0.46 2.35
Italy 7.5 3.9 2.08

Source: Marion (1994), p. 220.

Note: France operated a dual market from August 1971 to March
1974, Italy from January 1973 to March 1974.

6.8 ITALY: AN ECONOMY UNDER SIEGE

Initially Italy was less afflicted by the international monetary turbulence in the
beginning of the 1970s. Speculative capital inflows seeking refuge from the
US dollar bypassed the Italian economy, which unlike most other continental
European countries was not considered to be a safe haven. In the face of
increasing domestic political instability, which had negative repercusions on
the economy, the lira itself came under severe downward pressure, outflows
taking the form of illegal export of lira bank notes. Already in 1970 measures
had been taken to counter such outflows, which ran in the order of $ 2 billion
per year, and these measures were continually tightened. In January 1973 the
authorities introduced a dual market, following the earlier example of France,
in an attempt to preserve the nearly depleted official reserves, while main-
taining direct controls. As in France, there were additional considerations, in
particular the wish to shield the domestic economy as much as possible from
the turmoil on the exchange markets. When in February also the commercial
lira was allowed to float an important reason was 'to avoid jeopardising the
recovery of the economy which was just getting under way. ,26
In the highly indexed economy the subsequent depreciation of the lira led
to mounting inflation and further downward pressure. The Italian economy
was tumbling down in an inflation-depreciation spiral. Mid-1973 an emer-
gency EEC loan was taken-up, after extensive discussions in the Monetary
Committee, which was accompanied by a further tightening of exchange
controls and monetary policy. At the same time a third parallel market devel-
oped for lira bank notes - in addition to the commercial and financial lira -
where the lira was traded at a discount of on average 4% below the financial
rate. Capital outflows in the form of bank notes, partly disguised as fictitious
tourism expenses, had increased tremendously. The dual market was soon
abolished because cross operations occurred as soon as the gap between the
commercial and financial rates widened. The exchange rate differentials were
 129

TABLE 22
Italy: economic indicators 1973-1979.

In per cent 1973 1974 1975 1976 1977 1978 1979

Inflation rate 10.9 18.5 17.1 17.1 18.1 12.0 14.8

GDP growth rate 7.0 5.5 -2.7 6.3 3.7 3.7 6.1
%ofGDP
Current account -1.5 -4.3 -0.2 -1.5 1.0 2.1 1.6
Government deficit -8.3 -7.3 -11.9 -8.5 -10.5 -13.5 -9.8

Source: International Financial Statistics, IMP.

much larger than those in Belgium or France (see Table 21) and attracted
another category of offenders, namely bounty hunters who were not so much
interested in exporting capital as in collecting the premium. Whereas in 1971
the Banca d'Italia still had professed great confidence in the effectiveness of
exchange controls, it now had to acknowledge that 'the experience of 1973
emphasized the difficulty of controlling capital movements with administra-
tive regulations (... ) when, given the country's general economic situation,
larger depreciations are expected. ,27 Together with France, Italy was forced
to leave the snake arrangement in the beginning of 1974. The authorities had
put their trust in vain in the protective powers of capital controls.
Later in 1974 in the light of a serious deterioration of the trade balance
(see Table 22) even more drastic steps were taken. A temporary non-interest-
bearing deposit of 50% was required on certain imports. Nearly half of imports
being affected, this had a price raising effect of 3 to 4% - still marginal as
compared to the price and exchange rate fluctuations -, but more importantly it
decreased bank liquidity. The measure went against the essence of the EEC,
but Italy's claim that it was taken on the grounds of the clause d'urgence
of Article 109 was accepted by the Commission. The Commission felt it
had no choice in doing so in the rather dramatic circumstances, where 'the
international and domestic press were alike convinced that bankruptcy was
the inevitable outcome and only speculated as to when it would happen', and
where there was no possibility of access to the international capital markets
because of the already high external indebtedness. 28
Despite financial assistance provided by the EEC and by the IMP, as well as
the continued application of tight exchange controls, the economic environ-
ment deteriorated further until in the beginning of 1976 an even more serious
lira crisis erupted. Control of domestic liquidity creation was lacking, partly
due to budget deficits running in the order of 10% of gdp, providing ample liq-
uidity for speculative movements against the currency, despite tight controls.
The situation worsened so dramatically that the foreign exchange market
130

had to be closed for forty days. In the meantime restrictions were tightened,
but when the market reopened on 1 March 1976 there was a sharp drop in
the exchange rate. In these circumstances emergency measures were taken,
some of them strongly condemned by the international community, which
merely provided short breathing spaces. 29 The Banca d'Italia and the Foreign
Exchange Office were 'faced with the unpleasant task of presiding over a pro-
cess which, as far as the management of monetary and foreign exchange flows
is concerned, is coming to resemble an economy under siege'. 30 When finally
decisive fundamental measures were taken, supported by an IMP program,
the external situation started to improve quickly. In the course of 1977 the
exchange restrictions gradually were relaxed. The central bank had become
exasperated by the continuous operation of exchange controls. Despite the
multitude of exchange restrictions, residents apparently could rather easily,
albeit at some cost, bring capital out of the country through illegal means.
These outflows were motivated both by the distrust in the economic and polit-
ical situation and by fiscal considerations. The restrictions were ineffective
remedies which temporarily may have softened the problems, but in doing
so did not contribute to real solutions, particularly as some restrictions were
maintained for a prolonged period of time. They most likely postponed such
solutions. As in France, monetary policy was traditionally directed towards
the ample provision of liquidity, given the underdeveloped domestic capital
market, and was characterized by reluctance to raise interest rates in view of
the wish to foster economic growth and the need to finance burgeoning fiscal
deficits. Continued easy monetary policies and a selective credit policy for
an increasing number of so-called prioritary sectors, could only lead to infla-
tion, monetary financing of budget deficits and capital flight. In the end, of
course, the wish to maintain low interest rates could not be realized either. Its
unorthodox loose budgetary and monetary policies, covered up by exchange
controls, had brought Italy to the brink of bankruptcy.

6.9 THE NETHERLANDS: LIBERALIZATION GAINING PACE

When in May 1971 the guilder, together with the Deutsche mark, had been
allowed to float, an important consideration had been that it was impossible to
introduce at short notice sufficiently adequate exchange controls to discourage
further capital inflows. Preparations for such controls in case of need were
completed when on 15 August 1971 the dollar convertibility was suspended.
The so-called O-circuit was established, a closed bond circuit with similar
characteristics as the French devises-titres market and the British investment
currency market, but unlike these markets not aiming at controling capital
outflows but rather intended to curtail foreign demand for Dutch guilder paper
(see Figure 13). Subsequently further restrictions were enacted, culminating
in the im~osition in March 1973 of a negative interest rate on non-resident
accounts. I
 131

Monthly averages
7 ___________

6 _ _ _ _-1+-_____________

3 --H---

°rllrrrrrrrrrrrrrrrrrrrrrrrrrrrrrri
71 72 73 74

Fig. 13. The Netherlands O-guilder premium 1971-1974.

Just as these events had influenced the attitudes towards capital restrictions
in all European countries, they constituted an evolution in the thinking of the
Dutch authorities. Before this time, exchange controls had been regarded
mainly as a complement to domestic financial and monetary policies. Now
there was a new additional motive: as other countries the Dutch wished to
avoid an undue appreciation of the exchange rate of the guilder and thus an
unwarranted deterioration of the competitive position.
The evolution in thinking was reflected in the subsequent drafts of the law
on external financial relations, which every time seemed to be overtaken by
events. A first draft of this law, which was to replace the Exchange Control
Decree (Deviezenbesluit) of 1945, had been presented in 1967, envisaging a
single law which gave only limited powers to impose capital controls. Then,
'after each wave of exchange unrest the draft, which had not yet been sent to
parliament, was reviewed with an eye to whether the authorities would have
been able to handle the situation. Each time this led to additions' .32 Finally a
draft law was submitted to parliament on 4 July 1972. The timing, however,
was rather unfortunate because this submission followed the recent adoption
of the 1972 Directive. When in 1973 the system of fixed exchange rates
disintegrated beyond repair, it was considered questionable whether it would
be wise policy to limit the powers of the authorities to impose restrictions.
The draft law was withdrawn. For a resumption of the liberalization drive the
Dutch authorities assumed that two conditions had to be fulfilled: the restora-
tion of a well-functioning international monetary system and a reasonable
degree of consistency between the economic and monetary policies of the
major countries.
132
The Netherlands was of the opinion that monetary policy was better
equipped to check undesired capital outflows than unwanted inflows. If in
the case of outflows the central bank concerned would let the resulting con-
traction work its way through to the money market, the capital outflows
inevitably would be slowed down. Admittedly, this could lead to a disorderly
money market or, if the resulting high interest rates would last long, undesir-
able cyclical consequences. Yet, in the short run exchange rate considerations
should prevail. In the case of inflows, however, non-sterilization would lead
to lower interest rates which could undermine domestic monetary stability
and have inflationary consequences. If interventions were sterilized through
mopping-up operations by the central bank, the inflows would only continue,
so it was felt. Yet, there were no illusions that capital controls were useful
instruments in the long run. They were a third-best option in circumstances
of extreme international divergences in economic and monetary policies. But
their imposition would not help to overcome these divergences and might
even perpetuate them.
Exchange controls were increasingly seen as having important drawbacks
both for the Dutch economy and for the effective functioning of the monetary
authorities. Among these drawbacks the tendency of restrictions to spread to
other transactions figured prominently. In the Dutch case the ban on borrowing
abroad by residents soon had to be extended to other categories, up to the
point that this was hindering genuine direct investment flows. 33 Another
drawback was that the commercial banks, which initiaily were compliant,
as in Germany were developing loopholes for their clients. 34 This involved
the risk of overburdening the good relationship between the banks and the
monetary authorities. Finally, there was great reluctance on the part of the
Nederlandsche Bank, which was entrusted with the execution of the capital
controls, to expand the needed technical apparatus.
After the turmoil had somewhat subsided the Dutch authorities were quick
to ease restrictions. The closed bond circuit was abolished on 1 February 1974,
when the premiums, which in earlier years had risen as high as 6.5 percent,
had returned to virtually nil. Further relaxations came about in the following
years and on 26 January 1977 then Minister of Finance Duisenberg presented a
somewhat amended bill on external financial relations to parliament, resuming
the proposal to change to a positive system. The negative system had become
so complex that the number of Bank staff who knew their way in the maze of
regulations gradually were depleted. Pending parliamentary approval of the
bill, it was decided to move to a de facto positive system in September 1977.
At the same time, issues of securities and loans on the domestic capital market
by non-residents were permitted, provided they would take their place in the
queue, like domestic issuers. However, restrictions on capital inflows were
maintained in order to prevent the prevailing domestic credit restrictions,
introduced at the beginning of 1977, from being frustrated. In the following
years these restrictions were gradually relaxed when the current account of the
 133
balance of payments began to show a deficit. The policy of the Nederlandsche
Bank, rightly tenned 'moderately monetarist' - the money supply being a vital
but not the only policy variable - actually was characterized by considerable
fine-tuning: in view of the current account deficit domestic credit restrictions
were applied, complemented by restrictions on short-tenn capital inflows;
at the same time medium and long-tenn capital inflows were liberalized
in order to facilitate the financing of the same current account deficit. The
bill on external financial relations eventually was adopted on 28 May 1980,
more than twenty years after the first legal work had been initiated, and took
effect on 1 May 1981.35 All these years the authorizations were based on
the Exchange Control Decree of 1945, as a living monument to prove the
stickiness of capital restrictions.

6.10 COMPARISON OF THE DUTCH AND FRENCH ATTITUDES

In the course of the 1970s the Dutch attitude towards capital controls gradually
evolved in a pragmatic manner. As we have discussed earlier, there were
certain similarities between the French and the Dutch control system and
range of monetary instruments. In the first decade of the EEC France and the
Netherlands were allies in their defence of capital controls. Both countries
applied controls to inflows as well to outflows. Both countries relied on direct
credit controls as a primary monetary instrument. But on closer scrutiny
there were important differences, which became more evident in the course
of the 1970s as the countries drifted apart as regards policy fonnulation. Of
course, there was first a difference of gradation: the French controls on capital
outflows were far more extensive than the Dutch controls. So was the technical
apparatus. The foreign exchange regulations department in the Nederlandsche
Bank numbered in the mid-1970s a staff of only a dozen persons, whereas
in the case of France hundreds of civil servants were involved. There was
also an important difference in vision. The French authorities considered
restrictions on outflows more effective than those on inflows, whereas in the
Netherlands it was rather the reverse. The Dutch authorities were convinced
that monetary policy was better capable of checking capital outflows than
inflows. This implied that the Netherlands primarily utilized capital controls
ifmonetary policy could not be effective in warding off capital movements,
viz. in support of restrictive monetary policies. In France, on the other hand,
capital controls precisely were intended to avoid the deployment of monetary
instruments, i.e. the raising of interest rates to ward off outflows.
In essence, the difference between the Dutch and the French attitude regard-
ing capital controls boiled down to a differing degree of willingness to utilize
the interest rate in order to defend the exchange rate. In the course of the
1970s the Netherlands visibly became more liberalized as opposed to the
French financial and monetary system. The Netherlands and France had been
134
close allies in various policy areas especially in the international monetary
arena, e.g. in their defence of the fixed rate system and their orthodox position
vis-a-vis gold, as well as their rather interventionist attitude in economic and
financial matters. But in the inflationary climate of the 1970s the Netherlands
aligned itself increasingly with Germany, which was fighting inflation by
orthodox macro-economic means.

6.11 THE BELGIAN-LUXEMBOURG DUAL MARKET

The rather satisfactory operation of the Belgian dual market had prompted
other member states to experiment with such a system as well. The dual
market was considered by the authorities as a useful instrument because it
safeguarded the officia.1 exchange rate and the official reserves against spec-
ulative capital flows, while at the same time upholding the notion of freedom
of capital movements. The IMF staff consistently supported the practice in
its Article IV consultations with Belgium, albeit each time for a period of a
year. Although the dual market in theory did not obstruct the free movement
of capital, the latter in practice was hampered by rather far-reaching domestic
regulations. The domestic financial markets were characterized by mutual
partitioning (the so-called 'cloisonnement'), partially inspired by the wish to
secure the provision of credit to the government. The parastatal Commission
Bancaire regulated the issues on the domestic capital market; in practice the
amount of foreign issues, which also needed the permission of the Ministry
of Finance, had been negligible. In his decision the Minister could take into
consideration the vital national interests. Like France, the Belgian authorities
furthermore discouraged the take-over of domestic firms by non-residents.
Approval procedures had been established in 1967 when Petrofina was threat-
ened by a US take-over, in contravention of the liberalization obligations.
Finally the local securities market was lacking in depth and therefore was not
attractive to foreign investors. In sum, there were practical and administrative
obstacles which prevented large cross-border capital flows.
The National Bank of Belgium was strongly supportive of the dual market
system. From time to time it intervened in the free market, as the Banque de
France did when it operated a dual market system. After the 1960 Congo crisis,
the system had only briefly come under strains in 1969 when the devaluation
of the French franc had triggered market expectations of a devaluation of the
Belgian franc as well. Although the dual market system may have played a
role in repulsing both attacks, more probably it was the fundamentally strong
current account position of Belgium, consistently in surplUS, which convinced
the markets that a change in the official rate would be unwarranted. 36 The
dual system had the advantage that in principle it could deal not only with
speculative outflows but also with inflows, without changing administrative
regulations. But in the exchange turmoil in the beginning of the 1970s inflows
 135
Monthly averages, per cent
6 _____________ _

-4 r - r - r - r - r - r - r - I
n n ~ ~ n n n

Difference between free and official exchange role of the Belgian franc.
Source: BIS.

Fig. 14. The Belgian dual market 1972-1978.

strained the system, the financial Belgian franc being for a time stronger
than the commercial one. It was eventually impossible to operate the system
without the introduction of quite far-reaching further controls. 37 Also the
dual market system itself was tinkered with. Before May 1971 several capital
transactions could be executed both on the free and the official market, to
the effect that the system provided exclusively a weapon against capital
flight but offered no protection against speculative inflows. After a change
in the exchange regulations all links between the two markets were severed
through the prohibition of all transfers between the markets. The Belgian
and Luxembourg authorities all along maintained that the abolition of the
dual market would necessitate recourse to other control techniques which not
necessarily would imply an improvement. Nevertheless, there was a certain
measure of surprise among other member states that Belgium in the era of
floating exchange rates maintained the dual market. All other EEe countries,
which had experimented with multiple exchange rates, abolished them rather
soon. The advantages for the Belgian and Luxembourg authorities apparently
outweighed the disadvantages. Among the latter: a control apparatus was
needed, just as for direct exchange control; changes in the financial franc
rate could provide undesirable signals which could amplify pressures on the
official exchange rate; the effectiveness of monetary policy could be reduced,
in so far as an increase in official interest rates in order to support the exchange
rate could lead to a reflow on the free market rather than to support of the
official rate.
136
In sum, the dual market system, like other types of capital control measures,
was not effective in warding off large and sustained capital flows in crisis
situations. It then had to be supplemented with further measures, which,
however, were likewise incapable of stemming the speculative tide. In quiet
times, when the differential was not very large, it may have provided some
protective shield, possibly preventing minor speculative movements from
running out of hand. But the counterpart of the relative external freedom
of the double market system in quiet times was a rather heavy domestic
regulation of the financial system in Belgium.

6.12 EUROPEAN INTEGRATION AT A STANDSTILL

The European countries had drifted apart. Each country had tried to find its
own way in the disarray caused by the external shocks of the demise of the
Bretton Woods system and the oil crisis. Capital controls were utilized in
varying intensity to insulate the domestic economy from those shocks, with
very little success. The new members of the EEC, Denmark, Ireland and the
United Kingdom which had joined on 1 January 1973, did not provide any
additional stimulus towards coordination or liberalization. On the contrary,
they had adhered to the EEC more because of its Common Market aspect
than because of further integration ideals. Moreover, they all had a histo-
ry of extensive exchange control, which in practice was condoned by the
Commission. 38 Therefore, the balance between liberal and restrictive coun-
tries initially swayed in favour of the latter.
Attempts were made to give body to the need to coordinate economic
policies. In 1974 a Council Decision on the attainment of a high degree of
convergence ofeconomic policies was adopted, but its procedures were rather
weak. There was no pressure on member states to follow the guidelines with
respect to budgetary policies. As regards capital controls there was no serious
discussion in the Monetary Committee on a common European approach. 39
Some countries on an individual basis gradually relaxed controls, but in other
countries the controls increasingly were considered to be a fact of life.
From the mid-1970s onwards the lack of policy consensus within the
Community stood in the way of progress towards economic and monetary
integration. The Werner Report was written against the comfortable back-
ground of a relatively long period of economic growth and price stability.
Budgets in the Community were in approximate balance and government
debt at the end of the 1960s averaged less than 30% of gdp. By contrast, the
1970s saw the average inflation rate in the Community rise to double digit
figures and government debt to well over 40% of gdp (see Figure 15 and Table
23). In the face of such serious divergences from inflation-free sustainable
growth the European mechanisms of coordination were powerless.
A new initiative was needed. Diverging economic policies resulted in
exchange rate instability, which formed an obstacle to further European inte-
 137

TABLE 23
Fiscal imbalances in the EEC as a percentage of GDP.

1971 1972 1973 1974 1975 1976 1977 1978 1979

Fiscal deficit
weighted average -1.2 -1.7 -0.9 -2.0 -5.2 -3.7 - 3.0 -3.7 -3.5

Government debt
weighted average 30 31 35 34 38 40 41 42 42
average 36 36 37 37 39 41 42 43 45

Note: Fiscal deficit - net lending (+) or net borrowing (-) of general government; average
of actual EEC member states; European Economy no 58, European Commission.
Government debt - gross public debt; OECD Economic Outlook 55.

Percentage changes

25 __________ _

20

15

10

5 ~~-=-=---=-=~,-
--- -__ _ ..... _.,...,;

°1_'_'_'_'_'_'_'_'_1
71 72 73 74 75 76 77 78 79

Weighted Best Worst

average EEC performing performing
country country

EEC: Average of actual EEC member states_

Source: International Financial Statistics, IMF.

Fig. 15. Inflationary pressures in the EEC 1971-1979.

gration. The masterplan of the French president Valery Giscard d ,Estaing and
the German chancellor Helmut Schmidt to establish a European Monetary
System, proposed in 1978, was precisely intended to redirect Europe on the
path of cooperation. It envisaged the establishment of a zone of monetary
stability. In view of the major macro-economic derailments of the 1970s this
was an ambitious goal, which provided an important signal that European
138
countries again wished to grow towards one another. In the resolution, estab-
lishing the EMS, there was no reference to capital liberalization. This absence
was telling for the priority of member states. Restoration of stable exchange
rates ranked first and foremost. The liberalization of capital movements was
pushed in the background. In the meantime, however, an important devel-
opment took place in the United Kingdom, which while not taking part in
the EMS embarked on a new economic approach which would impart a new
impetus to the goal of capital liberalization.

6.13 TIlE LIBERALIZATION IN TIlE UNITED KINGDOM

The dismal events of the 1970s reached a major turning point when the newly
elected Thatcher government in the United Kingdom came into power. After
having tested the water with some relaxations of exchange control, in October
1979 all remaining restrictions on capital movements were lifted at one stroke.
The United Kingdom had been the first European country to adopt a float-
ing exchange rate regime when in June 1972 it had left the snake after a
membership which had lasted only two months. Although with the transition
to floating the original rationale of the post-World War II capital controls, cod-
ified in the 1947 Exchange Control Act, namely to preserve foreign exchange
reserves, was lost, the authorities kept the controls in place. 4O In his memoirs
Nigel Lawson notes: 'People had lived with exchange control for so long
that it was not in any real sense an issue: it was a fact of life. ,41 There was
always the fear that their abolition might cause a run on the pound, with
serious political backlashes, and there was thus a preference for maintaining
the status quo.
When the United Kingdom had become a member of the EEC on 1 January
1973 a number of transitional provisions were agreed which provided time to
adjust domestic policies and regulations. With respect to capital movements
the Treaty of Accession provided that the liberalization under the Capital
Directives could be postponed until 1 January 1975 in the case of direct
investment, and until 1 July 1975 for other categories of capital ffiovements in
the personal sphere. However, in 1975 the United Kingdom experienced large
balance-of-payments deficits and asked for an exemption from the entry terms.
Also with respect to other aspects of the Community the United Kingdom
asked for delays and in March 1975 Prime Minister Harold Wilson, when
reporting to the House of Commons on these 'renegotiations' with the EEC,
said that the United Kingdom would avail itself of the Treaty safeguard clauses
to protect the balance of payments from capital outflows. The Commission
granted a delay for one year on the basis of the provisions of Article 108.3.42
These delays had to be repeated several times, since the United Kingdom
after the sterling crisis of November 1976 had if anything further tightened
its exchange controls. In the discussions in the Monetary Committee these
 139

measures routinely were approved, although recommendations were given

for a tightening of monetary and fiscal policy. Afterwards some relaxations
were carried through.
The UK economic performance in the 1970s continued to be mediocre
as the economy under the hoped-for autonomy for domestic monetary and
fiscal policy under the system of floating rates had run aground. Stimulative
policies had conjured up inflationary forces and led to repeated attacks on the
exchange rate. The net result had been stop-go policies which had frightened
off both domestic and foreign investors. The Conservative government was
elected in 1979 after a 'winter of discontent' when major strikes in the public
sector, lasting over six weeks, had paralysed the country. The ideological
platform of the incoming government assigned a high priority to deregulation
and the unhampered free functioning of the markets. Capital liberalization
fitted in well with this platform. The abolition of exchange controls was a sign
of belief in economic potential and a reflection of increased self-confidence
and economic strength. However, the decisive factor was oil. The prospect
of a substantial improvement in the current account because of oil proceeds
had triggered fears of a disproportionate appreciation of the pound sterling
exchange rate. This would further hurt the weak non-oil industrial base in
the United Kingdom. A relaxation of exchange controls was expected to
cause capital outflows because of the pent-up demand for foreign assets by
residents. 43 This would help to dampen the upward pressure on the exchange
rate. 44 The United Kingdom with its newly found treasure of North Sea oil
was positively affected by the rise of oil prices resulting from the second
oil shock. Actually 1979 was the first year in which the United Kingdom
moved from being an oil importing to an oil exporting country and the pound
reached petro-currency status. Another factor, very much felt within the Bank
of England, was the wish to maintain the position of London as one of the
main financial centres of the world.
When Chancellor Geoffrey Howe announced the abolition in the House of
Commons on 23 October 1979 it was a leap in the dark, but circumstances
on the currency markets could not have been more propitious. Nevertheless
he later remembered: 'I count this one of the most important achievements
of my Chancellorship - and certainly the most fraught with worry ... It still
stands as the only economic decision of my life that caused me to lose a
night's sleep. ,45 The extremely complicated structure of exchange rules and
regulations, the hundreds of civil servants who had to judge the applications
for capital movements and control possible breaches in the rules, this huge
edifice was demolished overnight.
It was an important decision both in political and in economic terms.
Capital liberalization marked the start of further deregulation, giving free
rein to market forces. It was followed by the removal of direct controls as
an instrument of monetary policy, because leakage - the tapping of banking
facilities abroad - was no longer frustrated by exchange controls. There
140

was a request from the Bank of England to the banks not to encourage
borrowing abroad, but it was to no avail. The marginal reserve requirements
on increments of interest-bearing deposits, intended to curtail funding for
credit, popularly known as the 'corset', had to be withdrawn in June 1980.
This was followed by an overhaul of monetary policy in 1981, in which
indirect means of monetary control were introduced.
As far as the consequences for the exchange rate of the pound sterling
were concerned, it is difficult to set apart the effects of liberalization from the
strong upward pressure on the exchange rate emanating from the orthodox
Thatcher government policies and the oil factor. Artis and Taylor (1989)
conclude that the most important effects have been on the size of portfolio
investment flows and on a greater degree of financial integration through the
removal of differentials between Euro rates and domestic interest rates. All in
all the increase in overseas demand for sterling assets probably was smaller
than that in the demand by UK residents for overseas assets in response to the
lifting of exchange controls. 46 Considered on its own, there must have been
some downward, though unquantifiable, pressure on the exchange rate.
It was rather paradoxical that the 1972 EEC Directive, requiring member
states to maintain powers to impose exchange controls, stood in the way of
repealing the 1947 Exchange Control Act in the United Kingdom. Although
the directive thus did not directly hinder the actual liberalization of capital
movements, it implied that the relevant legislation had to be kept intact. It
was only in the context of discussions on the 1988 Directive, in which full
liberalization of capital movements was to be codified at the Community
level, that the Act finally could be repealed.

6.14 CONCLUSION

At the tum of the decade a new motive for the imposition of capital restric-
tions had emerged. The continuous capital outflows from the United States
put upward pressure on the European exchange rates. For a long time appre-
ciation vis-a.-vis the US dollar was resisted by the authorities out of fear for
a loss of competitiveness. Capital controls on inflows were called in, even
in traditionally liberally-oriented countries as Germany. In an about-tum the
Commission, which in the 1960s had been the most vocal advocate of capital
liberalization, now called upon the member states to impose controls in order
to contain speculative capital movements. The Commission's main motive
was the wish to preserve the fixed exchange rate system.
The Werner Report had concluded that economic and monetary union
could be achieved within a decade, provided that the political will existed to
realize that objective. But the underlying differences of opinion as to the road
to economic and monetary union were not fully discussed. By the mid-1970s
the momentum had been completely lost. This can be attributed to the change
 141

in the international environment, such as the collapse of the Bretton Woods

system, together with the first oil price shock, whereupon the large member
states in the Community each formulated a different policy response. This lack
of consensus on the way Europe should adjust to the changed international
environment and the insufficient political willingness to pursue the integration
ideals resulted in a stalemate.
The establishment of the snake could be seen as an attempt to counter
the adverse international climate and preserve stability within Europe. But
this attempt was doomed because there were serious underlying disagree-
ments among European countries about a common policy response to the
oil shock. Expectations that more flexible exchange rates would enlarge
the scope for autonomous domestic economic management were shattered
when exchange rate movements quickly translated themselves into domes-
tic inflation-devaluation spirals. Capital controls were not able to enhance
substantially the freedom of the authorities to choose their own growth and
inflation paths.
Although in a number of countries the tightening of capital controls in
the beginning of the 1970s was primarily intended to counteract speculative
extra-European capital flows, controls were to remain a more permanent
feature to curtail intra-European capital flows as well when attempts to seek
closer cooperation faltered. Exchange restictions spread in Europe in an unco-
ordinated manner. The EEC was enlarged with countries which had a tradition
of even more extensive systems of capital controls: the United Kingdom, Ire-
land and Denmark, countries which had not yet associated themselves with
the goal of economic and monetary unification. Countries in the 'economist'
camp, such as Germany and the Netherlands, condoned the use of exchange
controls by other countries in so far as they were believed to hinder capital
movements into the Deutsche mark and the guilder. Countries in the 'mon-
etarist' camp, such as France and Italy, regarded capital controls as a useful
safety valve as long as economic convergence was lacking. Financial markets
in Europe at the end of the 1970s were less integrated than they had been in
the mid-1960s.
The decade clearly showed the limited effectiveness of capital controls.
Faced with strong disturbances or diverging fundamentals they were power-
less. Disillusionment as to the effectiveness of exchange controls was great,
especially among the central banks which were involved in the execution
and tried to close the loopholes in vain by ever tighter measures. Among
them the Bundesbank, which had briefly advocated capital controls, figured
prominently, but also the Nederlandsche Bank, which had been among the
proponents of control, and the Banca d'Italia were growing sceptical. One of
the central bankers had said that as central banks 'we try to make the best
of a bad situation trying to render controls as effective as possible; on the
other hand, few people are in a better position than we are to judge the lim­
itations of restrictions and the endless red tape and arbitrariness which they
142
inevitably imply'. 47 Although the limited effectiveness was generally rec-
ognized, member states did not draw the same conclusions. Only Germany,
where the experiment with controlling capital inflows hardly fell short of a
disaster, was quick in dismantling its restrictions. France played it safe and
kept its post-Bretton Woods crisis control system more or less in place, in
line with its interventionist economic philosophy.
To a certain extent capital controls may have shielded domestic mone-
tary policy in quiet times with stable exchange rate expectations. This was
probably the case in Belgium, France and the Netherlands, explaining in part
the stickiness of controls. However, they were largely ineffective as regards
their main objective, preserving the official reserves and the exchange rate.
In Italy the repeated tightening of exchange controls gained the character of
near-panic measures in the face of very serious macro-economic disturbances.
Consequently, the capital controls did not succeed in restoring confidence, but
rather impressed upon the markets the image of drifting policies. More and
more the view gained ground that capital controls in so far as they were effec-
tive gave the wrong signals, stifling economic development and conditioning
unsound macro-economic policies. Capital controls created the illusion that
policies could diverge within Europe.
Germany began to frame its monetary policy in terms of domestic monetary
targets. In fact, internal stability was put first and foremost. Late in the
decade, the United Kingdom completely liberalized capital movements in a
radical break with its stalemated economic past. It is interesting that both
countries came to these steps on purely domestic grounds. They had not
been preceded by European deliberations. Yet, they had great consequences
for Europe. The German quest for domestic price stability, accompanied
by strict budgetary and monetary policies, would set a standard for other
European countries. With the United Kingdom, switching over to a liberal-
oriented policy, Germany gained a powerful ally in breathing new life into
fostering the development of a truly common market, also as regards capital
movements. The British action lay at the basis of the evolution of dynamic
and competitive financial markets in Europe. In the end other countries could
not afford to remain on the sidelines.

NOTES

1. Monetary Committee (1967), 9th Report on the activities of the committee, p. 5-15.
2. Report to the Council and the Commission on the realization in stages of the economic and
monetary union in the Community ('Werner' Report), Official Journal of the European
Communities, 11 November 1970.
3. As regards economic policy-making the Werner report stipulated that 'the essential features
of the whole of the public budgets, and in particular variations in their volume, the size of
balances and the methods of financing or utilizing them, will be decided at the Community
level' . In the monetary sphere 'the creation of liquidity throughout the area and monetary
and credit policy will be centralized' .
 143

4. The immediate establishment of a European fund for monetary cooperation was envisaged,
which would take over the short and medium-term support mechanisms of the EEC and
would eventually manage the exchange reserves of the central banks of the Community. In
the final stage this fund would be integrated into the system of Community central banks.
5. Official Journal of the European Communities, 27 March 1971.
6. In March 1964 a withholding tax (Kuponsteuer) of 25% on proceeds of Deutsche mark
bonds held by non-residents was announced, originally motivated by the wish to curb cap-
ital inflows which threatened to undermine domestic monetary stability. The tax, however,
was maintained for budgetary reasons when the original motive had long disappeared, only
to be repealed in 1984. From 1 December 1968 t031 October 1969, a cash reserve of 100%
had been set against increases of non-resident deposits with a view to limiting inflows.
On 1 April 1970 an additional minimum reserve requirement of 30% was imposed on
increases in deposits of non-residents over and above the customary reserve requirements.
7. There were differences of opinion within the Zentralbankrat of the Bundesbank as well.
Emminger (1986, p. 177 et seq.) reports that a majority of 11 members, including Bundes-
bank president Klasen, was in favour of a 'Devisenbannwirtschaft' against a minority of
7 members who favoured a temporary floating of the Deutsche mark. Emminger reports
that the introduction of a dual market according to the Belgian model was considered
as well. The German government supported the position of minister Karl Schiller and
thus sidestepped the opinion of the Bundesbank. It could do so because activation of
capital controls under the Aussenwirtschaftsgesetz could only be decided upon by the
government.
8. With the switch-over to a positive system of capital controls, codified in the Aussen-
wirtschaftsgesetz of 1961 (Article 23), a measure of restrictiveness was maintained by the
introduction of a ban on the payment of interest on bank deposits of non-residents. The
ban was lifted in December 1969, only to be reintroduced in May 1971. Later, in 1973,
the imposition of a negative interest rate was considered, but the idea was rejected partly
because of disagreement as to which institution should be the beneficiary of the proceeds:
the Bundesbank, the Bund or the Under.
9. After two months the devises-titres market was merged with the financial franc market on
20 October 1971.
10. The legal basis for the Bardepot instrument had been provided by an amendment of
the Aussenwirtschaftsgesetz at the end of 1971. With the introduction of the Bardepot
the Bundesbank had to rebuild the technical apparatus which after the transition to a
positive system in 1961 had shrunk to nil. It seemed logical to entrust the execution to the
department dealing with the minimum reserve requirements (Hauptabteilung Bankwesen
und Mindestreserven). However, its director, Rolf Gocht, who as a member of the Monetary
Committee had been one of the most outspoken proponents of capital liberalization, had
so little sympathy for the control measures that the operation of the system was delegated
to another department (Hauptabteilung Ausland).
11. The Netherlands and Belgium observed mutual fluctuation margins of 1.5% on either side
of the parity.
12. See A. Szasz (1988), p. 141-45, for a vivid description of the various attempts to arrive at
a common European policy response.
13. Draft directive on regulating international capital flows and neutralizing their undesirable
effects on domestic liquidity, dated 23 June 1971.
14. Monetary Committee (1972), 13th Report on the activities of the committee, p. 21.
15. The text is reproduced in Annex 5.
16. After the adoption of the 1972 directive, an ad hoc Working Group on 'Short-term capital
movements' was mandated by the Monetary Committee to make an inventory of all
available instruments to curb undesirable capital inflows and to examine their execution.
In its report, dated 9 October 1973, it could only conclude that it was impossible to
144
harmonize exchange regulations and to introduce a preferential regime for intra-EEe
capital transactions as long as political impulses for closer integration were lacking.
17. De Nederlandsche Bank, Annual Report 1973, p. 17.
18. Other evidence of the 'KoffergeschMte' was provided by the fact that Gennan securities
were traded in Switzerland at a premium of 3 to 5% above the Gennan quotation (Han-
delsblatt, 5 August 1974). At the same time the existence of interest differentials showed
that the controls were effective up to a certain point in deflecting capital flows.
19. In July 1972 the Bundesbank concluded a gentlemen's agreement with the commercial
banks in which the banks were requested not to assist in transactions which could lead
to undesired capital inflows. In fact coopemtion was poor. Notably, the foreign bmnch
activities of Gennan banks, particularly in Luxembourg, expanded considembly. One
commercial bank reportedly sent out students to borrow in Luxembourg the basic amount
for which no cash reserve was required, which subsequently was deposited on a resident
account. Enforcement was hampered by the minor penalties in case of infringement of the
regulations. With respect to the Bardepot provisions the Bundesbank sued approximately
40 offenders, winning most of the cases. However, no proceedings were instituted with
respect to non-authorized transactions in securities.
20. Bundesbank, Annual Report 1973, p. 20 and 21.
21. For some years to come a number of indirect capital controls would continue to feature
in the German system for monetary policy reasons. Among these discriminatory reserve
requirements and restrictions on short term issues figured prominently.
22. Reserve requirements were introduced in France in 1967 and were mainly applied as an
instrument to counteract capital inflows. When direct quantitative credit controls even-
tually were abolished in the 1980s (after a brief experimentation with indirect monetary
control from 1 October 1970 until the First Oil Crisis), reserve requirements were targeted
towards controlling the growth of the money supply.
23. Governor Wormser of the Banque de France once jokingly said that in the face of impend-
ing parliamentary elections (in 1973) socialist leader Mitterrand and communist leader
Marchais provided for two guardians at the gate, who would discoumge investors from
converting US dollars into French francs. However, this did not hold true as the wish to
unload dollar assets was overwhelming (see Emminger (1986), p. 241 et seq.).
24. Compare Chapter 5, note 37.
25. Goodman (1992), p. 123 et seq.
26. Banca d'ltalia, Annual Report 1973, p. 65.
27. Banca d 'ltalia, ibid., p. 66.
28. Banca d'ltalia, Annual Report 1974, p. 204. The Commission authorized the derogation
from the BEC obligations ex post on 8 May 1974. The Monetary Committee established
a working group under the chairmanship of De Strycker, vice-governor of the Belgian
National Bank, in order to monitor developments under the financing arrangement pro-
vided by the EEC.
29. The compulsory import deposit scheme was restored for a period of 3 months, affecting
nearly 90% of imports. Prior authorization, requested from the Commission under Article
108.3, was readily given. In September 1976 foreign exchange restrictions were tightened
further and an emergency 10% tax was imposed on purchases of foreign currency and pay-
ments abroad. However, as soon as the tax expired tensions reappeared with a vengeance.
The special tax was reintroduced, now for a period of 4 months. When a law was adopted
condoning past foreign currency offences, some flight capital repatriated.
30. Banca d'ltalia, Annual Report 1975, p. 197. Looking back on the unfortunate episode it
was concluded: 'The intensification of controls has afforded some relief from the effects
of expectations; however, it has not only narrowed the range of alternatives open to
business for legitimate commercial purposes, but has brought a burdensome increase in
the formalities to be performed at three levels: that of businessmen themselves, that of
the foreign exchange departments of the banks and that of the authorization and control
 145
functions entrusted to the Italian Foreign Exchange Office. The array of instruments
available for such interventions now appear to have been exhausted; the reinstatement
of those that have fallen into disuse is forbidden by the international community and the
continued application of those that are still valid is onerous. '
31. On 9 March 1972 the payment of interest on non-resident accounts was prohibited. On 17
July 1972 measures were taken to contain capital movements through shifts in leads and
lags and through foreign credits to residents. Moreover, the taking-up of intercompany
loans by Dutch multinationals in third countries, a notorious loophole, was prohibited.
32. See Szcisz (1974), p. 308.
33. The Netherlands did not go so far as Germany which banned all direct investment inflows
unless financed in Germany itself. See Szcisz in Swoboda (1976), p. 173.
34. Szcisz (in Swoboda (1976), p. 175) mentions the following example: ' ... when we forbade
the payment of interest to non-residents on guilder deposits, we soon discovered that an
important part of these deposits were swapped by the banks: though these deposits were
officially dollar deposits, the holder was to receive guilders in the end so that, for practical
purposes, these were guilder deposits which escaped the prohibition of interest payments.
Such a practice could not have developed without the cooperation of the banks.'
35. The adoption of the bill was delayed because parliament insisted that first legislation
with respect to the imposition of (financial) sanctions and the supervision of the credit
system was to be enacted. Although the bill was a step forward, the authority to impose
restrictions was far-reaching and was still motivated by the same considerations as held
earlier by Governor Holtrop. The main purpose of exchange restrictions continued to
be the support of domestic financial and monetary policy. To this end the Nederlandsche
Bank was authorized to restrict certain categories of capital inflows in case domestic credit
ceilings were applied, and the Bank, in agreement with the Minister of Finance, could
restrict capital outflows if the Dutch domestic capital market would become overburdened.
Furthermore, the Minister of Finance, after having heard the advice of the Bank, could
impose restrictions in case of large-scale speculative capital movements.
36. See Lamfalussy in Swoboda (1976), p. 177 et seq.
37. Lamfalussy (ibid.) mentions as a striking example that in February 1973 the Belgian
commercial banks were prohibited from accepting Belgian franc deposits from non-
residents on so-called 'convertible' accounts beyond a given maximum amount.
38. Upon accession to the EEC the new member states were granted transitional periods. Den-
mark had transitional periods ranging from 1 January 1975 for non-residents' purchases
of Danish securities to 1 January 1978 for purchases by residents of foreign securities.
When high domestic interest rates in combination with the prospect of EMS membership
attracted massive foreign interest in Danish government bonds, Denmark reimposed in
February 1979 restrictions on capital inflows under the safeguard clause of Article 73.
Ireland received special treatment up to 1 July 1977. The Irish pound being linked to the
British pound, exchange regulations roughly corresponded to the exchange control applied
in the United Kingdom, although the regulations generally were more lenient with respect
to direct investment, both inward and outward. There was close cooperation between the
British and Irish authorities in order to prevent 'back door' evasion of the controls of one
country by the residents of the other country. The United Kingdom could avail itself of
transitional arrangements until 1975 (see for discussion par. 6.13).
39. In April 1974 the Monetary Committee had formulated a new mandate for the group on
short-term capital movements (compare Note 16). In the first instance the group should
exchange information on capital controls applied in the member states. At a later stage it
should try to reach consensus on elements of a common minimum set of instruments as
well as on the coordination of the use of such instruments. Ultimately it should examine
how a distinction could be made in the use of instruments with respect to intra-EEC and
extra-EEC capital movements. Also in the beginning of 1974 the Monetary Committee
in conjunction with the Committee of Central Bank Governors established a working
146
group on the 'Harmonization of instruments of monetary policy'. A tremendous amount
of effort was put into cataloguing instruments and analysing their respective merits, but
in the absence of any drive towards integration dust was piled on the conclusions of these
groups.
40. The various restrictions were set out in A guide to United Kingdom exchange control,
Bank of England, February 1977. Major restrictions included: the requirement of prior
permission for investment abroad; certain types of capital transactions had to be led
thfough the investment currency market; restrictions on the holding of other foreign
currency assets, such as bank deposits (except for trade); and restrictions on lending of
sterling to non-residents, including trade credit.
41. Nigel Lawson (1992), p. 39.
42. Commission Resolution 75/487 IEEC, dated 23 July 1975. The German government raised
objections to the procedure followed by the Commission. In particular it was deplored
that the Monetary Committee had not been consulted on the matter and that no formal
decision by the Council had been taken. Against this the Commission argued that no
consultations or decisions were needed because the United Kingdom had not requested
mutual assistance. However, the Commission mended its ways on later occasions when
the Monetary Committee was consulted for approval of further delays in the liberalization
of capital movements by the United Kingdom.
43. One factor was the abolition of the investment currency market, where the premium stood
at over 40% at the end of 1978. The value of premium-worthy securities was estimated
at £5.3 bIn, implying a premium of £1.6 bIn. It was expected that attempts by investors
to restore the pre-abolition share of overseas assets in portfolios could give rise to capital
outflows. The lifting of barriers and the resultant psychological impact were expected to
lead to an increase beyond this pre-abolition share. The possibility to finance overseas
direct investment in sterling might also give rise to capital outflows; see Bank of England
(1981, p. 369 et seq.).
44. Nigel Lawson (1992) recalls having urged for a substantial relaxation of exchange control
as early as 1977. Exchange rate considerations were a major factor, as was the consideration
that in the longer run capital invested abroad would yield a useful stream of foreign
exchange as North Sea oil gradually ran out. Abolition of exchange control, however, was
not mentioned in the Conservative manifesto.
45. Geoffrey Howe in a lecture in 1991, quoted in Lawson (1992), p. 40.
46. See Bank of England (1981).
47. Szasz in Swoboda (1976), p. 172.
 CHAPTER 7

The 19808: Liberalization and Deregulation

While some countries have almost completely liberalized capital

movements, others fall far short of their obligations. The European
Commission's zeal in proposing new commitments has in the past
not always been matched by the same attention to have old obli-
gations respected. It can grant dispensation by empowering mem-
ber countries in difficulties to take temporarily so-called safeguard
measures. In one case this dispensation has been in force without
interruption since 1968, when De Gaulle's France got into trouble
because ofthe students' revolt. One should assume that the specific
circumstances justifying it at the time have changed since then (and
I do not only mean that those students have hopefully graduated by
now).
w.F. Duisenberg, 1985

7.1 INTRODUCTION

The decade of the 1970s in many respects had been a lost decade for Europe.
TIl-conceived plans and unrealistic time schedules had left European coun-
tries floundering about for newborn faith in the integration ideals. However,
the decade had ended on an optimistic note with the establishment of the
European Monetary System. Admittedly, the EMS was not without its ritual-
istic jargon: the ECU being at the centre of the system, whereas of course in
practice the Deutsche mark was to form the focal point for the participating
currencies; and the divergence indicator signalling the need for policy action,
whose frequent ringing, however, was left unanswered. 1 But if all the frills
were cut out, a pragmatic system it was, resembling closely the snake in its
essential operational elements. Unlike the snake, the EMS was not placed in
the framework of the Werner Report's goal of Economic and Monetary Union.
This implied that there was no institutional pressure for capital liberalization.
Such liberalization was not needed because the arrangement lacked the goal
of monetary unification. 2 It was not wished for either because capital move-
ments were still seen as potentially threatening for exchange rate stability.
The founding fathers of the EMS were convinced that without exchange rate
stability, there would be no resumption of European integration. The system
was a realistic attempt to precisely reach this goal of 'a zone of monetary
stability in Europe'. Later, it could be seen if the foundation had gained
sufficient strength to build the European house further.

147
148
Index; start= 1 00 (currency against DMark)

105 _ _

79 80 81 82 83

Dutch French Belgian Danish Italian Irish

guilder franc franc crown lira pound

Realignments are marked by vertical lines.

Fig. 16. The EMS 1979-1983: a shaky start.

The Exchange Rate Mechanism of the EMS had a shaky start. As shown
in figure 16, in the first years there were frequent and sometimes sizeable
realignments, partly because of different policy responses to the Second Oil
Crisis of 1979, and there were relapses into a tightening of exchange controls
on the part of some of the participants. Since the inception of the system, there
had been a continuous debate, reminiscent of the debate preceding the Werner
report, between those participants who aimed to transform the EMS as quickly
as possible into a final system (the 'monetarists') and those participants who
wanted to make this dependent on progress in economic convergence and
in the liberalization of capital movements (the 'economists,).4 In particular
there had been repeated French-inspired proposals for the strengthening of
the EMS mechanisms for which the Commission let itself happily be used as
an intermediary. These proposals aimed at enhancing symmetrical responses
to tensions within the system, therewith sharing-out the burden of adjustment
among the currencies under downward pressure and those under upward pres-
sure, the latter for all practicat"purposes being the Deutsche mark. Although
these initiatives were always framed in technical terms, the policy issues
involved were scarcely hidden. 5
In fact, the customary issue in any exchange rate mechanism, i.e. the dis-
tribution of the burden of adjustment, was at stake all along, as well as the
decision-making process with respect to monetary policy in Europe. As long
as countries whose currencies were under downward pressure had not put
their house in order, Germany was not willing to jeopardize its own sta-
 149

bility by coming to the rescue of weaker currencies. The Dutch monetary

authorities supported this position, arguing that the pursuit of a European
zone of monetary stability could only be successful if the anchor curren-
cy was not hindered in its anti-inflation policies. The continuous stream of
proposals to intensify monetary cooperation, carrying along in their slip-
stream suggestions to amplify credit mechanisms, antagonized Germany and
the Netherlands. These countries grew tired of being put on the defensive
and having to say 'no' against these proposals to finance the deficits of the
weaker currencies in the system without visible adjustments on their part.
They went on the counteroffensive. In search for a mechanism which would
enhance discipline among the weaker members of the system, they chose
one of the long-forgotten objectives of the Community: the liberalization of
capital movements. And their forum was the Monetary Committee.

7.2 CAPITAL LIBERALIZATION REINTRODUCED ON STAGE

In contrast to the leading role the European Commission had played in the lib-
eralization directives in the early 1960s, it now was the Monetary Committee
which, after some hesitations, took the lead in 1982. In the intervening years
since the inception of the EMS the Monetary Committee had been absorbed
in discussions on the institutional set-up of the EMS and on proposals for
the strengthening of the system's mechanisms. Among the latter, plans to
increase the liquidity and acceptability of the ECU figured prominently. As
far as the institutional set-up of the EMS was concerned, discussions focused
on the provision in the EMS Agreement that not later than two years after
its start the European Monetary Fund would be created. In this Fund the
existing arrangements and institutions would be consolidated. The European
Monetary Fund figured no less than ten times on the agenda of the Monetary
Committee in the period 1979-81. But it all came to nothing. In the wake
of the Second Oil Crisis attention in the Monetary Committee shifted to the
financing of balance-of-payments deficits, and in particular to an enlargement
of the Community loan mechanisms.
The constant push for a shift of part of the adjustment burden to the creditor
countries, implied by the proposals to strengthen the EMS and the enlarge-
ment of credit facilities, fuelled the fear among the strong-currency countries
that the wish to maintain exchange rate stability would come at the expense of
domestic monetary stability in their own countries. In particular Commission
proposals for non-institutional changes in the EMS, put forward early 1982,
had divided the member states. The proposals comprised intra alia increased
acceptance obligations of ECU s, facilitation of intramarginal interventions,
stabilization of the ECU exchange rate vis-a.-vis third currencies, and promo-
tion of the private use of the ECU. This was supported by France, Italy and
Belgium and strongly opposed by Germany and the Netherlands. The latter
150
resented being presented continually with steps, which by themselves might
be rather limited, but taken together always went in one direction of shifting
the burden of adjustment to the hard-currency countries. Discussions on the
final objectives of these steps were evaded and the hard-currency countries
thus found themselves in the uncomfortable position of being constantly on
the defensive. Presumably the Commission and France wished to develop
the ECU gradually as a global reserve currency, possibly alongside national
currencies, whereas Germany and the Netherlands saw the ultimate goal as an
economic and monetary union, with clearly defined institutional responsibil-
ities in the Treaty. They sought means of bringing the differences of opinion
in the open and see which steps could be taken which would not prejudice
any of these ultimate objectives. A logical step would be capitalliberaliza-
tion, which was anyway one of the Treaty obligations, and which would be
required for both objectives. It had the advantage over the other divisive EMS
proposals that in principle all member states could agree that this was a sine
qua non for further monetary integration. 6
Capital liberalization was not an extraordinary desire. It was in the air.
The United Kingdom had liberalized in 1979, and so had Japan in 1981. The
Reagan administration had adopted a deregulatory attitude. In the framework
of the EEC the Netherlands authorities, which had grown irritated over the
yearly packages of EMS amendments while others did not live up to their
Treaty obligations, viz. capital liberalization, decided to make an issue of
it. In the Ecofin Council meeting on 15 March 1982, when the Commission
proposals were discussed for hours, the Dutch finance minister van der Stee
proposed to reconsider the liberalization of capital movements in Europe and
not to confine this to ECU -denominated capital. One of the initiators, Andre
Szasz, put the issue of capital liberalization on the agenda of the Monetary
Committee in July 1982. This marked the beginning of a new era since the
adoption ten years earlier of the 1972 Directive which had institutionalized
capital restrictions in Europe. It also marked the beginning of a constructive
attitude of the hard-currency countries towards monetary integration, after
their initial hesitant stance towards the EMS.
Szasz called for the development of a common philosophy among member
states with respect to capital liberalization. A first step could be to reinstate
the regular annual examination of the use of capital restrictions, as provided
for in the First Capital Directive of 1960 and in the statute of the Monetary
Committee. Against the rules, the practice had developed that derogations
from the liberalization obligations had been granted for an unlimited duration
(see Table 24). He advocated that the committee should resume its normal
task of examining whether the circumstances still justified recourse to such
derogations.
In the committee there was sympathy from the side of Germany and the
United Kingdom, the only two member states which had liberalized all capital
movements themselves. Germany was attracted by the idea that liberalization
 151

TABLE 24
Application of safeguard measures.

Country since ended Treaty basis

France 1968 1986 109.1

Italy 1974 1977 109.1
1981 1987 109.1
United Kingdom 1975 1977 109.1
1977 1979 108.3
Denmark 1977 1979 108.3
1979 1984 73
Ireland 1977 1988 108.3
Greece 1985 1990 108.3

Note:
Article 73: disturbances in the functioning of the cap-
ital market;
Article 108.3: (threat of) difficulties in the balance of
payments;
Article 109.1: sudden crisis in the balance of pay-
ments.
At the end of the transitional arrangements, which are
not presented in this table, the Commission applied
Article 108.3 directly for Denmark, Ireland and the
United Kingdom.

would strengthen market forces and thus would put pressure on governments
to follow stability-oriented policies, with more emphasis on the maintenance
of price stability. For the United Kingdom the integration ideal implicit in the
Dutch and German argument played a less important role. Liberalization of
capital movements fitted well in the more modest British concept of Europe
as one market without barriers where economic development was fostered by
the free play of market forces. The issue, however, was extremely sensitive
for France. For the Tresor capital liberalization was a difficult exercise,
both in political as well as in psychological terms. In the French view there
was no urgency at all. Instead, all attention should be directed towards the
strengthening of the EMS. If liberalization was to be discussed at all, then
only in the framework of discussions on improving the mechanisms of the
EMS. By explicitly formulating this link, capital liberalization again was to
be made part of wide-ranging European negotiations.
There were attempts within the Monetary Committee to persuade France.
The issue, so it was pointed out, was not the total abolition of restrictions in the
short run. From a European viewpoint the real issue was that a certain degree
of liberalization would be needed for any meaningful form of monetary and
152

Quarterly averages, per cent

France

12 __________ _

-3 I - r - I- r - r - r - r - r - r - r - r - I
79 80 81 82 83 84 85 86 87 88 89

Italy

12 __________ _

-3 r- r - r - r - r - r - r - r - r - r - r - I
79 60 61 62 83 84 85 86 87 88 89

Source: BIS

Fig. 17. French and Italian Euro interest rate differentials 1979-1989.

economic integration. But the French committee members saw major risks
in capital liberalization and wanted only to postpone the whole exercise.
The position of France was clear. In the 'monetarist' tradition France ranked
monetary cooperative arrangements higher than market-driven convergence.
In the absence of symmetric arrangements it felt vulnerable to speculative
attacks. Abolition of capital controls would expose the French franc even
more. Therefore it held the existing exchange restrictions close to its chest,
as if they were its principal bargaining chip in the further development of the
EMS.
 153

7.3 A STRATEGIC REORIENTATION IN FRANCE

The uncomprising, dogmatic attitude of France can best be understood in the

context of the political and economic situation in France in the beginning
of the 1980s. Shortly after the election of Fran~ois Mitterrand as the first
socialist president under the Vth Republic, a socialist government had taken
office in the summer of 1981. Soon the government embarked on expansion-
ary policies in order to lift France out of the recession. Capital restrictions
were regarded as a cornerstone in this policy in that they separated domestic
financial markets from the outside world. At the same time the nationalization
of financial institutions was initiated with a view to making them instrumen-
tal in the government's retlationary strategy. Both developments antagonized
the international financial community and sparked off speculative capital
movements against the French franc. Speculation initially was countered by
a further tightening of exchange controls, which sharply increased differen-
tials between domestic and Euro interest rates (see figure 17). Eventually a
devaluation of the French franc could not be avoided (8.5% in October 1981).
Neither could another one (by 10% in June 1982), when the French go-it-
alone retlationary policies proved unsustainable in the face of a world-wide
recession. Not much later additional capital controls were imposed to stem the
continuing outtlows. But it was a waste of effort. The capital controls were
porous. Outtlows continued and they were accommodated by double-digit
growth rates of domestic credit, as long as the central bank was forced to play
its part in giving an impulse to the French economy.
The major confidence crises, which hit the French currency, eventually
led to a volte-face in French economic policies in March 1983 when France
for the third time within 18 months had to devalue (this time by 8%). From
now on France would turn towards stability-oriented policies. It had realized
that with its open economy it was not possible to go against the international
tide. It had run against external constraints, among which the dwindling of its
official foreign reserves was an important one. France had to make a strategic
choice. Either it could break apart from the EMS and follow an isolationist
course. This, however, would bring European integration to a halt. Moreover,
there was the genuine fear that such a course would lead to a fre'e fall of the
French franc. Or it could align itself with Germany in its quest for domestic
price stability, keeping open the perspective of further European monetary
integration. It chose, with grandeur, for the latter direction, combining it with a
major reformulation of its financial and industrial strategy. The latter implied
the opening-up of markets with the aim of enforcing rationalization upon the
French industry through the forces of competition. Accompanying measures
to deregulate and liberalize the financial markets were taken in the coming
years. One of the chief architects of this new economic policy was the then
Minister of Finance Jacques Delors, who later was to become the President of
the European Commission: The new stability-oriented policies of the French
154

government strengthened greatly the Franco-Gennan axis in Europe, which

traditionally had been the driving force behind European integration. This was
fertile soil pennitting the issue of financial integration again to be put high on
the European agenda. But the Commission needed considerable prodding.

7.4 THE CHANGE OF ATTITUDE OF THE COMMISSION

The Dutch initiative, supported by Gennany and the United Kingdom, to

bring capital liberalization back on the European agenda had been given a
frosty reception on the part of the Commission. As we have seen the attitude of
the Commission had been transfonned from that of an enthusiastic supporter
of liberalization in the beginning of the 1960s to an outright sceptic. But in
the wake of the French reorientation, there gradually was a change of heart
in the Commission's thinking.
A contributing factor was that the Commission had come under increased
external criticism for its pennissive attitude. The Commission had tolerated
the intensifications of the existing exchange restrictions in France in the course
of the years 1981-83.1 All these restrictions had been effected unilaterally,
without prior consultation and without examination whether the conditions
for the use of safeguard clauses were fulfilled. When the European Parliament
questioned these developments, the Commission had answered that the new
restrictions fell within the limits of the safeguard granted to France more
than a decade ago, in December 1968, in accordance with Art 108.3. Rulings
of the Court of Justice indirectly condemned this attitude and called on the
Commission to observe the procedures of the Treaty strictly, i.e. to examine
regularly whether the circumstances justified the application of the safeguard
clause and to see to it that derogations would only be temporary. 8 A similarly
pennissive attitude of the Commission vis-a.-vis the restrictions on trade
and capital flows imposed by Italy had provoked another indignant reaction
of the European Parliament. In a resolution the parliamentarians sharply
criticized the failure of the Commission to act in accordance with the spirit
of the Treaty.9 The Parliament was concerned about the increasing number
of unilateral actions taken by member states, which clearly ran counter to the
spirit of the Treaty. The Commission was called upon to act more vigorously
as guardian of the Treaty. I0
In April 1983, not long after the third French devaluation, the Commis-
sion issued a communication to the Council on financial integration in the
Community, II in which an attempt was made to give new impetus to the
process of capital liberalization. The Commission acknowledged that the
continued recourse to the safeguard clauses was inappropriate: 'Otherwise,
direct exchange controls become a pennanent economic policy instrument,
which is incompatible with the intentions of the Treaty'. In its paper the
Commission sided with the French position that any progress would have
 155
to depend on the simultaneous strengthening of the EMS mechanisms, as
well as on improved EEC procedures to bring about economic convergence.
The Commission argued that progress in these three areas was interrelated
and would be mutually supportive. Greater exchange rate stability and closer
economic convergence would facilitate the gradual removal of capital con-
trols. Conversely, the liberalization of capital movements would contribute to
greater discipline in economic policy by making the external consequences of
domestic policy mistakes visible at an earlier stage. However, the road chosen
by the Commission was not one of general capital liberalization as promoted
by the majority of the Monetary Committee, but rather one of liberalization of
EEC-related or ECU-denominated capital transactions. The Commission's
leitmotiv was not yet capital liberalization per se, but rather the promotion
of its pet child the ECU. As Vice-President Ortoli formulated: 'A useful
means of progressively establishing a Community financial market would be
to facilitate ECU financial transactions, particularly in those countries which
operate exchange controls.' 12
Apparently, the Commission wished to shield the EEC internal financial
market from the outside world. In its paper the Commission reproachfully
stated that European savings dissipated through the Euromarket into US
dollars 'for ill-defined economic purposes and subject to somewhat uncertain
~angements, as recent events have shown', the latter being an obvious
reference to the vicissitudes of the American currency and the international
debt crisis. The Commission wanted to replace the role of the US dollar by
the ECU, thus hoping that international financial flows would shift to Europe
and in particular to EEC deficit countries. It would then be a matter of striking
the appropriate balance between the 'constraint of internal adjustment and the
advantages of external financing' .13
There was French support for the Commission'sfavouritism vis-a-vis the
ECU on political grounds: the EMS in practice functioned too much as a
Deutsche mark zone, implying that French policies had to adjust to German
policies. But there was opposition from other sides to such positive discrim-
ination of the ECU. The German viewpoint was that it would be of little
use to deploy the financial instrument of the ECU as long as there was no
common monetary policy in the EEC and no European central bank with
appropriate powers to control and maintain the value of the EeU. Besides,
Germany, supported by other countries with a liberal exchange regime and
well-developed financial centres such as the United Kingdom and the Nether-
lands, was vehemently opposed to any shielding of EEC financial markets
from outside influences. Yet, despite all opposition, the Commission's mem-
orandum was indicative of a gradual shift from its detached attitude vis-a.-vis
exchange restrictions to a more favourable stance towards capitalliberaliza-
tion. After the experiences both in the snake and, again, in the Exchange Rate
Mechanism of the EMS, the Commission had come to the conclusion that
capital controls had only a passing effect on exchange rate stabilization and
156

did not contribute to adjustment of economic policies: 'Fluctuations in capital

movements are sometimes due as much to speculation as to the trend of basic
economic variables' . Moreover, experience had shown that short-term capital
flows were difficult to regulate, because 'operators are very clever at finding
ways through the tangled web of national rules' .
The change of attitude in the Commission's thinking, encouraged by the
outside criticism of its permissive application of the safeguard clauses, reflect-
ed a greater awareness of the advantages of the establishment of a European
capital market. Although it phrased its proposals initially in the framework
of the promotion of the ECU and the shielding from external disturbances,
the Commission was convinced that European industry needed free access to
capital in the member states. When at a later stage the framework of a shielded
European capital market on the basis of positive discrimination of the ECU
did not prove to be a realistic proposition the Commission, mindful of the
interest of European industry, retained the concept of capital liberalization
and accepted this being brought about in an open, non-discriminatory manner.
Thus these first Commission proposals on financial integration can be con-
sidered as a run-up to the far-reaching implications for capital liberalization
of the White Book which was to appear two years later.

7.5 ACTIVE GRADUALISM

In the course of 1983 and 1984 numerous meetings of the Monetary Commit-
tee were devoted to the financial integration dossier. The Ecofin Council was
regularly informed of the state of the discussions in the Monetary Commit-
tee. Ministers, however, did not discuss themselves the issues in a substantive
manner until a very late stage. The de facto negotiations were delegated to
the Monetary Committee.

7.5.1 Promotion of the ECU

In a meeting in Venice in the autumn of 1983 the committee discussed the

matter at length. The Commission stressed that its proposals were intended
to strike a 'political balance' between mutual intra-European capital liberal-
ization, with the possibility to introduce common restrictions vis-a-vis third
countries, on the one hand and the promotion of the ECU on the other hand.
There was fierce opposition from Germany, the Netherlands, Denmark and
the United Kingdom to the implicit discrimination vis-a-vis third countries.
For Germany in particular the rejection of the erga ommes principle was
unacceptable, as it had been ever since the subject had been brought up. But
now there was an additional reason. After the policy of active discourage-
ment of the build-up of external Deutsche mark holdings had been given up
by the authorities in 1981 in view of its apparent failure, the Deutsche mark
 157
had evolved into an internationally traded reserve currency. The monetary
authorities now tried to make the best of it. Its reserve currency status would
be irreparably damaged if transactions were to be curtailed by EEC-wide
capital restrictions vis-A-vis third countries. France, on the other hand, stood
ready to liberalize ECU transactions but did not wish to go beyond that, seeing
no room for further generalized liberalization.
The discussion in the Venice meeting was overshadowed by a fundamental
debate on the why's and how's of a promotion of the ECU, the quid pro
quo demanded by the restrictive countries. From the Dutch side the question
was put quite bluntly and repeated in the central bank's annual report: 'A
number of countries, including the Netherlands, are loath to make agreements
about further technical refinements as long as existing agreements, which are
often of a more fundamental importance, are not fully complied with and
as long as it remains unclear what such refinements are meant to achieve.'
The Bundesbank was not less outspoken: 'Convergence (... ) and freedom of
money and capital movements are the areas in which progress is necessary in
order to secure the EMS in the long run. On the contrary, questions concerning
the role of the ECU bear the risk that they detract from the real needs for a
durable holding together of the EMS. In any case the attention given to the
ECU in the public discussion bears no relationship to its importance for the
monetary integration process.'14 Germany and the Netherlands apparently
took the position that the liberalization of capital movements was a goal in
itself, to be aimed at both on its own merits as well as in accordance with the
Treaty provisions. They felt that it was not acceptable to demand concessions
in the form of ECU promotion schemes or enlarged financing mechanisms in
exchange for measures by other member states which were called for in the
Treaty anyway.
The question why the role of the ECU should be strengthened had been
evaded, so it was felt. Some countries probably aimed at an economic and
monetary union, but were disinclined to discuss the fundamental premises of
such union, reasoning 'let's begin by 'perfecting' the ECU'. Other countries
probably wished to see the ECU develop into an international reserve asset.
Apart from these possible long-term goals of developing the ECU, it was
questioned how the ECU in the near future could serve a useful role in coun-
tering speculative capital flows or be instrumental in bringing about economic
convergence. In short, there was considerable scepticism with respect to the
added value which the promotion of the ECU would bring in relation to the
liberalization of capital movements. And there was a genuine fear that in the
end technical measures would be taken with respect to the ECU in the central
bank sphere, whereas with respect to capital liberalization it would remain
merely a matter of good intentions in the political sphere.
Nevertheless, the fact that there was a political link between capitalliber-
alization and the strengthening of the EMS was eventually accepted by the
major participants. France and Italy, as the major restrictive countries, indicat-
158

ed a willingness to dismantle capital controls in exchange for improvements

in the EMS mechanisms. However, they wished to do so in a gradual manner
because they saw great risks in a quick dismantling in a situation of high
inflation and external imbalances. Only recently France had still been forced
to draw on one of the Community loan mechanisms. 15 When these large
countries moved, Denmark and Ireland did not resist gradual liberalization
any longer, as long as they could determine the pace on their own. Belgium
did not actively engage in the discussion, because it maintained, as it had done
all along, that under its dual market system for all practical purposes freedom
of capital flows was established. All along, it sided with France in its demands
for a strenghtening of EMS mechanisms. Germany, the United Kingdom and
the Netherlands reluctantly had to go along with the idea of a package deal.
But they insisted that the promise of relaxation of controls should not prove
to be an empty gesture. Therefore, to start with, the Commission and the
Monetary Committee should take up their statutory obligation to examine
existing restrictions and safeguards regularly, as had already been demanded
in mid-1982.
In the meantime the liberalization movement gained force. On 1 January
1984 Denmark decided to abolish at one stroke the major remaining exchange
restrictions. As the United Kingdom had experienced earlier in 1979, no
significant disturbances on the domestic capital market followed and the
Danish members in the committee professed great satisfaction with the results
achieved. In the spring of 1984 the European Commission finally heeded the
exhortations of the Monetary Committee and initiated a series of official
bilateral talks on the justification of the continued use of the safeguards of
France, Italy and Ireland under Article 108.3. 16

7.5.2 Formulation of a Package Deal

The contours of a possible package deal began to take shape when a shopping
list of desiderata was formulated by the ministers of finance in the informal
Ecofin meeting in Rambouillet on 12 May 1984. This list had three headings:
economic convergence, financial integration and the strengthening of the
exchange arrangement of the EMS. Apart from capital liberalization, the
last two headings combined a variety of topics, ranging from preferential
treatment of ECU-denominated transactions, extension of the official and
private use of the ECU, to a narrowing of the margins for the Italian lira and
the entry of the pound sterling in the exchange arrangement. It was clear that
the most extravagant wishes, among which the latter, sooner or later would
have to be dropped from the list. But the shopping list made one thing clear:
from the viewpoint of the restrictive countries there had to be a quid pro quo
for capital liberalization in their countries. And this quid pro quo was to be
the ECU.
 159

At the request of the Monetary Committee, the Alternates headed by Jean-

Jacques Rey from the Belgian National Bank, were asked to report on concrete
steps with respect to the liberalization of capital movements. On a German
initiative the liberalization process was nick-named' active gradualism'. This
implied that Germany accepted that the restrictive countries embarked on a
process of gradual liberalization - as distinct from the British and Danish
examples - but that concrete visible steps would be set which would transcend
the already existing obligations. Therefore it was suggested that certain capital
items should move up the lists to the unconditional regime. 17 As a back-up
exercise to the Commission's examination of the justification of safeguard
measures, the Monetary Committee should resume its annual examinations
of the whole range of capital restrictions. Both the European Commission and
the Monetary Committee thus implicitly, in a rare show of self-accusation,
were chastised for their absent-mindedness over the past years to see to it that
the Treaty obligations were fulfilled.
The report of the Alternates was discussed in the Monetary Committee in
September 1984. As could be expected, there was firm support from the Ger-
man, British and Dutch sides for further steps towards capital liberalization
which in their view would reinforce the disciplinary effects of the EMS on
economic policies. But also France could now accept the active gradualism
with respect to capital liberalization, promoted by Germany, as long as this
would be accompanied by symmetrical efforts by others, in particular with
respect to the promotion of the position of the official and the private ECU, on
which separate discussions were underway both in the Monetary Committee
and the Committee of Governors. The Italians and hish, by subscribing to
the temporary character of the safeguard clauses, accepted that in time they
would have to abolish the controls on capital transactions which fell under the
1960 and 1962 Directives. The French chairman of the Monetary Committee,
Michel Camdessus, in summing up the debate in the committee, elaborated on
four elements which would distinguish active gradualism both from' gradual-
isme prudent' and 'gradualisme hardi ': (1) the temporary nature of safeguard
clauses, (2) enlargement of liberalization obligations, (3) de facto liberaliza-
tion of certain EEC-related capital transactions, and (4) the drawing-up of a
negative list of measures in the grey zone of informal restrictions. This was
encouraging.
The breakthrough on the principle of capital liberalization was confirmed
at the political level in the informal Ecofin meeting in Dromoland Castle
(Ireland) in October 1984. The ministerial discussions focused on the techni-
cal improvements in the EMS mechanism on the understanding that capital
restrictions would be abolished in due course. In the meeting further evi-
dence was furnished that France, which had been the driving force behind
the call for promotion of the ECU, gradually was taking a more pragmatic
standpoint. When demands for Community-wide positive discrimination of
160

the ECU were dropped, the contours emerged up of a package which would
be acceptable for all. Obviously, the political tide had changed at last.
The Committee of Governors was invited to work out a package which
eventually would comprise: the raising of the interest rate on ECUs held
by central banks to market-related level; the setting-up of a mobilization
mechanism under which ECUs would be exchangeable for dollars; extension
of the obligations to accept ECUs in the settlement of intervention debts; and
the extension of the circle of holders of official ECUs to third countries or
international institutions. 18 These were minor changes, which did not in any
way affect the main characteristics of the ECU or the functioning of the EMS.
But they served a useful political purpose in demonstrating that a step-by-step
approach was followed with respect to both the development of the ECU and
capital liberalization.
Apparently, there had been an evolution in French thinking since the reori-
entation of France's economic strategy iIi 1983. This reorientation encom-
passed a major deregulation of the financial sector in stages, which needed to
be supplemented eventually by the liberalization of exchange control. At the
same time the change of direction in monetary policy influenced the func-
tioning of the French financial markets. The beginning of the disinflation
process, accompanied by a rise of real interest rates, enabled the Treasury
to finance its budget deficit in a non-monetary way, and enabled the com-
mercial banks to issue bonds. This in turn paved the way for the Banque de
France to prepare a wide-ranging change in the quantitative credit control
mechanism, which came into effect in 1985, as well as a reform of the money
market. 19 The French authorities thus followed a well thought-out sequenc-
ing order, in which first deregulation of the financial sector, restoration of
real interest rates and more market-oriented ways of monetary control were
implemented, while still making use of the shield of capital controls. When
the French macro-economic situation would have been strengthened - the
current account returning into a surplus in 1984 - and the financial sector
would be strong enough to withstand foreign competition, the capital con-
trols could be withdrawn. Its declaration of intention to this effect was an
important political signal.

7.5.3 Examination of Derogations

In December 1984 the Monetary Committee held its first annual examina-
tion of capital restrictions since 1965. Twenty years had passed. Yet, there
still were collisions between the committee and the Commission. The Com-
mission felt that the Monetary Committee was only authorized to examine
whether there were possibilities to expand the liberalization obligations. In
its view, it was precisely because of the fact that such extensions were not
feasible that the yearly examinations had fallen into abeyance. The exami-
nation of the existing safeguard clauses was a matter for the Commission.
 161

The Commission's viewpoint was in flat contradiction with the provisions of

the Treaty and the First Capital Directive.2o Accordingly this position was
strongly contested by members of the committee, who still had a vivid mem-
ory of the lethargic attitude of the Commission vis-a-vis the application of
the safeguard clauses. The outcome was that the derogations would be moni-
tored more strictly, both by the Commission and by the Monetary Committee,
and that their duration would be limited in time. The restrictions would be
continually reviewed and were to be gradually abolished as the difficulties
which originally justified them diminished. As a first step expiry dates were
set for the remaining recourse to safeguard clauses by France (two years)
and by Italy and Ireland (three years).21 In a show of good will France and
Italy relaxed their restrictions somewhat, although the French easing had no
bearing on the transactions for which the safeguard clause had been invoked.

7.6 PRESENTATION OF THE WHITE BOOK

A further contribution to the changed sentiment in Europe was made when

on 1 January 1985 Jacques Delors, who as a minister of finance had steered
France through turbulent times to a new economic orientation, was appointed
the President of the European Commission. He gave an invigorating impulse
to the European integration process. Soon after his appointment he came
forward with an ambitious plan to breathe new life into European integration
by focusing on the completion of the Internal Market. 22 In the meeting of the
European Council on 29 and 30 March 1985 in Brussels this goal was further
specified: a single large market should be achieved by the end of 1992. The
Commission was called upon to draw up a detailed programma with a specific
timetable. These plans were elaborated by Commissioner Lord Cockfield and
culminated in the publication of the White Book in June 1985, in which the
Commission presented its proposals to complete the Internal Market by 1
January 1993.
In the White Book the complete liberalization of capital movements was
taken up as an essential ingredient of the Internal Market. No longer was
there any reference to Community-wide positive discrimination of the ECU,
the idea having been clearly rejected by the Monetary Committee. European
industry and private individuals would need an efficient capital market for
the free movement of goods, services and persons not to be a dead letter, so
it was argued. The integration of national financial markets would foster the
economic development in the Community through an optimal allocation of
savings. Beyond these traditional arguments in favour of free capital flows,
there was a new argument, reminiscent of the Werner Report of the early
1970s, which had come up in the discussion on the financial integration
paper. Capital liberalization would exert a disciplinary effect on domestic
economic policies needed for exchange rate stability, which in tum was seen
162

as an essential condition for the proper functioning of the Internal Market. 23

Therefore capital liberalization should move in parallel with a strengthening
of the European Monetary System.
As far as the concrete plans with respect to capital liberalization were
concerned the Commission gathered up the threads. Plans were reconfirmed
to phase out in time recourse to the safeguard clauses. Plans were reconfirmed
as well to enlarge the unconditional liberalization obligations for transactions
in shares issued by collective investment undertakings (unit trusts) as well as
in the mortgage lending field. Certain transactions would be added to the list
of unconditional liberalization obligations. 24 All these plans were not new.
But the time framework in which they were put added a sense of urgency.
And there was the clear aim that all operations of Community interest should
be gradually liberalized.
All in all the White Book contained daring steps on the road to integration.
It appealed to governments and the public at large, where the mood was ripe
for liberalization and deregulation after the disappointing results of interven-
tionist policies in the 1970s. But it also presaged the later proposals for the
more final and definitive step of economic and monetary union. In taking the
logical step towards the fulfilment of the original goal of the founding fathers
of the EC - the establishment of a common (now called internal) market -
the White Book at the same time called attention to the further-reaching step
of ultimate unification. This process would eventually call for the surrender
of national sovereignty.

7.7 DISCUSSIONS ON THE SINGLE EUROPEAN ACT

In order to implement these ambitious plans it was felt necessary to insert into
the Treaty of Rome provisions which would facilitate the decision-making
with respect to the establishment of the Internal Market and broaden the lat-
ter's range. In the Milan summit on 28 and 29 June 1985 an Intergovernmental
Conference was convened to work out amendments to the EEC Treaty with
a view to achieving concrete progress on European Union.

·7.7.1 Freedom of Capital Movement

The Commission proposed that in the new so-called Single Act the definition
of the Internal Market would also encompass the free movement of capital. In
doing so, the Commission set a further step beyond the targets specified in the
White Book, because its proposal implied that capital liberalization no longer
was confined to transactions of Community interest. The Commission wished
to seize the occasion of the Treaty amendment to get rid of the escape clause
in Article 67 which provided that capital liberalization would be abolished
only 'to the extent necessary to ensure the proper functioning of the Common
 163

Market.' In order to achieve this, the Commission used the device of defining
the Internal Market as comprising an area without internal frontiers in which
the free movement of goods, persons, services and capital would be ensured
under the same conditions as in a member state.25 This formulation would
lead to a situation in which on 1 January 1993, the date foreseen for the
completion of the Internal Market, residents of the EEC could rightfully
claim that cross-border capital movements should be completely freed as
long as they were not curtailed at home. This would apply, even if secondary
legislation to implement the capital directives would not be forthcoming in
the meantime.
The central banks and ministries of finance were somewhat taken aback,
because this proposal as well as an accompanying one to strengthen Com-
munity procedures in the monetary field had important implicati~ns in their
fields of competence but initially were not dealt with in the relevant bodies,
i.e. the Ecofin Council and the Monetary Committee. The Intergovernmental
Conference which was called upon to prepare the Treaty modifications could
not be founded on prescribed procedures and they got alarmed only at a rather
late stage of the negotiations. The member.states were not yet ready for direct
applicability of Community law in the field of capital movements. Eventually
the following text for a new article 8a was adopted: 'The internal market shall
comprise an area without internal frontiers in which the freedom of goods,
persons, services and capital is ensured in accordance with the provisions of
this Treaty.' The latter ensured that the relevant existing provision, i.e. the
escape clause of Article 67, was left intact. Apparently the member states did
not wish at this stage to tie their hands with respect to capital liberalization.

7.7.2 A Monetary Dimension

Accompanying attempts by the Commission to introduce a monetary dimen-

sion in the Treaty, as it were through the backdoor, got an even more frosty
reception. The idea that Europe should be given a monetary identity had been
forcefully pushed by France after the adoption of the EMS package.26 But the
vagueness of the concept had turned off others and prompted initiatives first to
discuss the long-term goals of the EMS. In the European Council meeting in
Milan in June 1985 it had been stressed by the Chairman of the Ecofin Council
that given the fact that in the area of monetary integration technical measures
could have far-reaching political effects, and in view of the balanced function-
ing of the EMS, it would be appropriate that the further development of the
EMS would remain a matter for the finance ministers and the two competent
committees, i.e. the Monetary Committee and the Committee of Governors.
The Commission proposals negated this political declaration by proposing
to include the European Monetary System as well as the objective of eco-
nomic and monetary union in the Treaty.27 The progressive bringing about of
such union should be endeavoured by increased cooperation within the EMS,
164

under the aegis of the European Monetary Cooperation Fund which would
be the organ responsible for running the EMS. The EFMC would be re~laced
eventually by a European Monetary Fund, with institutional autonomy. 8 The
inclusion of economic and monetary union as one of the objectives of the
Treaty would imply that institutional measures in the field of monetary policy
could be taken by the Council pursuant to Article 235, even if no monetary
powers were conferred upon the Community. 29
In a hastily convened meeting of some Monetary Committee members,
on the occasion of the IMP and World Bank annual meetings in Seoul, it
became clear that Belgium, France and Italy were positively inclined towards
the inclusion of a monetary dimension in the Treaty. However, Germany
categorically refused such a clause. The granting of monetary competences
at the Community level without further specifications would imply by def-
inition that the decision-making procedures of the Treaty would apply, i.e.
the Council decides on a proposal of the Commission. This would contradict
the independence of the Bundesbank, written into German law, and might
trigger a constitutional crisis at home. The British were also opposed, albeit
on different political grounds: the objective of EMU in their view showed
little sense of reality and was deemed to be totally out of character with the
other changes which were more of a modernizing and updating character.
With the encouragement of the Commission, the Belgian government at
a rather late stage came forward with similar proposals for the inclusion
of economic and monetary union in the EC's mission statement in Article
2.30 However, these proposals, as those of the Commission, did not contain
any provisions with respect to the decision-making in such union nor to the
task and the position of the national central banks. To the disappointment
of France - Minister Beregovoy: 'Peut-on evoquer l'Europe sans dimension
monetaire?' - the proposals fell down. The awkward handling by the Com-
mission of this matter had antagonized the monetary authorities in a number
of countriesY It was clear that too little time had been allowed to have a
thorough discussion with respect to future European monetary integration.
The concept of economic and monetary union had too many important impli-
cations for it to be forced through.
Eventually, at the request of Germany, a clause was inserted in the Single
Act which explicitly decreed that 'in sofar as further development in the field
of economic and monetary policy (would) necessitate institutional changes,
the provisions of Article 236 shall be applicable' (Article lO2a). This referred
to the article which provided the procedures for amendment of the Treaty,
requiring ratification by all Member States in accordance with their respective
constitutional requirements. If there had been any lingering doubt as to the
monetary powers of the EEC, from now on it was clear that any institutional
step in the monetary field would require a change of the Treaty of Rome.
Moreover, it was explicitly stipulated that the Monetary Committee and the
Committee of Governors should be consulted regarding institutional changes
 165

in the monetary area. The only concession made was that the title of the
new Chapter for Article 102a - Cooperation in economic and monetary
policy - was supplemented with the addition' Economic and monetary union' ,
significantly within brackets. 32

7.7.3 Assessment

The Single European Act was adopted by the European Council in Luxem-
bourg in December 1985 and signed by the member countries in February
1986. How should one judge the outcome of the Single European Act? As far
as the monetary dimension was concerned the outcome was not impressive.
The Commission had tried to force through monetary arrangements, without
having granted member states sufficient time to think them over. Opinions
as to the ultimate goal of integration still diverged and in the end countries
hardened their positions, rather than making compromises. It would be some
years before the subject of monetary integration would come up again when,
after thorough preparation in the Delors Committee, another Intergovernmen-
tal Conference could be convened, which eventually agreed on the Treaty of
Maastricht on European Union. By this time ministers of finance had already
secured that they were to be the ones who would draft the Treaty texts on eco-
nomic and monetary union and not their colleagues from the foreign affairs
departments. They would not let themselves be taken by surprise for a second
time.
As far as capital liberalization was concerned the accomplishments on
paper were not impressive either. Eventually, some declaration of intent was
wrangled out of the discussions and inserted into the Treaty: the highest
possible degree of liberalization should be attained and unanimity would
be required for measures which would constitute a step back as regards the
liberalization of capital movements (Article 70). But this reference was more
in the nature of a political declaration than that it implied any commitment on
the part of member states. But the dynamic ingredients of the Single Act were
very powerful indeed. They consisted of two major ingredients concerning
the decision-making process: qualified majority voting and the principle of
mutual recognition, as already spelled out in the White Paper. The first meant
that powerful alliances could be forged which could overcome a veto of
individual states. This would facilitate the adoption of secondary legislation
with respect to the liberalization of capital movements. The second ingredient
implied that the cumbersome process of trying to reach harmonized rules
within the EC, for instance with respect to financial services, was abandoned.
From now on, member states would only have to agree on a minimum degree
of harmonization. This had to be mutually recognized, but could be expanded
upon by individual member states if they wished to do so.
166

7.8 COMMISSION PROPOSALS FOR A NEW DIRECTIVE

Despite the political agreement that capital liberalization and strengthening

of the EMS should go hand-in-hand, it took some time before the March
1985 agreement on a package of technical measures to strengthen the EMS
was followed-up by concrete measures in the field of capital liberalization.
In the Monetary Committee Szasz, who as chairman of the Alternates of the
Committee of Governors had presided over the completion of the package,
stated that, the central banks having done their fair share, it was now up
to the treasuries to take their part in the Rambouillet understandings, i.e.
to fulfil the liberalization obligations of the Treaty.33 In the wake of the
publication of the White Book the Commission had finally started work on
a new directive after having received political backing from the Ministers in
the Ecofin Council meeting in June. Preliminary Commission proposals were
eventually discussed in the Monetary Committee in December 1985 on the
basis of a report of the Alternates. 34
In general, the proposals to broaden the liberalization obligations were
positively received in the committee. Some members, however, warned the
Commission not to be overambitious in reforming the existing directives.
There was a diminishing need for detailed classification of capital trans-
actions in the eyes of those countries which had already freed all capital
transactions. An outspoken position in this respect was taken by the British
members. London had been the scene of an extremely rapid development
of new financial instruments. It was clear that in this process of innovation
the distinctions between different sorts of capital transactions were getting
blurred more and more. Instead of the subtle fine-tuning of the Commission,
it might in their view be preferable to leave the directives as they were,
so that each country could decide for itself when it wished to follow the
British example of radical liberalization at one stroke. There was the fear
among some that the directive might actually discriminate with respect to
countries which had liberalized their capital transactions. If those categories
which now also had to be liberalized were easily brought under the existing
safeguards, the end result would be that liberal countries which did not avail
themselves of derogations would be confronted with expanded obligations,
whereas the restrictive countries would continue to be protected under the
safeguard clauses. 35
On balance the modest proposals of the Commission for merely partial
liberalization of capital movements were in line with the agreed 'active grad-
ualism' approach. But they constituted a disappointment for those who would
have expected a more ambitious approach in the slip-stream of the White
Book. In fact the Commission had done no more than resume its attempts to
expand on the 1960 and 1962 Directives. It had proposed similar transactions
to be unconditionally liberalized in its failed attempt for a Third Directive in
the 1960s. Now that it had picked up the thread some countries resumed their
 167

ritual of raising technical objections. There was a genuine risk that the time-
consuming negotiations on a new directive actually might slow down rather
than accelerate the process of liberalization and that the political momentum
would get lost. What was lacking was a longer-term vision. However, for this
the member states would not have to wait long.
In the meantime some concrete progress was made by the adoption by the
Council of a directive on the liberalization of transactions in shares of under-
takings for collective investment in securities (unit trusts). A draft directive
to this effect had been on the table since 1979 but the discussions had dragged
on. As was discussed in Chapter 5, France had objected to its inclusion in the
First Capital Directive. After adoption of another directive which harmonized
the protection of investors and coordinated the supervision of these unit trusts,
the road had been freed for the first concrete progress in capital liberalization
in Europe since 1962.36 More was to follow soon.

7.9 A NEW AMBITIOUS INITIATIVE OF THE EUROPEAN COMMISSION

In the discussions on the Single European Act the Commission had already
tried to insert freedom of capital movements as an integral part of the Internal
Market. That proposal had been one bridge too far for member states. But
the Commission's thoughts had evolved considerably since then. Eventually
the strategic decision was taken to give top priority to the liberalization of
capital movements and to aim ultimately for the complete freeing of all capital
transactions, regardless of their duration or their purpose. It is significant that
the President of the European Commission, Jacques Delors, first outlined the
Commission's initiative before the Committee of Governors. It seemed to be
an attempt to improve the relationships which had become strained during
the negotiations on a Single European Act.
In the Basle meeting on 13 May 1986 Delors mentioned two fundamental
reasons for the choice to give high priority to full capital liberalization. The
first reason was the link with the White Book and the objectives of the Single
European Act, where the unification of the financial area should be consid-
ered as a constituent part of the establishment of the large internal market
by 1992. The second reason advanced by Delors derived from the fact that
greater freedom for the movement of capital would be a necessary condition
for making monetary cooperation more effective. He concluded from this
that both the development of the EMS as well as of the ECU must be based
on a wide measure of freedom for capital movements within the Communi-
ty. Allowance should be made for gradual adaptation by lagging countries,
but liberalization should not be postponed unduly because greater freedom
for capital movements would bring pressure for achieving convergence of
economic policies.
The strategy outlined by Delors had a highly political dimension. The
Commission's claim that all capital transactions, i.e. including short-term
168
movements, were an integral part of the Internal Market implied an outright
negation of the escape clause of Article 67, which it had tried in vain to remove
from the Treaty in the Single Act. By referring to more effective monetary
cooperation being dependent on capital liberalization the Commission heeded
German insistence that it was not prepared to consider further EMS packages
unless concrete liberalization steps had been taken in other countries. 37 But
Delors took things one step further: by embracing the goal of full capital
liberalization, he gambled on setting in motion a dynamic process which
would eventually bring German monetary policy into the European orbit.
In the liberalization pr0fgamme which the Commission presented two
phases were distinguished. 8 The first phase consisted of three fields of
action: (1) general liberalization for the transactions covered by the 19.60
and 1962 Directives should be achieved through the termination of the safe-
guard measures which several countries had applied for so many years; (2) the
transitional arrangements for the new members should be ended as soon as
possible; (3) enlargement of the liberalization obligations through the adop-
tion of a new directive. The first two fields of action provided reassurance for
the liberal countries which had feared that further liberalization obligations
would only apply to them and not to the derogation countries. As regards
the enlargement of liberalization obligations, the Commission proposed to
include all transactions in financial securities, including non-listed securi-
ties not dealt with on a stock exchange, and long-term commercial credits. 39
Moreover domestic regulations should allow companies to issue securities on
any market within the Community on the same conditions as those applying
to resident issuers. By ending discriminatory treatment the linkages between
the European national financial markets would be improved.
The second phase would lead to the full liberalization of capital movements
and thus would imply the effective lifting of all remaining exchange controls.
In practice this would mean that the liberalization obligations would extend
to short-term flows such as financial loans, money-market operations and
the opening of sight and other deposit accounts. The Commission wished
to follow a tight time schedule,40 while recognizing that not all member
countries would be able to take the necessary steps at the same time. Therefore,
safeguard clauses would be applied, but they were to be closely monitored.
Expressis verbis it was admitted that capital liberalization would be a two-
speed process.
The Commission had come up with an ambitious, far-reaching programme
which went considerably beyond what most member states seemed prepared
to contemplate. It was most likely that the operation of the EMS would be
complicated through complete freedom of capital flows. The proposals drew
heavily on the hoped-for economic convergence. Here the Commission took
a calculated risk. Ifgreater freedom of capital flows would have to be bought
at the price of more frequent realignments or larger fluctuation margins within
the EMS, the end result would be worse than the existing situation. These risks
 169

were very much realized at the time. 41 On the other hand, if there was a time
when economic conditions were favourable to try an attempt to leap forward,
it was now. The German objections to contemplating further institutional steps
with respect to the EMS and the ECU as long as capital restrictions remained
intact in other countries would continue the stalemate the Commission was
fearful of. The argument that any further strengthening of the EMS was
not on the cards had propelled the Commission to direct its attention to
capital restrictions. It seemed right to embark on a dynamic process which,
if successful, would bring high rewards. Financial liberalization would force
the central banks to coordinate ever more closely, opening up the perspective
of changing the EMS from a Deutsche mark zone into a truly commonly
managed system with the perspective of monetary union.

7.10 THE RECEPTION OF THE COMMISSION'S PROGRAMME

At the time of introduction of the Commission proposals in May 1986 only

3 EEC countries, Germany, the United Kingdom and the Netherlands, had
virtually abolished restrictions on capital flows for all practical purposes. But
the announcement of the Commission more or less coincided with a major
relaxation of restrictions in France, including the abolition of the devises-titres
market and an easing of direct investment abroad, which made it possible to
end the use of the safeguard clause, in force since 1968. The breakthrough
in France provided an important political signal for other countries. Other
member states still had more far-reaching restrictions in place, sometimes
necessitating quite an extensive bureaucratic apparatus for control. Ireland
and Italy continued to have safeguard measures in place, whereas Greece
and the new members Spain and Portugal were under various transitional
arrangements, agreed at or, as in the Greek case, extended since their entry
into the EEC. 42 In Belgium and Luxembourg the dual exchange market still
had its place, although the differential between the financial franc rate and
the official franc rate normally was small. Denmark continued to avail itself
of certain short-term capital controls. Many of these restrictions affected not
only the commercial and the banking sector. The general public at large was
equally confronted with limits on the amount of travel money, restrictions on
the purchase of foreign equity or of foreign assets, such as second homes.
The restrictions therefore had a negative psychological impact on the sense
of European citizenship. But the position of some of the major restrictive
countries was rapidly changing. Among those, the French attitude was of
paramount importance. If France were to liberalize in a decisive manner, the
regimes of other countries would become more exposed. Their being out of
step with the core of Europe carried political costs, as well as risks in the
financial markets.
170
7.10.1 The French Position

Since its entry into the European Monetary System in 1979, France had
tightened further its exchange controls, in order to ward off speculative cap-
ital outflows. These found their logical counterpart in a system of direct
monetary control, with special credit ceilings and interest subsidies for spe-
cific industries targeted by the government, which, as discussed earlier, had
been a constant characteristic of French monetary policy, apart from a brief
experimentation with indirect instruments in the beginning of the 1970s. The
tightening of exchange controls had peaked in May 1983 with the intro-
duction of the 'camet de change', a drastic measure which controlled the
allowance for foreign nonbusiness travel up to a maximum of merely FF
2000 ($ 270) per year per person. Also the use of personal credit cards abroad
was forbidden. Galy (1986) estimates that both measures reduced French
tourist expeditures abroad in 1983 by 13%. As regards the primary goal of
exchange control - maintenance of the external value of the currency and
the preservation of official exchange reserves - it was clear that exchange
restrictions were powerless in the face of unsound policies, the French franc
having been forced to devalue by more than 25% in just 18 months between
1981 and 1983. The tightening of restrictions provided only short-term relief,
but this effect quickly dissipated. It provided a dangerous sense of comfort
that short-term solutions could prevent a haemorrhage of offical reserves. The
policies pursued and their attendant restrictions had completely undermined
the confidence of the public at large, depleted the official reserves of the
Banque de France and had failed to contribute to spurring economic growth.
The disastrous developments and the disillusionment as regards the effective-
ness of the regulation of economic life led to a turnround in French policies,
aimed at a transformation of the way the economy functioned. Already at the
end of 1983 the unpopular camet de change was withdrawn.
Apart from the ineffectiveness of exchange control there were three other
inconveniences which underlined the need for a reorientation of policy. (1)
The bureaucratic procedures implied by the tightening of exchange control
became a heavy burden. Especially the workload for the banks in keeping
files for the 'domiciliation' of imports and exports, enabling the matching of
trade and financial data, became cumbersome. (2) The system invited evasion.
The big French enterprises used their political weight to obtain derogations
from the burdensome controls, with considerable success. This in tum caused
serious competitive distortions for the small and medium-sized enterprises
which had less political clout. (3) Commercial and financial activities of
French industry and banks were diverted to other centres. Especially the
establishment of the financing divisions of Renault and Peugeot in Geneva,
as well as the development of activities of French banks in London and
Luxembourg caused grave concern among the authorities.
 171

There were thus real economic drawbacks of the exchange control sys-
tem in the French economy. These came on top of the ineffectiveness of the
controls, following a general move towards lower costs of financial transac-
tions through technological developments, which enhanced the possibilities
to evade the restrictions. France, as a modem state, could no longer afford to
stay on the sidelines of the international move towards deregulation of finan-
cial markets. But first the domestic economy needed strengthening. To this
end there were basic reforms in industrial policy under then Minister of Indus-
try Laurent Fabius. Subsidies to inefficient firms were discontinued. Frontier
sectors were targeted in order to bring about industrial modernization. Quanti-
tative credit controls were abolished and financial markets were deregulated.
Thus it was sought to restore a climate of confidence, encouraging saving and
investment by the private sector. Minister of Finance Beregovoy - in 1983
still one of those who favoured dropping out of the EMS - was later to say that
he wished to liberalize not only in order to observe the obligations under the
EC Treaty, but also to make life easier for the French population at large. 43
The deregulation and liberalization process was supported throughout the
political spectrum. When the socialist-led governments under Prime Minister
Mauroy (1981-84) and Fabius (1984-86) were succeeded by the centre-right
Chirac government (1986-88) the gradual dismantling of restrictions was
continued. The economic climate was propitious for such liberalization: after
the change of policies in 1983 France made good progress in the fight against
inflation and the restoration of balance-of-payments eqUilibrium. From end-
1983 until end-1985 the restrictions were gradually eased by removing their
most annoying aspects. At the Luxembourg summit on 2 and 3 December
1985 President Mitterrand announced that capital liberalization would contin-
ue at such pace that all restrictions for which France had obtained derogations
would be lifted before the end of 1986.
For France the proposals of the Commission were introduced at the appro-
priate time, synchronized as they were with the substantial relaxation of
foreign exchange controls in May 1986. It had embarked on an irreversible
process of gradual unwinding of restrictions. But France tried to gain political
advantages by linking it to the European integration dossiers. Further progress
should take place in the sphere of what could be called 'institutional' sequenc-
ing, i.e. further liberalization was to be made conditional upon firm agreement
on stronger monetary cooperation between the EEC countries. This form of
institutional sequencing, in which quid pro quos were asked from partner
countries to compensate for liberalization, was presented under the heading
of the umbrella term 'strengthening of the EMS.'

7.10.2 The German Position

There were three mainstays in the German position with respect to capital
liberalization: (1) liberalization was good in itself because it improved the
172
allocation of resources; (2) it would contribute to disciplining economic poli-
cies; and (3) it should be applied erga omnes, i.e. in a non-discriminatory
fashion for EEC and non-EEC countries alike. The German attitude was
inspired by free market ideology, but it was also influenced by the experience
of prolonged surpluses on current account. Capital exports by nonbanks were
considered to facilitate the task of the monetary authorities in two important
ways. By helping to prevent current account surpluses from feeding into mon-
etary aggregates inflationary pressures were allayed. And by helping finance
the current acco!lnt surpluses, undue upward pressures on the exchange rate
were diminished as well. 44
As a traditional surplus country Germany frequently had to cope with
inflows of funds which disrupted the formulation and implementation of mon-
etary policy. The dilemma between the external constraints and the require-
ments of the domestic economy had been the leitmotiv of German monetary
policy. The brief attempt to alleviate this dilemma by the imposition of restric-
tions on capital inflows in the beginning of the 1970s had not been a success
and the last regulations were lifted in 1981. 4s The restrictions partly had been
aimed at limiting the reserve role of the Deutsche mark in the post-Bretton
Woods years through a policy of determent. In fact, there had been an impor-
tant change in the attitude of the authorities vis-a.-vis the Deutsche mark's
international role. The acceptance of the role of the Deutsche mark as an
international reserve currency prompted a tumround in domestic regulation
as well. The requirements with respect to the form of domestic paper were
eased gradually in line with developments elsewhere. Liberalization in third
countries provoked a certain competition between monetary authorities in
deregulation: the easing of form requirements was now explicitly motivated
by the wish to sustain the Deutsche mark's international reserve role. 46
The progress achieved in the convergence of economic developments and
monetary stability in Europe had created much scope for liberalization in
other European countries as well, so it was felt. This would enhance disci-
pline in economic policies of the countries concerned and thus strengthen
convergence within the EMS.47 In the German position there was a distinct
ideological undertone - freedom of capital movements was good per se -, but
Germany was realistic enough to acknowledge that countries should not pre-
maturely liberalize short-term capital flows, i.e. not before a certain degree of
convergence had been established. Therefore it had sympathy for a degree of
gradualism. The complete freeing of capital flows would place high demands
on stability-oriented policies, in particular with respect to price stability. If
countries were not able to fulfil these demands, there would be a risk of seri-
ous backlashes which could prompt demands for a further strengthening of
the EMS and could lead to disturbing inflows. Germany was opposed to insti-
tutional back-ups in the EMS because this would merely weaken discipline
and postpone adjustment. Liberalization, so it was argued by Bundesbank
director GIeske (1986), would rather boost the confidence in the currency.
 173

The experience in the United Kingdom and Denmark seemed to vindicate

this standpoint. Such confidence was hampered if conflict situations were
resolved with 'dirigistic' capital controls. The message was clear: Germany's
vision of an integrated Europe was a market-oriented one with economic
agents being as free as possible in making their decisions. Only on that basis
was it willing to discuss institutional changes in the economic and monetary
setting of Europe.

7.10.3 The Dutch Position

The Dutch authorities were satisfied with the active stance of the Commis-
sion: 'Thus a better climate (would be) created for policy discussions on
the advancement of European monetary cooperation and the role which the
ECU could play here.,48 However, they initially held that existing obliga-
tions with respect to capital liberalization should be fulfilled first, before new
ones could be accepted. They feared that new obligations would simply be
brought under the existing safeguards for the restrictive countries, implying
that it would only be the liberal countries which would take additional obliga-
tions on board. The Netherlands, which unlike Germany used direct methods
of monetary control, wished to retain the possibility to impose restrictions
on inward capital flows to close the external gap when imposing domestic
credit ceilings. If it were prevented from applying controls on borrowing in
third countries in case of a domestic credit ceiling, direct monetary control
measures could be easily circumvented. 49 It was felt that it would be hurtful
to Dutch pride ever to invoke the safeguard clauses for this purpose.
When at the end of 1981 the domestic credit ceilings were completely
lifted, the legal basis for controls on capital inflows disappeared as well. 5o
Domestically it was felt increasingly difficult to keep the controls in place.
Industry had grown used to taking up credit with commercial banks abroad.
All in all, the Dutch no longer held an ideological position with respect
to capital restrictions as they had done in the Holtrop era, but were rather
pragmatic. They had changed from a negative system to a positive system in
1977, largely because of doubts as regards the effectiveness and fairness of
exchange restrictions. This doubt was also enhanced when it became evident
that prosecution for non-compliance was rare and that in no single instance
had offenders been sentenced. The token reference in the annual reports of
the Nederlandsche Bank that 'investigations were held to check compliance
with the exchange control regulations' only scared off jellyfish. The move
towards a more market-oriented approach gained force among the monetary
authorities.
As a first step, important deregulations of the Dutch capital market were
carried through. Regulations had been in place with the aim of ensuring order-
ly market conditions as well as maintaining a strict separation of liquidity and
capital in order to attain monetary objectives. However, the rapid development
174

of financial markets, spurred by innovations and technical progress, as well

as their internationalization made it increasingly difficult to enforce national
rules. A major consideration was the wish to maintain Amsterdam's position
as a financial centre and to ensure that transactions in guilder-denominated
paper would continue to take place as much as possible in the Netherlands.
The deregulation, effective as from 1 January 1986, involved the virtual abo-
lition of all requirements as to form, thus ending the strict separation of liquid
and capital assets, as well as a considerable easing of the calendar require-
ments. As a logical sequence the second step was taken shortly afterwards.
The remaining restrictions on capital outflows were lifted and the Exchange
Control Regulations Department, which had already shrunk to only 3 profes-
sional staff members, was dismantled. On 1 October 1986 the Netherlands
became the fourth OECD member country which had liberalized all ~apital
movements.

7.10.4 The Belgian Position

Belgium kept a low profile in the discussions on capital liberalization, in

order to avoid drawing too much attention to the dual market. Although the
ultimate goal of full freedom of capital movements was supported, the dual
market, where differentials between the two markets had decreased to 0.5%,
was functioning satisfactorily and was not questioned at home. When it was
questioned by other member states the Belgian authorities reacted irritated. 51
They formulated conditions which other member states would have to fulfil
before abolition of the dual market could be contemplated. In particular, actual
liberalization of exchange controls should take place in France and Italy. But
also further-reaching measures should be taken, such as participation of the
pound sterling in the EMS and reduction of the fluctuation margin of the
Italian lira. 52 From this it was clear that Belgium and Luxembourg would sell
their dual market dearly.

7.10.5 The Danish Position

Denmark had not experienced an easy entry into the EEC. Although it had
managed to stay in the snake - together with Germany and the Benelux
countries -, the 1970s were a decade of persistent current account deficits,
run-away inflation, extensive controls on capital exports and repeated deval-
uations. Interest rates were kept high to attract capital inflows and domestic
monetary policy was conducted through direct controls on credit expansion.
Monetary policy and exchange controls were arranged with a view to allow-
ing private capital imports to finance part of the current account deficits and
preventing capital outflows from becoming too bulky. There was a growing
conviction that these policies merely prolonged the stagnation of the real
economy. It was. felt that the restrictions were ineffective and outdated in
 175

Monthly overages, per cent

14 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

- 2r-r-r-r-r-r-r - r-r-r-r-r-1
79 80 8 1 82 83 84 8S 86 87 88 89 90

Fig. 18. The Belgian dual market 1979-1990.

an integrated world, and that they had produced distortions in the national
financial system. Some transactions, such as the purchase of foreign shares,
had been banned for over half a century. 53
In the beginning of the 1980s a radical change was carried through and
Denmark switched over to a hard-currency policy in the EMS (see Figure
19). Interest rate policy from now on was to be the main policy instrument
to peg the Danish krone to the other hard currencies in the EMS. In line
with this change of policy direct domestic monetary controls were abolished
and exchange controls were dismantled at a rather quick pace. Denmark's
experiences with vigorous capital liberalization were positive. The hard-
currency policy gained considerable credibility, when it was shown that the
central bank indeed was prepared to let market forces work their way through
into interest rates. Denmark thus became, like the United Kingdom, a convert
to the gospel of capital liberalization and joined forces with other liberal-
minded countries like Germany and the Benelux countries.

7.10.6 The Italian Position

Since the beginning of the 1980s proposals for a reform of the extensive
exchange control system had already circulated in Italy. Parliament had been
offered draft laws in 1981 and 1983, which aimed at reforming the regulations
which since 1976 had considered violations to be criminal offences, as well
as at changing from a negative to a postitive system of exchange control.
The impulse to proceed towards such liberalization came from the perception
176

- I. .U- • "_. .::

"

Fig. 19. Denmark's switch-over to a hard-currency policy.

among the authorities of the contradiction of the strong presence of Italy in

the international trade and financial system, Italy belonging to the Group of
Seven, and the persistence of restrictive domestic regulations. In the Banca
d 'Italia it was increasingly felt that an easing of restrictions and a streamlining
of administrative procedures would improve the allocation of resources and,
by increasing the efficiency of the domestic capital market, would eventually
make capital cheaper. 54 In fact the perceived contradiction between Italy's
position in the world economy and its domestic regulatory and institutional
framework gave rise to a vivacious political and cultural debate.
The adoption of the relevant legislation, switching-over to a positive sys-
tem, nevertheless was continually delayed because of the precarious economic
situation. The balance of payments continued to be fragile in the early 1980s,
inflation was too high and there were repeated devaluations of the Italian
lira. A process was started to gradually remove barriers and restrictions with
respect to capital movements. Total liberalization was not the starting-point
in the process but might eventually be its conclusion. Full liberalization was
viewed as being not without risk and Italy would in practice ask for long
transition periods.
 177

7.11 THE 1986 DIRECTIVE

In line with the outcome of the Monetary Committee's discussions towards

the end of 1985 and as a follow-up to the programme presented by President
Delors the Commission came forward with a new draft directive for the first
phase. 55 In this proposal the Commission had dealt with some of the concerns
which had been voiced with respect to the earlier draft, notably by excluding
short-term securities from the liberalization obligation. Although the directive
now received a warm welcome in the Monetary Committee,56 again there was
a battle of words over parallelism. Although all countries in principle could
subscribe to the notion that capital liberalization should move hand-in-hand
with increased convergence, there were considerable differences of opinion
as to the operational implications of parallelism. Implicitly, the sequencing
of liberalization measures was at stake.
The 'restrictive' weak-currency countries still had drawn a demarcation
line for further liberalization measures between long-term and short-term
capital transactions in order to avoid the risk that speculative short-term
capital flows would jeopardize exchange rate stability. The sequencing of
capital liberalization had been partly determined by the relative strength of
the national currency. In the realignment discussions in the informal Ecofin
meeting in Ootmarssum in April 1986 this link was explicitly established by
Minister of Finance Balladur. After an initial request for a devaluation of
the French franc by 8 to 9%, which was deemed excessive by most other
countries, the parties settled for a range of 6% to 7%. Balladur declared
that, in the case of an adjustment of 7%, all restrictions which fell under
the safeguard clause would be lifted. If, however, other countries insisted on
an adjustment of only 6%, France would liberalize less. The EMS partners
did not allow themselves to be blackmailed, and an adjustment of 6% was
eventually agreed upon. Shortly afterwards, France liberalized nevertheless
up to the point that the safeguard measures could be withdrawn.
For further liberalization France wished to have assurances that hard-
currency countries would stand ready if the French franc would get under
speculative attack, either by giving financial support to shore up official
reserves or by taking measures, preferably interest rate decreases, which
would enhance the relative attractiveness of the weak currencies. The view
that a proper sequencing of liberalization measures required ample financing
possibilities for weak-currency countries was most forcefully espoused by
the European Parliament. President Delors was reminded of his proposals
that the financing mechanisms of the EC would be used not only in case
of balance-of-payments difficulties, but also as a form of support on the
road to capital liberalization. 57 The Parliament proposed that instead of the
application of safeguard clauses recourse should be had to financial support
and EC loans. 58 In its meeting on 17 November 1986 the Council final~
adopted the directive which was to enter into force on 28 February 1987. 9
178

TABLE 25
Third amendment of the 1960 Directive.

July 1982 The Monetary Committee exhorts the Commission to come forward
with proposals for capital liberalization.
20 April 1983 The Commission outlines new initiatives in its paper to the Council
on Financial Integration.
4 May 1983 First discussion of the Commission proposals in the Monetary
Committee.
17-18 October 1983 A package deal comprising capital liberalization, promoting the
ECU and strengthening of the EMS is discussed in the Monetary
Committee.
26 March 1984 Preparation in the Monetary Committee of the informal Ecofin
meeting.
12 May 1984 Informal Ecofin meeting in Rambouillet in which the contours of a
package deal began to take shape.
24 May 1984 Further discussions in the Monetary Committee on a package.
September 1984 Discussion in the Monetary Committee on a report of the Alternates.
4 December 1984 Resumption in the Monetary Committee of yearly examinations of
capital restrictions.
19 December 1984 The Commission sets expiry dates on the safeguard clauses for
France, Italy and Ireland.
March 1985 Agreement among central banks with respect to a package of mea-
sures designed to promote the ECU.
June 1985 The Commission presents a White Book on the completion of the
Internal Market.
17 December 1985 The Commission proposal of a new Directive on capitalliberaliza-
tion is discussed in the Monetary Committee.
23 May 1986 Presentation of a programme by the Commission to fully liberalize
capital movements in two phases.
18 July 1986 Discussion in the Monetary Committee.
10 September 1986 Presentation of the final proposal for a directive by the Commission.
17 November 1986 Adoption by the Council of the third amendment of the 1960
Directive.
28 February 1987 Entry into force of the Directive.

It was approved unanimously after .the Italian, Greek and Danish ministers
had withdrawn their reservations. They could not have blocked the directive
anyway, because a qualified majority had been secured. However, Minister
Goria of Italy, supported by his Greek colleague, made a unilateral declaration
for the Council minutes in which he advocated the simultaneous development
of financial instruments to cope with destabilizing capital movements. As far
as he was concerned there would be a price tag on the next liberalization
round. 60
 179

7.12 CONCLUSION

The first years of the European Monetary System were characterized by

repeated exchange rate tensions under the influence of continuing large infla-
tion differentials. A tightening of exchange controls in France and Italy did
not succeed in stemming speculative flows, which time and again forced the
authorities to devalue their currency. In an attempt to secure support form
their hard-currency partners in the Exchange Rate Mechanism yearly pack-
ages to strengthen the EMS were tabled, which in practice entailed additional
financing obligations for the latter with potentially inflationary consequences.
Irritations mounted in Germany and the Netherlands when they were forced
on to the defence and risked, by declining the packages, as being perceived
as obstructing the monetary construction of Europe. In search of developing
a constructive attitude, the Dutch authorities proposed to take up again the
nearly-forgotten issue of capital liberalization. This fitted in well with the
global drive towards liberalization and deregulation.
. The initiative was immediately seized by Germany which was attracted by
the disciplinary effect of freedom of capital movements on macro-economic
policies. Another side to the sequencing argument thus emerged, with coun-
tries in the 'economist' camp, as Germany, reasoning that monetary cooper-
ation would only be possible if other countries, such as France, would follow
more strict, stability-oriented policies. The United Kingdom, too, support-
ed the initiative because it would strengthen the market orientation of the
Community.
The Commission needed considerable prodding before it came into action.
First, in line with French preferences, the road of discriminatory liberaliza-
tion in favour of the BCU and BEC countries was tried out. This, however,
ran into fierce opposition from those countries which had already fully lib-
eralized capital flows and strongly advocated adherence to the erga ommes
principle. When France, after its reorientation of policies in 1983, had suc-
cessfully modernized its domestic financial system, while restoring external
eqUilibrium and regaining a measure of domestic price stability, a significant
liberalization of capital movements could be carried through. The Commis-
sion, under the visionary leadership of Delors, seized the opportunity to come
forward with a programme for full capital liberalization. Delors invariably and
successfully sensed the lay of the land and adjusted his policies accordingly.
From now on the Commission would play the leading part. Capitalliberaliza-
tion could prove to be the dynamic element, lacking in the post-Werner era,
which could create internal momentum by introducing elements of external
discipline. In the improved economic climate the liberalization process could
gather momentum and in its slipstream bring monetary integration closer. By
aligning himself with a proposal of the hard-currency countries, and there-
with discontinuing the perpetual opposition of these countries towards the
180
EMS packages, De10rs had made a political and strategic choice, which if
successful could bring great rewards.
The position of France in this respect was crucial. Initially, France was
hesitant. But growing self-confidence was evident in successive French gov-
ernments. Whereas previously the risks of free capital flows had been stressed,
there was a growing feeling that because of its balanced economic policies
France now finally could afford to capture the gains of free capital flows
without having to be overly concerned about their potentially destabilizing
effects. Capital liberalization increasingly was seen as a sign of strength and as
a reward for good policies. A multi-speed Europe was more and more visible.
There was a leading group, composed of Germany, the Benelux countries and
Denmark, which had a low inflation rate, virtually no exchange restrictions
and exchange rate stability. Apart from the last aspect, the United King-
dom formed part of this leading group as well. There was a lagging group,
composed of Spain, Portugal, Greece and Ireland, which as far as economic
development was concerned still had a long way to go. And there was an
intermediate group, consisting of France and Italy, which could seek its allies
on either side. France was ready to break away from the 'Southern' pack and
to join this first group.
The outcome of the 1986 Directive fell short of the modest conception
of the first phase by the Commission. In particular the transitional periods
had been lengthened instead of shortened; short-term capital transactions still
were excluded from the liberalization obligation. Thus there was not yet a
breakthrough towards full capital liberalization. The discussions nonetheless
had shown that the arguments in favour of capital restrictions had become
weaker; in particular their effectiveness seemed to be limited and, if anything,
decreasing. On the other hand, the arguments in favour of liberalization were
gaining force, especially the advantages of efficiency. But apart from these
underlying economic motives, there were important international considera-
tions. When, following Germany, which, apart from a temporary experimen-
tation, had been a steady supporter of liberalization, the United Kingdom in
1979 and now also France were clearly moving in a liberal direction, this had
important consequences for other European countries as well. With a third
large European country having become inclined towards liberalization, the
European pursuit of the free movement of capital could no longer be stopped.
It was clear that the adoption of the second phase of Delors' programme
would not come about easily.' Italy had accepted the directive with visible
reluctance. Other restrictive countries were not bursting with impatience and
would come up with costly proposals for compensation. The Commission
would now have to show whether it wished to gQ all-out for forcing capital
liberalization on its member countries.
Among the central banks there was support for the liberalization because
of growing scepticism as to their effectiveness. But there also were fears.
There were especially doubts as long as convergence of budgetary policies
 181

was lacking. It was feared that with progressive liberalization the burden of
adjustment would fall lopsidedly on monetary policy. On the other hand partial
liberalization contained a dynamic element because it became increasingly
easier to circumvent restrictions through the construction of special financial
instruments which fell under the liberalized regime. Thus the liberalization
drive could not be stopped easily, once it had gathered speed. Partly for
this reason some countries, particularly the United Kingdom and to a lesser
extent Denmark, had opted for a shock treatment by liberalizing all capital
movements at one stroke. But the United Kingdom did not yet participate in
the Exchange Rate Mechanism of the EMS. The crucial question was whether
France and Italy, which did follow a policy of exchange rate stability, would
be prepared to follow suit.

NOTES

1. Resolution on the Establishment of the European Monetary System and related matters,
Brussels, 5 December 1978. Although article 2.1 provided that' a European Currency Unit
(ECU) will be at the centre of the EMS', in operational terms the system functioned on
the basis of a grid of bilateral exchange rates. Article 3.5 provided that 'a threshold of
divergence will be fixed at 75% of the maximum spread of divergence for each currency'.
However, the presumption that the authorities of a currency crossing this threshold would
correct the situation by adequate measures, in practice was not carried into effect.
2. It may be argued that the European Commission considered the EMS as a step towards
monetary unification. At the time of the inception of the ECU - 'at the centre of the system'
- the Commission may already have had in mind its development as a parallel currency
which eventually was to supersede the national currencies. In later communications this
intention was explicitly stated (e.g. in its note on 'Financial integration', April 1983). This
was a different concept from Werner's proposals for the progressive narrowing of fluc-
tuation bands and the eventual irrevocable fixing of parities. Neither of these approaches
was yet intended by the participating countries. Ifanything, the French authorities wished
to develop the ECU into an international reserve currency. The Council Resolution of 5
December 1978 merely provided that the EMS within two years would be consolidated
into a final system, entailing the creation of a European Monetary Fund, whose functions
still had to be defined. See also Szasz (1988), p. 164-166.
3. Resolution of the European Council (ibid.), article 1.1.
4. See Ludlow (1982), p. 4-7 for a discussion of the debate between 'economists' and
'monetarists' in the run-up to the Werner report.
5. France had two motives to propose changes in the EMS: the wish to present the EMS not
as the Deutsche mark bloc into which it had developed, but as a truly European system,
implying an enlargement of the role of the ECU; and the wish to reach a more symmetric
distribution of the adjustment burden, by putting additional obligations on the creditor
countries. The French proposals took the form of packages of technical improvements in
the EMS. These packages gave rise to lengthy discussions where the underlying policy
disagreements were fought out 'in code'(e.g. Szasz (1988), p. 169 et seq.). In its Annual
Report on 1981 the Nederlandsche Bank disapprovingly writes: 'With progress towards
convergence of policies proving more arduous, tendencies are gaining ground within the
EMS to focus on technical aspects. (... ) Monetary techniques ought not to be an excuse
for failure in other areas.'
6. Later, in the Annual Report of the Nederlandsche Bank on 1984, p. 18, the point would
be made clearly that diverging objectives of the member states did not necessarily entail a
182
standstill: 'Mter all, those travelling from The Hague to Groningen and Leeuwarden take
the same train as far as Zwolle. Thus, by the same token, if the ECU is to be promoted
either as an international reserve asset or as a common currency, the intermediate station
of completely free capital movements is a sine qua non. This would also mean that the
undertakings to liberalise capital flows previously entered into would actually be honoured.
Let us work towards this goal first of all.'
7. France had modified its exchange controls in the wake of speculative pressures on 21 May
1981,25 March 1982 and in April 1983 with a view to encouraging capital inflows and
discouraging outflows.
8. In case 36183 (ECSC re deviations from 1i'eaty provisions) the Court of Justice had ruled
that the requirement for the maintenance of restrictive measures is that the conditions
under which the original authorization is given still apply. If those conditions were to
disappear, the authorization should be withdrawn. This contradicted the opinion of the
European Commission that the restrictive measures taken by the French administration in
the beginning of the 1980s could still fall under the authorization given in 1968.
9. On 18 June 1982 the European Parliament adopted a very critical resolution on the lax
attitude of the Commission vis-h-vis Italy, which in September 1981 had reintroduced
compulsory deposit measures. The Commission, which had authorized similar measures
in 1974, again authorized them unquestioningly under the safeguard clause of Article
108.3.
10. Although in theory the Commission's position could be challenged before the Court of
Justice by a member state, in political terms this was neither a viable nor a desirable route.
Likewise, the Council of Ministers in theory could amend or revoke the authorization
given by the Commission with a qualified majority in accordance with Articles 108 and
109. However, such majority could not be reached as long as France, Italy, Ireland and
Denmark maintained exchange controls under the safeguard clauses of the 'Ii'eaty and
could form a blocking minority. Therefore, in practice all depended on the good will of
the Commission.
11. Communication of the European Commission to the Council of Ministers on 'Financial
integration', 20 April 1983, COM(83)207.
12. Vice-President Ortoli quoted in ECU Newsletter, May 1983.
13. Communication of the Commission, COM(83)207, p. 17, Note 6.
14. De Nederlandsche Bank, Annual Report 1984, p. 17. Deutsche Bundesbank, Annual
Report 1984, p. 70.
15. In May 1983 France was granted ECU 4 billion under the oil facility (Community loan
mechanism), which had been established in 1975, in the face of rather outspoken protests
of some member states which considered the use of this facility improper. Later this facility
was merged with the medium-term financial assistance mechanism into the so-called single
facility for medium-term financial assistance.
16. Bilateral talks with Denmark were no longer needed because its use of the safeguard
clause under Article 73 (disturbances on the domestic capital market) had been lifted after
a major liberalization exercise on 1 January 1984. The European Commission did initiate
talks with Greece, which still could benefit from transitional safeguard arrangements, in
order to see whether there was room for some relaxation of capital controls.
17. The unconditional regime applied for lists A and B (compare Chapter 5, Note 8).
18. These proposals had been contained in a report of the Committee of Governors on the
possibilities for strengthening the EMS which was presented in Dromoland Castle. The
package in its final form was accepted in March 1985.
19. See Icard (1994).
20. See Chapter 4, p. 62 and 71, and Chapter 5, p. 88.
21. Decisions 85/14,15 and 161EEC, dated 19 December 1984.
22. The European Council, in its meeting on 3 and 4 December 1984 in Dublin, had agreed that
steps should be taken to complete the internal market, albeit without further specification.
 183

The completion of the internal market should be accompanied by a strengthening of the

EMS. In his inaugural speech for the European Parliament on 14 January 1985 Delors had
advanced that 'a strengthened EMS (... ) could re-open the path to economic and monetary
union mapped out by the Werner report almost 15 years ago'.
23. The White Book provides in paragraph 126 that: ' ... Action to achieve greater freedom
of capital movements would need to move in parallel with the steps taken to reinforce
and develop the European Monetary System. Exchange rate stability and convergence of
economic policies help the gradual removal of barriers to the free movement of capital;
conversely, greater financial freedom leads to greater discipline in the conduct of economic
policies'. See also discussion in Chapter 7.4, p. 155.
24. These operations concerned the issue of securities representing risk capital, transactions
in securities issued by Community institutions and long-term commercial credits. They
were largely the same categories of transactions as had been proposed at the time of the
discussion on the Third Directive in the beginning of the 196Os.
25. Proposal by the European Commission to amend the Treaty of Rome, dated 7 October
1985.
26. Under the heading of the strengthening of the 'monetary identity' of Europe France advo-
cated that the Monetary Committee should come up every year with a balanced package
which should contain steps in four related areas: convergence, capital liberalization, devel-
opment of the ECU and enlargement of the participation in the ERM. Others considered
such a yearly package to be a strait-jacket which could obstruct progress in separate areas.
27. President Delors had mentioned the possibility of a clause on monetary cooperation to
be inserted into the Treaty during the informal Ecofin meeting on 20 and 21 September
1985 in Luxembourg. The Monetary Committee and the Committee of Governors both
formulated an opinion concerning the Commission proposals on Monetary Provisions,
which were discussed in the meeting of the Ecofin Council on 18 November 1985. See
for a detailed discussion Louis (1988).
28. New Commission proposal for Monetary Provisions in the Treaty of Rome, dated 16
November 1985, in which Article 2 of the Treaty was to be supplemented as follows:
'The objective shall be to achieve economic and monetary union of the Member States in
accordance with Articles 103 to 107 of this Treaty, thus bringing about parallelism between
alignment of economic and monetary cooperation.' Article 107 was to be supplemented by
clauses concerning the European Monetary System, the ECU, the EMCF and the European
Monetary Fund ('with institutional autonomy').
29. Article 235 provides for supplementary powers for the EC, not provided for in the Treaty,
to act in order to attain one of the objectives of the Community.
30. Belgium had been approached by the Commission to come forward with a proposal of
its own in the Intergovernmental Conference. The purpose of the request was to lend
additional political weight to the proposal on a monetary dimension in the Treaty. Minister
of Foreign Affairs Tindemans complied with the request against the advice of the National
Bank.
31. It has been suggested in talks with officials that the Commission approach had been
particularly counterproductive with respect to a possible entry of the pound sterling into
the EMS. The fear that the EMS would prove to be the hell's gate of economic and
monetary union through the inclusion of a monetary dimension in the Treaty stiffened
British opposition.
32. Interpretations of Article 102a vary. For an elaborate discussion see Louis (1988). The
inclusion in Article 102a ofthe EMS and the ECU was heralded by some as a strengthening
of the monetary competences of the Treaty, while others stressed that the article at the
same time acknowledged that cooperation shall respect existing powers in this field.
The Commission added a Declaration to the Single Act, supported by the Presidency,
in which it considered 'that the provisions inserted in the EEC Treaty with reference to
the Community'S monetary capacity are without prejudice to the possibility of further
184
development within the framework of the existing powers.' Margaret Thatcher in her
memoirs (1993, p. 555) describes that she hoped that by adding to the phrase 'Economic
and Monetary Union' the gloss 'cooperation in economic and monetary policy' the limits
the Single European Act placed on it would be signaled. Lawson in his memoirs (1992,
p.894) disapprovingly writes of this that she mistakingly had heeded Foreign Office advice
that what remained of the reference to EMU was' 'little more than hot air'. In Lawson's
view Thatcher had instead allowed the genie out of the bottle (p. 902), as became clear in
the Hanover summit in June 1988.
33. Szasz indicated that the Committee of Governors on a Dutch initiative would start a
discussion on the long-term perspective of the EMS. In this way more clarity could be
reached regarding the future role of the ECU. The Monetary Committee would conduct a
discussion in parallel.
34. In the draft directive the Commission proposed to place three categories of capital restric-
tions on the list for which there was an unconditional obligation to liberalize: the issue
of securities, transactions in non-tradable securities and long-term commercial credits (5
years and more). This went somewhat further than the earlier proposal in the White Book
(compare Note 24). Furthermore, the Commission proposed to merge the unconditional
lists (A and B) and the conditional lists (C and D).
35. Liberal countries, as Germany and the Netherlands, were particularly irritated that the
Commission in its draft directive tried to curtail the powers of the Monetary Committee by
restricting the committee's examination to the transactions which figured on the conditional
list only. This meant that the committee would no longer be involved in the examination of
the safeguard clauses and would have to leave this completely to the Commission. Given
the Commission's track record, this was unacceptable for the liberal countries.
36. Directive (85/583/EEC), dated 20 December 1985, brought transactions in shares of unit
trusts on the list of transactions to be unconditionally liberalized. It was supplemented by
Directive (85/61 lIEEC) , also dated 20 December 1985, which coordinated the legal and
administrative regulations with respect to unit trusts. Both directives were effective from
1 October 1989.
37. Minister Stoltenberg: ' .. a further strengthening of the EMS is absurd as long as there is
no further liberalization of capital movements .. ' (Die Zeit, 15 March, 1985). Bundesbank:
director GIeske: ' .. the dismantling of the still numerous restrictions on capital movements
that stand in the way of real monetary integration are the areas in which progress is required
in order to consolidate and further develop the EMS .. ' (Handelsblatt, 25 April 1985).
38. Programme for the liberalization of capital movements in the Community, Communication
from the Commission to the Council (COM(86)292), 23 May 1986.
39. It would seem an anomaly that precisely long-term commercial credits had not been
placed under the unconditional regime in the 1960 and 1962 Directives. The reason for
this was of a practical nature: long-term commercial credits being not very common, they
had been subject to special authorization procedures in several countries with the aim of
verifying that there was a genuine link between the credit and the underlying commercial
transaction. In this manner it could be ensured that the restrictions on financial credits
were not circumvented. The authority to control such a link with commercial transactions
was recognized in the draft directive.
40. Prompt revision of the safeguard clauses for France and Italy, so as to incorporate the
easing of restrictions which had been carried out in the meantime; the presentation to
the Council, early in the summer of 1986, of a proposal for a directive with respect to
phase one; the submission to the Council towards the end of 1987 of a new directive
incorporating the full liberalization of capital movements in phase two.
41. For instance, at the symposium 'L'Europe des services financiers', organized by the
European League for Economic Cooperation in Brussels on 11 and 12 December 1986,
EC Director-General Russo admitted that the full liberalization of capital flows would
 185

not facilitate the operation of the EMS. In particular it would be necessary for monetary
authorities to subordinate domestic interest rate policy to exchange rate stability.
42. Italy had kept in place the system of interest-free bank deposits for transactions in foreign
securities, although it had lowered in steps the required percentage. Ireland still kept in
place restrictions on transactions in foreign securities. There was a special regime for the
new members of the EEC: in November 1985 the transition period for Greece had been
extended until end-1988. Under the Accession Treaty Spain and Portugal had bargained
for transition periods until end-1988 and end-1990 respectively.
43. In Favier and Martin-Roland (1990), p. 489, Pierre B6r6govoy stated, as quoted by the
authors: 'The franc would have floated, it would have fallen, then it would have recovered
and opinion would have supported its regained strength. Then it would have been possible
to reintegrate the EMS. I remain persuaded that, sooner than having to accept a discipline
imposed from the outside, we would have been able to find the strength to discipline
ourselves. '
44. See also Koenig and Ledig (1989) for an elaborate survey of the interrelationship between
capital movements and German monetary policy.
45. Germany had up till 1981 kept in place restrictions on the sale of short-term Deutsche
mark paper to nonresidents. The authorities wanted to control the holdings of such paper in
foreign hands in order to suppress the development of the Deutsche mark as an international
reserve currency. These attempts, however, were in vain and the German authorities
gradually gave up their resistance. On 17 March 1980 the maturity of interest-bearing
paper which was allowed to be sold to nonresidents was lowered from four to two years.
On 4 November the maturity was lowered to one year and on 19 February 1981 the
restriction was abolished altogether. On 12 March the last remaining obstacles to inward
capital movements were de facto lifted. It should be noted that also in the case of Germany
exchange rate considerations played a role. The abolition of these last controls on inflows
helped to underpin the Deutsche mark against continued upward pressure on the US
dollar. The coupon tax on nonresidents' interest income, which did not constitute a capital
restriction per se but was likewise intended to fend off capital imports when it was
introduced in 1964, was not lifted until 1984.
46. On 1 May 1985 issues with variable interest and zero-coupon certificates were allowed,
albeit in the longer end of the market (above 3 years). Also foreign banks in Germany
were allowed to participate in issuing syndicates. This deregulation was propelled by the
expansion these instruments had shown in the dollar segment of the market. A brief spell of
weakness of the Deutsche Mark vis-iI-vis the US dollar had precipitated decision-making
in this area, which explicitly was meant to boost the Deutsche mark's international role.
47. Deutsche Bundesbank, Annual Report 1986, p. 75-76.
48. De Nederlandsche Bank, Annual Report 1985, p. 19.
49. In a written comment from the Dutch members of the Monetary Committee on the directive
proposed by the Commission, dated 4 July 1986, a symmetrical application of the safeguard
clause was demanded, whereby under certain circumstances balance-of-payments reasons
(to check outflows) as well as monetary policy reasons (to check inflows) could justify
measures, both being a consequence of the combination of liberalized capital flows and
still imperfect convergence. Although the Commission considered the risks for monetary
policy to be small, it argued that the 1972 Directive was still valid and could be applied
in such circumstances, as could Article 73. Under the latter article control measures in
Denmark, taken for domestic monetary reasons, had been authorized in the past as well.
It was, however, questionable whether the Commission was right that the 1972 Directive
could be invoked, because this directive was based on Article 70 which only applied to the
coordination of exchange rate policies vis-a-vis third countries, i.e. non-EEC countries.
Obviously this would not help the Dutch.
50. The law concerning financial relations with foreign countries (1980) contained ample
possibilities to impose controls on capital inflows (see Chapter 6, Note 35). There was,
186
however, a certain fear that such restrictions, which needed to be approved in parliament,
would not be comprehended well and would give rise to counterclaims for checking capital
inflows by relaxing monetary policy and decreasing domestic interest rates.
51. In an interview with L'Echo de la Bourse on 8 May 1985 Jean Godeaux, Governor of the
National Bank of Belgium said that he 'found it paradoxical and even irritating at times
that some of Belgium's foreign partners pointed to the two-tier foreign exchange system
as an example of an obstacle to complete financial integration within the Community. '
52. Interview with Jean Godeaux (ibid.).
53. Freiberg-Jensen and Hald (1986), p. 13.
54. Banca d'ltalia, Annual Report 1985, p. 161.
55. Proposal for a Council Directive amending for the third time the first Council Directive
for the implementation of Article 67 of the EEe Treaty, COM(86) 326 final, published in
Official Journal of the European Communities, No. C 229/3,10 September 1986.
56. Meeting of the Monetary Committee on 18 July 1986.
57. Press conference of Jacques Delors, President of the European Commission, on 22 May
1986.
58. Resolution of the European Parliament, dated 10 October 1986.
59. Directive of the Council of 17 November 1986 amending for the third time the first Council
Directive for the implementation of Article 67 of the EEC Treaty, Offical Journal of the
European Communities, No. L 332122,26 November 1986.
60. Spain and Portugal had lifted reservations on an earlier occasion when they were granted
additional terms after the end of the transitional period provided for in the Accession
Treaties. Furthermore, a transitional period for the application with regard to a number
of transactions under the present 1986 Directive was granted until 31 December 1990 for
Spain and 31 December 1992 for Portugal. This was one of the first instances where the
~ommission had applied the two-speed principle by differentiating transitional periods
acCOfding to the economic development of the member state. It was at least curious that
these extensions were already granted at this juncture, regardless of the economic situation
at the end of the agreed transition period.
 CHAPTERS

Towards the Full Liberalization of Capital Movements

L' ouverture des frontieres financieres est une chance qu'iL ne faut
pas laisser passer, rnais La construction du grand rnarcM europeen
ne doit pas aboutir amettre en panne l'Europe monetaire.
Edouard Balladur

S.l INTRODUCTION

It had taken a long time to reach agreement on the 1986 directive. From the
initial call in the Monetary Committee in mid-1982 for a resumption of the
liberalization process to the entry into force of the directive in February 1987,
nearly five years had been needed for reaching agreement on an enlarge-
ment of the liberalization obligations. Yet, these were not wasted years. The
lengthy discussions were needed to bring about a change in official thinking,
both among the officials as well as among the politicians. Countries had been
able to try out cautiously the effects of a gradual relaxation of domestic regu-
lations and exchange controls. Helped by macro-economic policies directed
towards price stability and budgetary discipline, these steps generally had
been received well in the financial markets. Nonetheless, at times there was a
flare-up of tensions in the markets, usually sparked by political interference
with interest rates.
A rather painful experience was the realignment within the EMS on 12
January 1987, in which the French franc and some other currencies had to be
devalued by 3%. It was generally felt that this realignment 'a chaud' was not
justified on fundamental grounds, but was forced by pressures in the markets
after uncoordinated interest and intervention policies and a noticeable lack of
verbal discipline on the part of some of the authorities involved.! At the same
time, it was acknowledged that the changing environment in which financial
markets operated made the maintenance of the remaining restrictions ever
more ineffective. The increasing capital mobility was caused not only by the
liberalization of exchange controls which had already taken place, but also
by financial innovations, technical developments and domestic deregulation.
The advantages of increased efficiency in the allocation of capital, which
had played a role in the change of attitude of the Commission, as discussed
in Chapter 7.4, could only be fully exploited if all capital movements were
liberalized. The translation into agreed common obligations would be the
subject matter of political negotiations. After a brief discussion of the changed

187
188
financial environment this chapter deals with the political process leading up
to the acceptance by all member states of full and unconditional freedom of
capital movements as a Community obligation.

8.2 THE CHANGING FINANCIAL ENVIRONMENT

The increasing integration of national markets and the growth of international

financial markets had made it ever more difficult to isolate domestic financial
markets from external influences, especially the more developed ones. Four
main influences were at work:

8.2.1 The Role of Innovations

The traditional distinction between short-term and long-term financial trans-

actions had become increasingly blurred through financial innovations such
as the introduction of interest rate options, financial instruments with variable
interest rates and the like. This decompartmentalization of market segments
had important implications for the transmission mechanism of monetary poli-
cy. Monetary instruments typically affect the short end of the market and many
restrictions with respect to short-term capital flows were precisely intended
to strengthen the effectiveness of domestic monetary policy actions. Because
of innovations the traditional concepts of monetary aggregates became less
reliable as indicators of the monetary policy stance, while at the same time
the lags of their working-through in the domestic price level were affected.

8.2.2 The Administration of Controls

The increased size, number and sophistication of international financial oper-

ations, partly on account of technological advances, made it increasingly dif-
ficult to control capital transactions. Control being dependent on compliance
by the commercial banks, considerations pertaining to cost and competitive-
ness came into play. The reporting requirements and strict surveillance of
the banking system involved considerable costs for the banks as well as for
the controlling authorities. Especially in France the requirement of so-called
domiciliation dossiers, enabling the matching of financial and trade data, had
become extremely burdensome. The banks came under increased competitive
pressure from banks in third countries which sometimes had less strict control
systems in place. At times, there was evidence of complicity of the banks in
circumventing such controls. 2

8.2.3 The Effectiveness of Controls

The effectiveness of controls varies inversely with the state of development

of domestic financial markets. The more developed these markets are, the
 189

greater the possibilities for legitimate substitution. The markets for goods
and services having become more and more integrated, industrial and invest-
ment companies had developed ingenious ways of circumventing controls
by intercompany transactions or by using non-bank channels, thus leading
to disintermediation. Countries experienced that over time controls, once
imposed, had to be constantly reinforced and extended in scope in order to
maintain their effectiveness. 3 Given the fungibility of capital, the prolonged
closing of certain channels for capital transactions had the effect of deflect-
ing flows to alternative, less controlled or regulated channels. Controls gave
rise to disintermediation and to the migration of short-term operations to the
international (Euro)markets or their spill-over into longer-term operations. In
some instances capital restrictions thus had the unintended effect of develop-
ing the international markets for the currency in question, just as the controls
in the United States had given rise to the development of the Euromarket in
the 1960s.

8.2.4 Financial Integration

In nearly all European countries financial markets had developed rapidly

because of deregulation and capital liberalization. Institutional investors had
been given more leeway in the management of their assets and had become
active cross-border players in the financial markets. The deregulation of insti-
tutional investors necessitated the freedom to protect assets against exchange
rate changes. This protection could mainly be provided at the short end of
the market (forward exchange transactions, interest rate options and futures,
short-term financial transactions). Therefore, the corollary of financial inte-
gration was that there were increasing market pressures to abandon the
remaining capital controls on the short end of the market.
To many observers the final step to full liberalization seemed inevitable
and highly desirable. The question no longer was: why liberalize, but rather
how soon. For full freedom of capital movements short-term transactions, still
restricted in many countries, had to be liberalized, in particular financial loans
to non-residents in domestic currency, cross-border transactions in money
market paper and the opening of deposit accounts by residents in foreign
currencies. Economic conditions were propitious for capital liberalization:
the inflation differential, as measured by the gdp deflator, of France vis-a-vis
Germany had declined from a high of 8.2% in 1982 to a mere 1.2% in 1986.
As shown in Figure 20 in other countries inflation differentials had decreased
as well.

8.3 COMMISSION INITIATIVES FOR FULL LIBERALIZATION

After the conclusion of the discussions on the first phase of its liberalization
programme, culminating in the acceptance of the 1986 Directive, the Commis-
190

Monthly averages in per cent

14 ___________ _

10

-4,_,_,_,-,-,-,-,-,-,-,-,-1
\..I

83 84 85 86 87 88 89 gO 91 92 93 94

France Italy Netherlands United

Kingdom

Inflation differential vis-a-vis Germany

(consumer price index).

Fig. 20. Convergence of inflation in Europe.

sion was quick to start discussions on the second phase. Late 1986 thoughts
were ventilated for the steps to be taken towards the complete liberalization of
capital movements in due course. 4 In the Commission's words: 'The logic of
(European) financial integration inevitably leads to the ending of all restric-
tions on capital movements and to the lifting of all types of discriminatory
treatment.' In the document the Commission dealt with the implications for
the conduct of monetary policy as well as with a number of related issues,
which will be discussed in section 8.4. Full liberalization would imply, within
the context of the EMS, a relative loss of national autonomy with respect to
monetary policy. It would become impossible to isolate Euromarket inter-
est rates from those prevailing on the domestic money market. Therefore
short-term interest rates could hardly be used any longer to pursue purely
domestic objectives. Increased capital mobility following full liberalization
did not need to be destabilizing, however, as long as nominal divergences
were reduced and strengthened coordination procedures would assure stable
exchange rate expectations. Monetary policies in particular would have to be
coordinated more closely. To this end the Commission proposed a greater role
for symmetrical, non-sterilized intramarginal interventions. It also wished to
develop an EC-wide monetary aggregate. This would help create a situation
in which the basic monetary choices would have to be as collective as possi-
ble. A set of 'rules of the game' would have to be put in place to give content
to the coordination procedures.
 191

At this stage the Commission did not elaborate further, but the implications
were clear: in an environment of full freedom of capital movements the Com-
mission would like to make the use of domestic monetary policy instruments,
presumably interest rates, the subject of Community coordination. Common
decision-making procedures with respect to monetary policy would in prac-
tice imply more symmetrical interest rate adjustments in case of exchange
rate pressures. Symmetrical sterilization of intramarginal interventions would
imply that Germany would be confronted with increased intervention obliga-
tions as well. The Commission thus supported the long-standing French claim
that German monetary policy called the tune too loudly and that the EMS
should be operated in a more symmetrical way. Jacques Delors, the President
of the Commission, had lamented publicly that 'the West German government
lacks the same interest in the construction of Europe now that it had in former
years'.5 But the Commission did a fine balancing act. Traditionally inclined
to follow French convictions it had to allow for German considerations as
well. With its strategic choice for full capital liberalization it had heeded Ger-
many's vision of European integration. It now remained to be seen whether
the Commission would stick to its choice with no strings attached or whether
it would postulate conditions to be fulfilled simultaneously.

8.3.1 Reactions of Member States

A wide-ranging discussion was held in the Monetary Committee in February

1987. The fundamental issue was whether full capital liberalization would
contribute to convergence and thus to exchange rate stability, or whether
accompanying measures in the field of monetary policy would be needed.
Germany, so it became clear, was unwilling to consider any transfer of mon-
etary policies to the EC level, as was implied in the Commission document.
While Germany acknowledged that exchange rate tensions were more like-
ly to arise when capital movements were fully liberalized, monetary policy
remained the responsibility of the member states. Strengthened coordination
thus could not be interpreted in such a way that the goal of domestic monetary
stability in Germany would be subordinated to the maintenance of the EMS
parities. As long as convergence was not complete the EMS should therefore
leave room for exchange rate adjustments.6
Some smaller countries, such as the Netherlands and to a certain extent
Denmark, took a rather relaxed attitude with respect to the de facto loss of
monetary autonomy, which in any case had already been eroded consider-
ably. But in their view, strings were attached: countries should be prepared to
use market-oriented monetary instruments and accept the interest rate conse-
quences of external constraints. Policies should be directed to domestic price
stability in order to combine free capital flows with exchange rate stability.
This was in line with their traditional fear of realignments of other currencies
which always could undermine confidence in the national currency as well.
192
Price convergence at higher levels was considered to be not good enough,
because of the intrinsic merits of price stability and the i~erent unsteadi-
ness of higher inflation rates. The Dutch particularly disliked the inflationary
consequences of the Commission's proposals. The call for increased intra-
marginal interventions and symmetrical interest rate adjustments in their eyes
were aimed at hedging in German monetary policy. They involved the risk of
postponing adjustment in the weaker-currency countries. Thus the potential
conflict between internal and external stability eventually would increase,
endangering the stability of the Exchange Rate Mechanism.
The French professed sympathy for the Commission's ideas. For them the
strengthening of the EMS remained an important theme, which should accom-
pany the move to freedom of capital movements. The French concern was
that capital liberalization in itself did not further the European cause because
it was mainly a reflection of the world-wide deregulation and globalization
of international financial markets? As a follow-up to the mandate given after
the January 1987 realignment the French members of the Monetary Commit-
tee had presented a memorandum in which proposals were made for a new
package deal to strengthen the functioning of the EMS. 8 In this memorandum
the French members mounted their hobby-horses once again with respect to
the functioning of the EMS, in line with their 'monetarist' approach towards
monetary integration. France demanded symmetric macroeconomic adjust-
ment measures in hard-currency and weak-currency countries alike as well
as symmetric intervention obligations, backed by greater resources. One way
of achieving the latter would be that EC central banks would hold each oth-
er's currencies in their official foreign reserves. These proposals were based
on the fear that the EMS could break apart in the face of increased capital
mobility. All progress made with respect to convergence would then dissipate.
Therefore, the French held that capital liberalization should not proceed too
quickly. In any case, it would be a great step backwards if France were to be
compelled to once again have recourse to the use of safeguard clauses.
Italy, which considered its regained external equilibrium to be precari-
ous, went a step further by calling for institutional changes. In the Italian
view full liberalization, by creating a new environment, called for new rules
with respect to monetary policy coordination, such as the collective fixing of
domestic monetary targets. The latter would require the transfer of powers
to a centralized European institution which would then oversee the develop-
ment of these monetary objectives.9 In this respect the Italian attitude came
closest to that of the Commission. The implication was clear: the Bundesbank
might have provided a useful anchor for disciplining weak-currency coun-
tries, now that convergence was progressing this dominant position was no
longer acceptable. German monetary leadership was challenged.
The discussion made clear that there was no agreement on the fundamen-
tal question whether full capital liberalization necessitated accompanying
measures in the monetary field. Although it was accepted by all that capital
 193

TABLE 26
A political tally of attitudes towards capital liberalization.

pro contra intennediate

l. Full liberalization Gennany Greece Belgium

Netherlands Denmark·
UK France··
Italy
Ireland

2. Ergaomnes Belgium France··

Denmark UK··
Gennany
Italy (?)
The Netherlands

3. Extension of Belgium Denmark

safeguard clauses France Gennany
Greece Luxembourg
Ireland UK
Italy
Netherlands

4. Stricter coordination Ireland Denmark Belgium

of monetary policies Italy Gennany France
Netherlands UK

5. EC credit mechanism Greece Denmark

to support capital Ireland Gennany
liberalization Italy Netherlands
UK

Note:
* Liberalization first to be applied only to industrial sector.
* France favoured preferential EC system for financial services, the UK reciprocity.

liberalization would promote discipline on economic policies, France and

Italy, supported by a number of restrictive countries, asked for quid pro quos
in the operation of the EMS. Despite this continuing divergence of views,
the Commission could feel strengthened by the discussion in the Monetary
Committee. No fundamental objections to full capital liberalization had been
raised. And it was taken for granted that the pace of progress should not
194
be dictated by the countries with the lowest degree of liberalization, but by
those countries which had made real progress. For countries which could not
keep the pace, transitional arrangements would be made. The Commission
reported to the Council that the implications of full liberalization would be
multiple and major, but that none of them would represent an insurmountable
obstacle. 10 It would be an irreversible process, providing a challenge to the
EMS, but also an opportunity to strengthen it. As far as the Commission
was concerned, it declared that it would set no preconditions for full capital
liberalization. This was an important declaration, removing the sting from
the Commission's call for increased symmetry. As discussed in Chapter 7 the
Commission put its hope on a dynamic process, in which capitalliberaliza-
tion would stimulate the adoption of the accompanying measures which it
favoured. The Commission had set out a strategic course and now it would
stick to it.

8.3.2 1Wo Rival Schools o/Thought

The Commission had derived from the discussion in the Monetary Committee
that there were two rival schools of thought as to how to resolve in the long
run the 'triangle o/incompatibilities' between the coexistence of exchange
rate stability, free movement of capital and autonomy over monetary policy
(at least in certain countries). One school relied on the common adherence to
the objective of monetary stability, i.e. domestic price stability. This would
spontaneously generate coordination of monetary policies, subject to a certain
degree of flexibility in the EMS. This school of thought was based on the
view that capital flows were basically induced by macroeconomic policies
and their credibility. The other school favoured an institutional solution with
collective monetary decision-making, accompanied by increased financial
solidarity to defend exchange rates. According to the latter view destabilizing
capital flows might also develop as a result of exogenous factors that were
neither linked to the stance of domestic policies nor to the fundamentals.
Such exogenous factors could be sharp swings in the exchange rate of the US
dollar or expectations of a realignment involving the main EMS currencies.
At the request of the Commission a group 0/ experts, chaired by profes-
sor Tommaso Padoa-Schioppa, vice director-general of the Banca d'Italia,
was invited to study the implications of capital liberalization. 11 The group
gave unequivocal support to the school favouring an institutional solution.
Its main conclusion was that '... the elimination of capital controls, cou-
pled to the requirement of exchange rate stability, (... ) will require moving
closer to unification of monetary policy. In a quite fundamental way, capital
mobility and exchange rate fixity leave no room for independent monetary
policies. In these conditions, it is pertinent to consider afresh the case for a
strengthened organisation of monetary coordination or institutional advances
in this field'. It suggested to move to a 'European central banking system
 195

with considerably enhanced policy coordination and executive responsibili-

ties' . In such a system the targets of monetary policy would be jointly agreed
or set through a common procedure and the attainment of these targets close-
ly coordinated.The report also called for the simultaneous strengthening of
EMS mechanisms to counter speculative capital movements along the lines
of the French memorandum. However, the report was remarkably silent on
the need to coordinate budgetary policies. Although it noted that the system
for coordination of budgetary policies under the 1974 Convergence Decision
had been ineffective, it favoured relying on the restraint the capital market
would exert on state borrowing. In this respect the report was considered to
be rather lopsided by many members of the Monetary Committee, some of
whom moreover preferred the common pursuit of domestic price stability
above symmetrical monetary policy cooperation. 12 Its findings did not play
an immediate role in the further decision-making with respect to the capital
liberalization directive. But its call for monetary unification had touched a
string.
The informal Ecofin meeting in Knokke on 4 April 1987 provided a first
opportunity for Ministers to discuss the further strengthening of the EMS and
the full liberalization of capital movements after the January realignment.
Some Ministers, among which Gerhard Stoltenberg of Germany and Onno
Ruding of the Netherlands, in the 'economist' tradition, argued that capital
liberalization could and should precede further measures with respect to
the EMS. In their view the dynamic interaction of free capital flows and
domestic policies would contribute to a strengthening of the EMS, especially
by bringing to bear substantial pressure for a higher degree of convergence.
Others held the opinion that the EMS should be strengthened further before
capital flows could be fully liberalized. Minister Edouard Balladur was a
vocal spokesman: '11 faut avancer avec pragmatisme sur les deux fronts
a la fois', echoed by Jaques Delors: 'Liberalization of capital movements
and reinforcement of the EMS must go hand. in hand'. 13 Chairman Eyskens
could not yet firmly conclude that both dossiers, on capital liberalization and
strengthening of the EMS, were linked. But he made clear that a common
position to be aimed at could not contain a fundamental revision of the EMS,
but rather would have to be limited to technical improvements. It was decided
that both dossiers would continue to be discussed in the Monetary Committee
and the Committee of Governors with the aim of reaching such a common
position. The Commission was invited to come forward in the autumn of
1987 with concrete proposals for the second phase, leading up to full capital
liberalization.
196
8.4 THE MONETARY SAFEGUARD CLAUSE AND THE ERGA OMNES
PRINCIPLE

Several related issues were discussed in the intervening months. One of these
concerned the implications for the financing of public deficits, if protected
home markets were to be opened up. It turned out that the privileged access to
domestic funds by public authorities was not yet seen as a problem. However,
the issue would be taken up later in the context of the EMU negotiations.
Three important questions remained: the need for safeguard clauses in the
new directive; the future status of the 1972 Directive, with the related question
whether intra-EC capital liberalization would equally apply to third countries;
and, finally, the need for enlarging the existing financing mechanisms in the
Community.

8.4.1 The Monetary Safeguard Clause

The Commission favoured the incorporation of a specific, so-called mone-

tary safeguard clause, which would allow controls on short-term inflows or
outflows to be imposed in case of serious disturbances either in the conduct
of monetary policy or in the stability of the exchange rate. 14 The Commis-
sion argued that the existing safeguard provisions of Articles 108 and 109
could not be invoked in all circumstances because they expressis verbis were
limited to crisis situations. Given the uncertain international monetary envi-
ronment, there could be instances where national monetary policies were
disturbed because of cyclical divergences, even when fundamental economic
factors would appear to be basically sound. The Commission took the view
that such special circumstances could warrant controls as well. Article 73
could not be invoked either, because the legal services of the Commission
considered that the term 'capital market' could not be interpreted widely to
include money-market and other short-term financial operations. Because it
was acknowledged that such controls lost effectiveness over time, the validity
of the monetary safeguard clause should be limited to 3 or at most 6 months.
Germany, the United Kingdom, Denmark and Luxembourg were not in
favour of a monetary safeguard clause. They considered such a clause to be
an unfortunate signal to the financial markets which could weaken confidence
in the Exchange Rate Mechanism, particularly with respect to the weak cur-
rencies. But there was a majority, consisting mainly of precisely these weak-
currency countries, which was in favour of such a safeguard clause: France,
Italy, Belgium, Spain, Portugal, Ireland and Greece. There was the example
of Italy which had taken restrictive measures late in the summer of 1987 when
the lira had come under temporary pressure. These measures had met with a
certain degree of success. It was felt that this case provided a good example
of the kind of instances when temporary restrictions, to be covered by the
monetary safeguard clause proposed by the Commission, would be useful.
 197

TABLE 27
Dutch non-bank capital flows in billions of guilders.

1963 1973 1983 1988 1993

Direct investments 2.8 10.8 27.5 111.6 246.8
Dutch securities 2.7 9.6 63.6 260.7 717.6
Foreign securities 3.1 14.4 62.4 162.2 579.9
Total long-term 9.8 39.8 168.6 551.9 1.565.6
Total short-term 0.5 0.2 21.0 128.8 458.3
Total 10.3 40.0 189.6 680.7 2.023.9

Note: Gross total of inflows and outflows.

The Dutch authorities initially took a completely different approach in an

attempt to maintain a measure of limited monetary autonomy. They pleaded
for an asymmetrical safeguard clause which would only apply to capital
inflows. Such restrictions would largely be of a technical character, since
they would be designed to supplement domestic credit restrictions if internal
monetary stability was threatened. The Dutch argued that safeguard measures
on outflows were of a different nature. They could even be counterproductive
by undermining the credibility of the currency, since foreign capital would
be mousetrapped in a country with restrictions on outflows.
The Dutch found themselves in an awkward position. By not aligning
themselves with the traditional liberal countries, they had played in the hands
of the more restrictive countries and thus swayed the balance in favour of a
safeguard clause. Internally, however, the discussion served a useful purpose,
because it triggered a fundamental debate on the methods of monetary control.
Historical data suggested that restrictions on credit-taking with banks abroad
as a supplement to domestic credit ceilings would affect at most 10 per
cent of total capital imports. The restrictions could be easily circumvented
by specially created short-term paper, by swaps, or by intra-group credits.
The apparatus to control these loopholes was simply not available. 15 The
monetary effect of such controls therefore was highly questionable; they had
merely symbolic significance in the light of the sharply increased capital
movements (see Table 27). In these circumstances the Dutch abandoned
their request for an asymmetrical safeguard clause and decided to ally with
those liberal countries which resisted any safeguard clause. At the same time,
it was conceded that in an open economy as the Netherlands it would no
longer be possible to control domestic liquidity creation. Instead, the focus of
monetary policy was shifted towards supporting the long-standing exchange
rate policy, i.e. the link of the Netherlands guilder to the Deutsche mark.
A complete overhaul of monetary instruments followed. The instrument of
198
direct credit restrictions was discarded and in future the Nederlandsche Bank
would rely solely on market-oriented indirect means of controlling monetary
developments. It was the final demise of the monetary tradition of Holtrop
which had governed for so long a time - and with considerable success - the
monetary policy actions of the Nederlandsche Bank.
In the meantime Germany and the United Kingdom had taken the position
that if a monetary safeguard clause was to be the price for full liberalization,
it was worth paying as long as the duration of controls was limited and
the application would remain under Community control. In any case, such
restrictions should not be taken on the initiative of the Commission, but
should be decided by the member states concerned. In the end a position
emerged where the dividing line between countries pro and countries contra
a safeguard clause approximately coincided with the dividing line between
more and less liberal countries.

8.4.2 The 1972 Directive and the Erga Omnes Principle

The Commission proposed to incorporate the monetary safeguard clause

into an amended version of the 1972 Directive, which in its view should be
retained alongside the new liberalization directive. The 1972 Directive was
considered to remain important, because the Community should not deprive
itself of the means for a coordinated regulation of capital movements to and
from third countries, in particular in the event of violent external shocks.
The erga omnes principle. adhered to by most countries, was considered
by the Commission as merely a political declaration. It had no plans to
write this principle into Community legislation. On the contrary, it might be
useful to leave third countries in doubt as to whether the Community might
actually impose capital controls vis-a-vis them. In the background the concern
lingered that the upheavals of the US dollar might again bring unrest to the
European Monetary System. Periods of dollar weakness had typically pushed
the Deutsche mark up and exerted pressure on the other EMS currencies.
In extreme cases the Community should be able to shield itself from such
external disturbances.
Apart from some token support of France and Italy, the Commission pro-
posal to retain the 1972 Directive and enlarge its scope did not receive much
sympathy. Italy had not applied the liberalization obligations which followed
from the 1986 Directive on an erga omnes scale. arguing that the liberalization
of portfolio transactions for non-EC countries would be too large a burden for
its weak domestic capital market. The Commission's concept of a shielded
European capital market was fundamentally different from the concept of a
Europe open to the outside world, favoured in particular by Germany and
some other countries. Germany wished to abrogate the directive altogether,
whereas other countries equally felt that it could be dispensed with as long
as the monetary safeguard clause was incorporated into the new directive.
 199

Nonetheless, some countries wished to reserve their own attitude as to a strict

application of the erga omnes principle on purely domestic grounds. For this
they did not need an EC directive but they favoured an interpretation of the
erga omnes principle which would allow them to take measures in the grey
zone of domestic regulations, especially with respect to the financial services
sector. France for example favoured the positive discrimination ofEC institu-
tions in some areas, and wished to protect its own financial services sector. 16
And the United Kingdom, although embracing the erga omnes principle,
favoured reciprocity vis-a-vis third countries. The British in particular were
fearful that a wide interpretation of the erga omnes principle would weaken
the negotiating position of the Community with respect to Japan. Japanese
financial institutions were aggressively entering European markets and it was
felt that this would be only permissible if the Japanese domestic financial
market would be opened up to foreign financial institutions as well.

8.4.3 The European Credit Mechanisms

The Commission favoured extending financial support to those member states

which would liberalize in spite of a precarious external position. It proposed
to combine the existing Community credit mechanisms and change their
application. It was envisaged that the combined credit mechanism could be
used not only in the traditional manner, i.e. in support of adjustment programs
of member countries in balance-of-payments difficulties, but also in support
of capital liberalization. These proposals met with mixed feelings in the
Monetary Committee. Of course potential users of the credit facilities such as
Italy, Spain, Greece and Ireland, were in favour, and saw a political trade-off
between the extension of the credit mechanisms and the transitional period
which would be allowed to them. Other countries did not consider such
extension urgent. In any case the usual conditionality tied to Community
loans should be maintained, if not strengthened. The previous experiences
with respect to the contribution EC loans had made to adjustment was not
encouraging. All in all the positions ran along the dividing line between
potential creditors and potential debtors, as had also been the case on the
monetary safeguard clause.

8.5 TRANSITIONAL ARRANGEMENTS

Some member states had got cold feet with respect to the timing of the full
liberalization of capital movements. France suggested that as a first step lib-
eralization could be limited to transactions by commercial enterprises only. 17
A similar idea to subdivide the second phase had been voiced by Denmark.
However, the Commission did not see any possibility for differentiation, argu-
ing that the remaining short-term operations were all highly substitutable. The
200

limitation of liberalization to such operations carried out by commercial enter-

prises, as had been effected in France, would be too complicated to codify
at the Community level. On the other hand, a differentiation in timing as
between the liberalization in individual member states was advisable, since
the starting positions were very different. The deadline of end-1992 set for
the completion of the internal market should, however, represent the absolute
limit for the transitional arrangements in the view of the Commission. IS
By accepting transitional arrangements, the Commission embraced the
argument that sequencing was justified to a certain degree. The Commission
based its judgment on three evaluation criteria: (a) The degree ofdevelopment
of the national financial system
The commercial banks and other financial institutions should be sufficient-
ly robust in order to hold their own against a very competitive international
environment and not be swamped by foreign institutions. In the eyes of the
Commission this presupposed a diversified body of institutions and instru-
ments, operating under predominantly market-oriented conditions. Further-
more, money supply and credit control should be based chiefly on indirect
methods, i.e. through movements in interest rates. Finally, the public sector
deficit should be of such a size that it could be financed at market conditions,
without excessive costs. Ifthese conditions were fulfilled capital liberalization
would have no harmful side-effects.
(b) The level of external debt
A very high external debt ratio might discourage spontaneous new capital
inflows. In such circumstances a serious consolidation programme would
have to be carried through, aimed at strengthening the balance of payments.
Such a programme might be jeopardized by a premature, radical liberalization
of capital flows.
(c) The degree of integration in the Community
Countries like Greece and Ireland, and the newly acceding countries Spain
and Portugal, were not yet fully integrated into the Community. Moreover,
they did not yet participate in the Exchange Rate Mechanism of the EMS, with
the exception of Ireland. The latter's membership, however, was complicated
by the non-participation of the United Kingdom. This criterion was considered
to be so important as to make it impossible to finalize the full liberalization
of capital movements within five years, i.e. before the end of 1992, without
accompanying measures, such as an extension of financing facilities. Indeed
under the umbrella term of 'cohesion' the Commission proposed to develop
special funds in support of the process of catching -up with the more developed
countries of the European Community. This was the price tag attached to
Community-wide capital liberalization.
In their initial reaction to the Commission proposals for transitional peri-
ods, the member states concerned showed a clear reluctance to move fast. For
Spain and Ireland the Commission had proposed a final date of 1990, whereas
for Portugal and Greece the deadline was set at 1992. All these countries opted
 201

for later dates: Portugal even mentioned 1995. Their main argument was that
sequencing was required and that entry into the Exchange Rate Mechanism
of the EMS had priority over capita1liberalization. To have both at the same
time was not possible, it was felt. In order to placate the lagging countries
the Commission pushed hard to reach agreement on its proposals for special
funds for those countries which wished to liberalize.

8.6 QUESTIONS OF COMPETENCE

In its proposals the Commission had taken a wide definition of the obli-
gation to liberalize: domestic regulations which would discriminate against
non-residents were not allowed. The liberalization obligation would not only
imply the abolition of exchange controls which restricted transfers, but would
ultimately also apply to any regulation which would limit the possibility to
conclude or perform the underlying transaction. Although this attitude was
widely accepted, it could give rise to questions regarding the division of
responsibilities between national monetary authorities and the Commission.
It was acknowledged that, for reasons of monetary control, the commercial
banks would have to comply with rules which in practice could have the
effect of restricting capital flows. In particular this was the case for limits on
the net external position of financial institutions or for compulsory reserve
ratios on their external assets or liabilities. Such measures would be needed
in the future as well for monetary or supervisory reasons and therefore the
Commission proposals provided for the exclusion of such measures from the
general obligation to liberalize. However, for this grey area a notification and
monitoring procedure was proposed in which not only the Monetary Commit-
tee and the Committee of Governors played a role, but also the Commission
itself. In this manner the Commission could monitor that monetary instru-
ments were not used improperly with the ulterior motive of limiting capital
movements.
Especially from the German side it was feared that this could impinge on the
national responsibilities in the monetary field as they had been reconfirmed
in the Single Act. They argued that only the two competent committees, in
which the Commission was represented anyway, should monitor this. The
Commission always could tum to the Court of Justice if it felt that Com-
munity legislation had been infringed. 19 Obviously the Commission could
only take this step after having heard the advice of the two competent bodies.
Eventually a compromise was reached and Article 2 of the 1988 Directive,
which is reproduced in Annex 6, would state that the Commission would be
notified of those measures to regulate the liquidity of the banks which would
influence capital transactions with non-residents; the two competent bodies
would advise the Commission whether such measures were indeed confined
to what was necessary for the purpose of domestic monetary regulation. 2O
202

Another question of competence came up, reminiscent of the earlier dis-

cussion in 1984. Again, it concerned the respective roles of the Commission
and the Monetary Committee. The Commission in its draft had not envisaged
a role for the committee as regards the examination of remaining restric-
tions. It had assumed that such a task would automatically lapse with the
establishment of full freedom of capital movements. Besides it felt that the
surveillance of compliance with the directive was the task of the Commission.
The members of the Monetary Committee again did not agree: safeguards
and transitional arrangements could have important policy implications and
should thus remain a matter for discussion by the committee.
The jury is still out on the question which approach would be the most
effective one to enforce compliance. On the one hand, the Monetary Com-
mittee might be expected to provide the right environment for exercising peer
pressure on countries to comply, not only with the letter, but also with the
spirit of the liberalization directive. On the other hand the Commission feared
that in the grey area of indirect controls a united front of member states might
emerge within the committee, which would seek to preserve the status quo.
That this fear was not completely unfounded became evident in later exam-
inations when the peer pressure did not materialize when the Commission
raised possible infringements of the liberalization directive in the four large
member states (see also discussion in Chapter 9.2.4).

8.7 THE BASLEINYBORG AGREEMENT

In the run-up to the Nyborg informal Ecofin meeting in September 1987

both the Committee of Governors and the Monetary Committee focused on
the package to strengthen the EMS, which had begun to take shape since
the Knokke meeting. As to the management of the EMS understandings
were reached on the proper use of interest rates to defend the exchange rate
and the more flexible use of the fluctuation margins. If realignments were
needed, they should be small and infrequent. The most important aspect
of the so-called Basle/Nyborg agreement among central banks (Basle) and
ministers (Nyborg) was that a common strategy was developed to withstand
speculative pressures. Large-scale interventions should no longer be the chief
line of defence, because experience had convinced the Monetary Committee
members that such interventions by themselves could be counterproductive
and were a cause of instability.21 The new set of instruments was designed
both to deter speculation as well as to punish speculators by showing that
speculation was costly (high interest rates), and unrewarding (the full use of
the fluctuation band in combination with small realignments implying only
limited changes in market rates).
There was also some expansion of the financing facilities of the EMS. This
was reluctantly accepted by the Bundesbank. It had agreed to this because
 203

the EMS had proved to be a stabilizing element and partner countries had
strengthened visibly their stability-oriented policies. And it had taken into
account the Governors' view that all central banks should give priority to
price stability in their monetary policy.22 This fundamental orientation was
worth a price. Germany again had made concessions. Some observers in
Germany feared that by giving other countries an inch, they would take
a mile. The Commission and France had always been quite open in their
strategy of reaching the ultimate goal by means of small steps. This meant
in practice that every concession by Germany would be followed by fresh
French demands.
This was not a hypothetical risk. President Delors had already sent a
memorandum to the informal Ecofin in Nyborg in which he presented some
new proposals which had far-reaching institutional implications. In particular
he proposed to transfer the monetary coordination from the Committee of
Governors to the dormant European Monetary Cooperation Fund and to open
the possibility to create ECUs against Community currencies.23 The German
reaction was predictably negative. Such steps could only be taken in the
perspective of the ultimate target of Economic and Monetary Union. This
obviously was a risky course as long as there was no political consensus on
EMU and governments were not prepared to surrender necessary powers in
the non-monetary area.
The Basle/Nyborg agreement, underneath the sobering resolutions on the
management of the EMS, constituted one of the distinct turning points in
the history of capital liberalization. It would be the beginning of a long
period of quasi-exchange rate stability, thus providing a background which
was conducive to both capital liberalization and the resumption of the debate
on economic and monetary union. To a certain extent in the Basle/Nyborg
agreement for the first time economic policy considerations, and in particular
the need to achieve convergence as a precondition for exchange rate stability,
took precedence over technical refinements of the system. The Commission's
attitude was an interesting one as well. On the one hand the forward thrust
was clearly discernible, on the other hand the traditional regulative position is
still there, as the ambiguous memorandum of Delors showed. This potentially
defensive line would remain sotto terre in the coming years but would re-
emerge in 1993 when Delors, shaken by the EMS crises would call for the
reimposition of capital restrictions. The Commission, while still maintaining
the line of full liberalization as set out in its plans, remained fearful that the risk
was increased that markets would amplify the exchange rate repercussions of
external disturbances or perceived policy divergences of a temporary nature.
Some others shared this fear as well. The operational consequence which the
Commission drew was to insist on safeguard clauses, transitional periods and
support mechanisms to avoid the EMS being shaken by too brutal shocks. In
Nyborg, however, these Commission fears were brushed aside.
204
8.8 A EUROPEAN FINANCIAL AREA

After the Basle/Nyborg agreement, aimed at strengthening the EMS, attention

again could be focused on the capital liberalization dossier. The Commission
presented in October 1987 a new document on the creation of a European
financial area in which its views were further elaborated in the light of the
first round of discussions in the Monetary Committee. 24 The new directive
would seek to reach full capital liberalization by the end of 1988, apart from
transitional penods for lagging countries. The timing of the Commission
document was somewhat awkward because on Black Monday - 19 October
1987 - share prices had plummeted world-wide, giving rise to concern over
financial fragilities in the international system. These concerns were raised
by the rapidity with which stock exchanges in different financial centres
nosedived. This covariance was partly ascribed to the deregulations which
had taken place.

8.8.1 Discussion in the Monetary Committee

In the discussion in the Monetary Committee, which took place only a few
days later, the stock exchange collapse was very much on the minds of partic-
ipants, but it detracted in no way from their willingness to positively appraise
the main thrust of the Commission proposals. The full liberalization of capi-
tal movements at one stroke was now accepted by all, on the understanding
that transitional periods would be granted to the lagging countries. And it
was agreed by a large majority that there would be no preconditions for full
capital liberalization as long as there was parallel progress in related areas.
This was an important political signal. For the first time, the quid-pro-quo
approach, still demonstrated by France in the 1986 Ootmarssum realignment
discussions (see page 177), was abandoned. Apparently, France on domestic
grounds had already decided for itself that it would abolish exchange control
altogether.
The most hesitant attitude vis-a.-vis full capital liberalization was adopted
by Italy. Had the problems which were associated with increased capital
mobility been discussed sufficiently in the Monetary Committee? In the Italian
view, there were actual dangers that both exchange rate and monetary stability
would be jeopardized. If monetary coordination could not be brought a step
further - and this became increasingly apparent in the German attitude - other
ways to strengthen the cohesion among EMS members should be explored.
This brought back a familiar theme in the Italian demands: expansion of
the EC credit mechanisms and enlargement of the financing possibilities in
surplus countries. With respect to the latter the Italians proposed to establish
a new Community recycling mechanism which would enable deficit countries
to attract funds on the capital markets of the surplus countries. 25 These were
the kind of demands which scared off countries like Germany: cohesion in
 205

their view was to be brought about by adjustment in the deficit countries, not
by the financing of the balance-of-payments deficits which would imply their
continuation.
The Commission insisted on maintaining the 1972 Directive, albeit in a
modified form, despite the outspoken resistance in the Monetary Committee.
Part of this modified directive would be a declaration of intent which would
state that the member states would endeavour to attain the same degree of
capital liberalization vis-a-vis third countries as within the Community. This
implied that member states were not bound by the erga omnes principle. The
Commission also proposed that it could issue a recommendation to activate
monetary instruments in order to regulate capital movements to or from third
countries causing serious disturbances to the exchange rate stability in the
EMS. Only the Italians and to a lesser extent the French seemed interested.
For France the main issue of importance was that the erga omnes principle
would not be a legally binding obligation, but rather a political declaration of
intent. In no way should this prevent the Community from taking steps vis-a-
vis third countries if their policies were a hindrance for the good functioning
of the EMS. For Germany such common measures would be unthinkable.
They would constitute a step backwards in the liberalization process.

8.8.2 The Belgian Dual Market

The Commission had left no doubt that full capital liberalization would not
be compatible with any multiple exchange rate practices. However, Belgium,
supported by its Luxembourg partners in· the monetary union, held its dual
exchange market close to the chest. It was again argued, as on previous
occasions, that this did not constitute a capital restriction, but rather should
be regarded as an imperfection in their exchange regime - a 'flaw' - of a nature
similar to the use of the wide band in the ERM in the case of Italy or the
floating of the British pound outside the ERM. The implication obviously was
that the dual regime only had to be abandoned if the latter 'imperfections'
had been removed as well. 26 This argument was contested by others on
procedural as well as substantive grounds. As regards procedure, it had been
agreed that there would be no preconditions and the Belgian double exchange
market could not form an exception. There was considerable peer pressure.
Belgium and Luxembourg were put through the wringer by their two big
neighbours: France and Germany. As regards substance, it was pointed out
that for the operation of a dual market administrative regulations and a control
apparatus were necessary as well, just as in case of exchange restrictions. The
uncertainty with respect to the exchange rate in the dual market brought
along additional costs and therefore did hamper capital movements, as it
was intended to do. The staff at the Nationale Bank of Belgium who were
controlling the dual market were not acting in a very different manner from
those in other bureaucracies dealing with exchange restrictions. For them it
206
was just as difficult when, with the eventual abolition of the dual market, they
had to be converted into statisticians. From now on they could only register
capital flows but no longer had the power to delegate applicants to the free
market by the stroke of their pen.
The reluctance of Belgium and Luxembourg to drop the system when it
increasingly seemed obsolete, can be traced back to several factors: - for
long, the entrenched domestic acceptability of the system weighed heavily
against the shade it was conceivably casting on the international status of the
Belgian franc;
- twice in the past, and as early as in the 196Os, preparations had been
made to abolish the system, but were cancelled at the last minute when a
crisis showed it could still play a useful role; .
- once dismantled the system could not easily be reinstated under a safe-
guard clause;
- the Luxembourg authorities were very supportive of the dual exchange
market. The system provided Luxembourg with an institutional guarantee that
capital flows would not be regulated by direct administrative controls. This
was of the utmost importance to the position of Luxembourg as a financial
centre. The Luxembourg authorities feared that if the dual market was to be
banned, the Belgian monetary authorities could have recourse to other means
of interfering with capital flows under Community regulations, which would
harm the position of Luxembourg.

8.8.3 Draft Directives

After this discussion in the Monetary Committee the Commission presented

its draft directive on the full liberalization of capital movements in November
1987.27 This directive was accompanied by two other draft directives, one to
amend the 1972 Directive and another one to revise the medium-term financial
instruments of the Community. President Delors presented the proposals both
in the Ecofin Council and in the meeting of the Governors.28 In the circle of
the central bankers President Delors raised the issue of the wide band of the
Italian lira and the dual exchange market for the Belgian franc. The position
of the Commission was that the lira should move to the narrow band and that
the dual market should be abolished, but that it was open-minded as regards
the precise timing, as long as the transitional period would be short. However,
as far as the Commission was concerned, the entry of the pound sterling into
the ERM was nearly a precondition for the proper functioning of a European
financial area. Despite the events on Black Monday, the Commission would
proceed with the necessary steps to bring about one integrated financial area
in Europa. This should be regarded as an act of faith in the functioning of
market mechanisms and in the capability of the Community to respond to
these events. Although on the whole the reception among Governors was
positive, there was a brief Italian-inspired discussion whether it was really
 207
necessary to bring about full freedom of capital flows soon. Could countries
not decide for themselves on the timing as long as they promised to fulfil their
obligations in this respect before the end of 1992? But President Delors did
not flinch. Four countries had already fully liberalized, four other countries,
including Italy, were perfectly capable of doing so in 1988 in the eyes of the
Commission. For the remaining four countries the Commission had already
proposed transitional periods up until the end of 1992 at the latest. 29
In the Ecofin meeting in the following week President Delors reiterated
that the degree of organization and the quality of the supervision of the
financial markets, one of the evaluation criteria, could be regarded as equal
in 8 out of the 12 Community countries. Therefore these countries did not
need any transitional periods. Chairmen Ciampi (Committee of Governors)
and Littler (Monetary Committee) reported on the state of the discussions in
their respective committees. It was typical of the European decision-making
process that ministers refrained from commenting on substance, but confined
themselves to discussing the procedure to be followed. Ministers agreed that
the technical working groups of the Council were not allowed to start their
work until the final advice of both committees had been received by the Ecofin
Council.
In the Alternates of the Monetary Committee, which prepared the commit-
tee's advice, the general support for full capital liberalization was reaffirmed,
apart from another last-ditch Italian attempt to subdivide the liberalization
process into two steps: first the non-bank transactions and then the bank
transactions. It was argued that such gradual implementation would permit
the harmonization of supervisory rules and the coordination of monetary poli-
cies to catch up with the capital liberalization process. There was, however,
no support for this approach. In practice such a distinction could not be made
easily and soon market operators would have found loopholes. Moreover, it
ran against the accepted policy line that no preconditions should be attached
to full capital liberalization.

8.9 FISCAL QUESTIONS

All along in the negotiations on the liberalization of capital movements the

implications for the collection of taxes in member states were an important
issue. There was a genuine fear among governments that with increased
capital mobility funds would flow to countries with lower tax rates. The
Commission on the other hand was concerned that if a certain degree of tax
harmonization were to be a precondition for full capital liberalization, the
whole process would be bogged down in interminable negotiations. On this it
was probably right. Taxation notoriously was the most difficult area to agree
upon, not least because of the ultimate authority to tax of national parliaments.
Although it was accepted by member states that other dossiers should not form
208

a precondition, pressures mounted on the Commission to undertake some

action and come forward with proposals for measures aimed at harmonization
or prevention of tax evasion. The Commission obliged and announced to
aim at establishing a framework of harmonized rules in the tax field by
1992. Member states thus could be satisfied that an environment would be
created in which possibly negative side-effects of full capital liberalization
would be minimized. Commissioner Lord Cockfield toyed with three ideas:
a general withholding tax on interest payments, an obligation for all banks to
disclose information on interest income to tax authorities or a more intensive
cooperation between the European tax authorities. He seemed to have a
preference for the first, most far-reaching solution. 3o
The Monetary Committee invited the Alternates, strengthened with some
seconded tax experts, to study the tax problem. Fiscal issues were very much
in the minds of the members of the countries which still maintained capital
restrictions. These countries feared in particular that in a liberalized environ-
ment the small savers would find easier access to financial outlets in third
countries. Italy shared a long border with Switzerland and feared tax evasion.
France was equally afraid that its citizens would transfer their savings to
countries with a mild tax regime. For some countries, such as Denmark and
Ireland, the taxation of interest income or of wealth was a politically sensitive
issue, not least because it constituted a significant part of fiscal revenues. This
could not easily be replaced by other sources. Ireland for instance maintained
a withholding tax of 25 per cent; when introduced this had already given rise
to considerable capital flight. It was felt that this could only become worse
if capital transactions were to be fully liberalized. If the directive were to be
adopted soon, there should be a sufficiently long transitional period before
its entry into force. This period could be utilized to solve the fiscal prob-
lems, either by taking measures at home or by harmonizing tax rules at the
Community level. It was noteworthy that the countries which had already
liberalized did not consider the taxation issue to be important. They pointed
to their own favourable experiences, where the magnitude oftax evasion was
of such a relative small size that it did not give cause for changes in taxation
legislation. 31 The British explicitly warned against Commission initiatives in
this sphere. They were afraid that proposals such as the establishment of a
withholding tax on interest income would hamper the competitive position
of the European capital markets and would involve the risk of capital flight
to the United States and Switzerland.
The discussion in the Alternates showed that there were no ready-made
solutions for the fiscal problems. 32 Taxation was a mine field. It was clear
that there was no consensus in sight. Hope could be drawn from the experi-
ence of liberal countries, which indicated that tax evasion by small investors
remained limited because of the high costs involved in foreign transactions.
Nevertheless, the French proposed to incorporate into the directive a clause
which would call on the Commission to make parallel progress in the field
 209
of tax harmonization. Eventually, this was agreed, together, as mentioned
before, with a later date of implementation of the directive (1 July 1990). In
the final text of the directive Article 6.5 required the Commission to submit
proposals before 31 December 1988, aimed at eliminating or reducing risks of
distortions or tax evasion, and the Council would take a position on this issue
before 30 June 1989. However, it was noted that all common tax regulations
would require unanimous approval.

8.10 ENHANCED SUPERVISION

Some members in the Monetary Committee from countries which still main-
tained restrictions considered that different regimes of national supervision
of financial institutions in practice might lead to distortions in or barriers to
the free flow of capital. They were of the opinion that further regulation in
this area would be required as a precondition for full liberalization. Inter-
estingly enough, the supervisors themselves did not share this view. 33 The
supervisors were already engaged in the drafting of directives with a view
to establishing a unified internal banking market in 1992. This was predi-
cated upon the assumption that monetary cross-border flows would be fully
liberalized. Their work was directed towards achieving sufficient 'minimum'
harmonization in order to secure mutual recognition of supervisory regimes.
This would enable them to apply the principle of home country control and
the recognition throughout the Community of licences granted in a single
country. The supervisors pointed out that full liberalization existed already
in a number of countries, without this ever having been made dependent on
supervisory legislation.
Liberalization and deregulation did not imply complete laissez-faire.
Instead, it was necessary to provide a dependable and trustworthy legal
framework in order to prevent imprudent or fraudulent behaviour. In fact
many countries introduced new legislation to counter unworthy behaviour,
such as insider trading or the offering of financial services in a misleading
manner. The tightening of supervision and prudential control of financial
institutions was already underway. The innovations resulting from financial
engineering had made it more difficult to assess the risks involved for the
commercial banks. Therefore solvency requirements for the banks had to be
strengthened. Because of the international financial integration this strength-
ening of prudential control had to be internationally coordinated, in order to
avoid regulatory arbitrage, with institutions seeking locations with the mildest
supervisory regime. This coordination took place mostly in the Basle Com-
mittee. The EC was to adopt secondary legislation giving effect to the Basle
agreements in the course of the next few years.
210

8.11 COMPLETION UNDER GERMAN CHAIRMANSHIP

In the first half of 1988 Germany had taken over the chairmanship of the
Community. The German authorities, who had become more assertive in
the course of the years with respect to full capital liberalization, considered
the finalization of the capital directive one of their prime targets among the
desiderata of the Internal Market. For them it was extremely important that the
completion of dossiers which had been linked to full capital liberalization,
i.e. tax harmonization and enhancement of supervision, were not regarded
as a precondition for the adoption of the directive. The other dossier which
had been linked all along to capital liberalization, i.e. the strengthening of
the EMS, had been temporarily closed by the adoption of the Basle/Nyborg
Agreement. However, there were increasing signals that there was more to
come as regards monetary integration. Indicative in this respect was the
embracement by the German Minister of Foreign Affairs Hans-Dietrich Gen-
scher of the initiative of the French Finance Minister Balladur for the further
strengthening of monetary cooperation through concrete moves towards the
creation of a Monetary Union and a European Central Bank.34 Balladur, who
had presided over the deregulation and modernization of the French financial
system, had tried to revive the idea of a European central bank with increasing
force in the latter half of 1987. Now, with full capital liberalization within
sight, a favourable cyclical situation and much improved convergence, the
most important preconditions had been fulfilled. France closed a pact with
Germany that end-June 1988, when the capital directive would be approved,
a study would be undertaken of the stages leading towards such a European
central bank.
The deadline for the finalization of the directive implied a tight schedule
and the Monetary Committee devoted a number of meetings to the subject in
the first six months of 1988. The erga omnes principle was accepted by all,
but Germany stood alone in wishing to have this included as an obligation in
the directive. Other countries continued to fear that such an obligation would
weaken the negotiating position of the Community, especially if it would
prejudice the EC position in the field of financial services. The requirement
of reciprocity should be maintained as a powerful tool to gain access for
European financial institutions to third markets, particularly in Japan. There
was, as had become increasingly clear in the course of the discussions, no
support for maintaining the 1972 Di.J;"ective, as requested by the Commission.
The Commission proposal to make the directive effective within 3 months
after its adoption was deemed to be too strict and Chairman Littler in February
proposed a compromise of 6 to 12 months. Howel'er, Italy in particular asked
for a longer period because of the possible consequences of the differences
in tax regimes. The Monetary Committee could not reach agreement and
left the issue to Ministers, which eventually decided that the directive would
become effective on 1 July 1990, i.e. in a period of two years. Belgium and
 211

Luxembourg, however, were allowed to maintain the dual market until the
end of 1992. The Ministers also decided on the transitional periods for the
four countries which were granted respite. As to the need for a monetary
safeguard clause opinions still differed. However, if there were to be such a
clause, the Monetary Committee agreed that it should apply (a) only for short
periods of time; (b) exclusively to transactions not yet liberalized; (c) only in
exceptional circumstances; and (d) by a Community procedure. 35 Eventually
a compromise was reached, under which the Council would decide before 31
December 1992 whether a monetary safeguard clause was still needed. 36
As to the Community credit mechanisms, consensus was reached that the
two existing mechanism should be merged into a single facility.37 This facility
would be financed primarily by the contracting of loans by the Commission on
the capital markets. There was, as could be expected, considerable haggling
over amounts, but eventually a compromise was reached within the Monetary
Committee on a maximum of ECU 16 billion. Access quotas for individual
member states were to be decided on a case-by-case basis. The suggestion of
the Commission that there should be a separate window to provide stand-by
credit arrangements to countries in the process of capital liberalization met
with considerable resistance. A majority was of the view that balance-of-
payments problems should remain the main trigger for the use of Community
credit mechanisms. It was, however, conceded that the threat of such problems
would also qualify countries for the mechanism, and at a proposal of Spain
it was recorded in the minutes of the Council meeting that the possible
consequences of capital liberalization could constitute such a threat. Although
this was not legally binding, it gave sufficient comfort that the Commission
and the Council would take capital liberalization efforts into account, when
deciding on requests for EC financing.
Shortly before the final Ecofin meeting in June 1988 a new problem
emerged. Denmark considered it to be of vital importance that the Danish
law which prohibited the sale of second homes to non-residents could not be
circumvented by the capital liberalization directive. The term 'vital impor-
tance' of course was ominous, because this could block acceptance of the
directive. This would obviously be a very bad signal for the financial mar-
kets, so it was felt. Denmark succeeded in incorporating a clause into the
directive which stated that national regulations with respect to the sale of
second homes in border areas would not be affected by the directive. 38
In the meeting of the Ecofin Council on 24 June 1988 the directive was
adopted. 39 Finally, after more than thirty years member states had agreed that
the escape clause - 'to the extent necessary to ensure the proper functioning of
the Common Market' - implied the full liberalization of capital movements.
At the same time the directive on the establishment of a single credit facility
was approved. An important hurdle on the road to monetary integration had
been taken. Now the biggest hurdle, economic and monetary union, could be
given a new try. In the following weekend, on 27 and 28 June, the European
212

Council in Hanover gave a mandate to a committee of central bank governors

and independent experts under the chairmanship of Jacques Delors to study
and propose concrete steps which should lead to economic and monetary
union.

8.12 CONCLUSION

The negotiations on full capital liberalization were completed with success

in a relatively short period, thanks to the agreement that there would be no
preconditions. The demands for quid pro quos, which at times had slowed
down the liberalization process, now lacked force. The Commission showed
great determination and did not let itself get side-tracked in the parallel issues
which were put on the table. It had made the strategic choice for the full
liberalization of capital movements in Europe and grasped the window of
opportunity provided for by the favourable cyclical situation and the rela-
tive calm within the European Monetary System. The Commission rightly
refused to put its weight behind the calls for parallel progress in other areas.
Its motives were threefold: European industry needed a well-functioning inte-
grated European capital market (efficiency argument), capital liberalization
was a precondition for further steps towards economic and monetary union
(integration argument), and the disciplinary effect on policies would align the
member states (convergence argument). The adoption of the 1988 Directive
was a landmark in the history of the Community.
The Commission was prepared to do concessions which were needed to
bring about agreement. It had to accept longer transitional periods from the
struggling member states, postponement of the date of entry and the incorpo-
ration of a monetary safeguard clause. But these were minor concessions in
view of the end goal. It was more dissatisfied with the abolition of the 1972
Directive, as the last vestige of a shielded European capital market, but it
gave up the fight against consistent German opposition.
France had become more and more in favour of capital liberalization - the
formation of one European financial area - as a condition for strengthening
the competitive position of Europe. And France, which had lost faith in the
effectiveness of capital controls, now was conviced that it was in its own inter-
est to abolish capital restrictions. It had put much efforts in the restructuring
of its financial system in order to esta,blish Paris as one of the leading financial
centres in Continental Europe. Its support of the liberalization process was
decisive. At the same time France advocated progress with the 'construction
moneta ire europeenne'. In the French view capi~lliberalization was linked
with the development of a common long-term vision on the economic and
monetary shape of Europe. In this respect the Dutch initiative in 1982 to put
capital liberalization on the European agenda had served its purpose. It had
in the intermediate years brought out the differences of opinion into the open.
 213

It had once again galvanized the debate between the 'economists' and the
'monetarists', but the debate had not ended up in dividing the member states,
as it had done in the 1970s, but it had succeeded in assembling countries in
a constructive way. The gamble of the Commission, which had regained the
initiative and pushed member states further than they initially were prepared
to go, had paid off. Edouard Balladur tentatively concluded that the histor-
ical quarrel between the monetarists and the economists might have been
overcome at last. 40
The Basle/Nyborg agreement, important as it was with respect to the under-
standings among central banks on how to beat off speculative attacks, had
been meagre in its institutional improvements. It fell far short of the demands
France had spelled out in its memorandum of February 1987. In fact, this
memorandum must be regarded as the last convulsions of the yearly EMS
and ECU packages. France having made the decision on domestic grounds
to abolish exchange control, its demands for monetary concessions from the
Germans lacked strength. There were increasing signs that what up till then
had been a coherent bloc of restrictive countries, the ECU block, coinciding
more or less with the 'monetarist' school, was falling apart. France changed
coalition. Many Southern member states and Belgium had put high stakes on
the maintenance of capital restrictions, and were only prepared to dismantle
them in exchange for increased financing mechanisms and symmetric inter-
vention obligations in the EMS. The French change of heart drove a wedge
in this bloc.
Italy in particular was left in the cold. It had taken over the leadership of
the camp which cautioned against full capital liberalization. Italy had insisted
on the incorporation of a monetary safeguard clause and it had continued to
come forward with proposals for enlarging the EMS financing mechanisms,
including the strengthening of the role of the dormant European Monetary
Cooperation Fund. It had come to resent what it perceived as the deflation-
ary bias of the European Monetary System, the system lacking a 'growth
motor' .41 But with the French-German rapprochement on monetary matters
Italy stood alone in its rather fargoing claims.
Germany could be satisfied. It had consistently advocated full capital lib-
eralization and it had not been forced to make concessions which could have
weakened autonomy over domestic monetary policies. Its increased assertive-
ness in advocating stability-oriented policies in Europe had got a hearing. In
the course of the years it had been joined by other partisans, in particular
the United Kingdom and the Netherlands, and now France had come along
as well. Germany's constant insistence on the principle that the freedom of
capital movements was a precondition for further steps towards monetary
integration had paid off. Now that this hurdle had been taken, the time had
come to give serious consideration to the long-term vision of European mon-
etary cooperation. The positive German response to the French initiatives
in this field, especially from Minister Genscher, led to the establishment of
214
the Delors Committee with a mandate to study concrete steps towards the
creation of a European economic and monetary union. It was a resounding
reward for the Commission's persistence in advocating the full freedom of
capital movements.

NOTES

1. In the preceding months in discussions in the Monetary Committee it had been concluded
that realignments in the EMS should be carried out' d froid' , i.e. in a timely manner and at
a time chosen by the authorities, rather than 'd chaud', i.e. forced upon the authorities by
market pressures. Nevertheless the January 1987 realignment was forced by speculation
on a German interest rate decrease - which did not materialize - in the wake of downward
pressure on the US dollar. The events had left President Delors with doubts whether
the existing system of 'dialogue and concertation' would be adequate to cope with such
tensions (Financial Times, 13 January, 1987). The realignment elicited a request from the
Ecofin Council to the Monetary Committee and the Committee of Governors to examine
ways of strengthening the operating mechanisms of the EMS. This would lead to the
BaslelNyborg agreement. Moreover, efforts were intensified to dampen the downward
trend of the exchange rate of the US dollar, which France saw as being at the root of the
problems within the EMS. These efforts were crowned with the conclusion of the Louvre
Accord on 22 February 1987.
2. OECD (1982), p. 6. See also Chapter 6, note 19.
3. There were two aspects here: (1) restrictions sharpened the minds of market participants
in finding loopholes, which subsequently had to be closed as well, (2) some restrictions,
such as those with respect to leads and lags, had only a short-lived net effect on the capital
account: the shortening of the period in which exporters had to surrender foreign exchange
to the banks in France had only a once-for-all effect and prompted the authorities to decree
a further shortening when the exchange rate came under downward pressure.
4. Note of the Commission on Implications of the full liberalization of capital movements
within the Community, dated 5 December 1986.
5. Financial Times, 23 March 1987.
6. Note by Bundesbank Director Leonhard GIeske, presented to the meeting of the Monetary
Committee on 12 February 1987.
7. Cf. the influential commentator Paul Fabra on the Internal Market: 'En realite, la liberte
de circulation pour les capitaux est II la fois l'un de volets les plus importants et les
moins 'euro¢ens', car Ie mouvement actuellement en cours concerne la globalisation des
marcMs financiers du monde entier'. Le Monde, 24 March 1987.
8. The memorandum was announced in February 1987 in the Ecofin Council, which asked
the Monetary Committee to examine the proposals.
9. Note by Banca d'Italia Director-General Lamberto Dini, presented to the meeting of the
Monetary Committee on 12 February 1987.
10. Note of the Commission to the President of the Council on Implications of the full
liberalization of capital movements in the Community, dated 19 March 1987.
11. Padoa-Schioppa (1987), Efficiency, stability and equity: a strategy for the evolution of the
economic system of the European Community, Brussels. The report was presented to the
Commission on 10 April 1987.
12. The Monetary Committee and the Alternates held a relatively brief debate on the report.
Scepticism as to the most radical elements of the report prevailed and it was generally
felt that the report exaggerated the problems which could arise from the full freedom of
capital movements. There was, however, French support for some of the proposals to be
 215

implemented in the short run, such as the enlargement of financing mechanisms, which
came close to those put forward in their own memorandum.
13. Minister Balladur quoted in Agence Economique et Financiere, 3 March 1987; President
Delors quoted in Financial Times, 23 March 1987.
14. Note of the Commission on The regulation of short-term international financial flows in a
situation in which capital movements are fully liberalized, dated 26 May 1987.
15. The Dutch exchange restrictions up till mid-1983 prescribed an authorization procedure for
guarantees given by the parent company for credits taken up abroad by foreign subsidiaries,
a notorious loophole. Such authorization was routinely granted if normal intra-company
payment terms would not be altered. In practice, however, the latter was not checked.
16. The French Minister of Finance Edouard Balladur had made his position clear in an
interview with Agence Economique et Financiere on 3 March 1987: "Si la Communaute
doit s'affirmer vis-it-vis des tiers comme un espace largement ouvert sur l'exterieur, elle
doit en meme temps mieux proteger ses interets face aux prestataires non communau-
taires de services financiers. A defaut, certains grands pays tiers pourraient ben6ficier
grandement du marcM int6rieur des services financiers, tout en conservant eux-memes
des reglementations protectionnistes. '
17. The French proposal for subdividing the second phase may not have been without self-
interest. France was already preparing a substantial easing of exchange control with respect
to commercial enterprises, which came into effect on 21 May 1987.
18. Note of the Commission on Preparation of a new directive for the implementation of
Article 67 of the Treaty, Scope of the obligation to liberalize capital movements and
periods within which the obligation could take effect, dated 23 July 1987.
19. The Court of Justice had ruled in the Brugnoni and Ruffinengo case that all administrative
restrictions hampering liberalized capital movements should be removed (see Chapter
3.8).
20. There were no official notifications of measures to regulate liquidity, which might affect
capital flows. The Commission, which was aware of such measures, in practice took a
rather pragmatic viewpoint, as long as the measures (1) were taken exceptionally, (2) did
not discriminate and (3) were confined to commercial banks. When the Commission in
1991 inventoried the measures, which in some countries were in place, they were regarded
as not problematic.
21. Monetary Committee (1988), Twenty-ninth activity report, p. 6. The report by the Chair-
man of the Monetary Committee to the informal Ecofin Council is annexed to the report,
p.15-23.
22. Deutsche Bundesbank, Annual Report on 1987, p. 71. In the report which the Committee of
Governors presented at the Nyborg meeting it was underlined that the gradual dismantling
of capital controls implied 'that all partners should pursue in a closely coordinated manner
policies that foster stability of domestic prices and costs and external balance as a basis
for lasting exchange rate stability: in particular, countries should agree that central banks
would be committed to giving priority to the objective of price stability in the conduct of
monetary policy.'
23. The proposals of President Delors, dated 30 July 1987, could be considered as an alternative
to the earlier proposal for cross-currency holdings in the reserves of the BC central banks,
which was contained in the French memorandum of February 1987. The latter proposal,
supported by the United Kingdom, envisaged that BC central banks would build up
not only Deutsche marks in their official reserves, but also the currencies of the other BC
countries, if these could be considered to be sufficiently liquid. Not unexpectedly, there was
considerable opposition from surplus countries like Germany and the Benelux countries,
which feared to be overfed with currencies which in case of need could not be used. The
more or less automatic financing of interventions in support of weak currencies would
imply that the disciplinary effect of the EMS would diminish. The proposals eventually
were dropped when it became clear that they received insufficient support.
216
24. Note of the Commission on The creation of a European financial area, dated 19 October
1987.
25. In its Annual Report on 1987 the Banca d'Italia elaborated on this proposal for a Com-
munity recycling mechanism. Its purpose should be to alleviate pressures which would
result from capital liberalization, but which would not be justified by changes in economic
fundamentals. To this end financial funds should be extracted from the domestic capi-
tal markets of the traditional capital exporting countries. On 24 February 1988 Treasury
Minister Giuliano Amato presented a memorandum in which it was provided that the
European Monetary Cooperation Fund should be entrusted with the recycling of funds. In
the same memorandum strong support was expressed for the monetary safeguard clause.
Finally Italy signalled that it was willing to renounce its six per cent fluctuation margin if
the pound sterling would also be brought in the EMS, and the normal fluctuation margin
of 2.25 per cent would be widened for all countries.
26. Belgium and Luxembourg took a cautious attitude in the debate due to the political delicacy
of the subject. Their preoccupation was to keep the dual market in place temporarily so
as to secure a smooth transition to complete liberalization. This attitude should, however,
not detract from the fact that both countries did support the Commission's initiatives for
full liberalization.
27. Proposal for a Council Directive for the implementation of Article 67 of the EEC Treaty,
SEC(86) 1660, presented by the Commission to the Council.
28. Meeting of the Committee of Governors on 10 November and meeting of the Ecofin
Council on 16 November 1987.
29. The four countries which had fully liberalized were Germany, the United Kingdom, the
Netherlands and Denmark; the four countries which in the eyes of the Commission did
not need a transitional period to fully liberalize as well were France, Italy, Belgium and
Luxemburg, whereas transitional periods were proposed for Spain, Portugal, Greece and
Ireland.
30. Lord Cockfield in the Ecofin Council meeting of 16 November 1987.
31. A notable exception was provided by the introduction of a withholding tax on interest
income in Germany in 1989, which was replaced after six months when it had given rise to
sizeable capital outflows. Nonetheless, the withholding tax was reintroduced in a modified
form in 1993 after a ruling of the Constitutional Court.
32. Meeting of the Alternates of the Monetary Committee, jointly with taxation experts, on
28 March 1988. Four possibilities were considered:
- a general withholding tax throughout Europe; drawback: difficult to decide on the
appropriate level: if the tax rate would be too low, it would not be effective; if it
would be too high, it would prompt investors to move their capital outside the EC.
- a general obligation for the banks to declare interest income to the tax authorities;
drawback: work load for the banks and the tax authorities.
- a strengthening of the mutual assistance of tax authorities; drawback: only effective
in case of presumption of fiscal fraud.
- the channeling of investments abroad through agreed intermediaries; drawback:
hampering of the free movement of capital through administrative controls.
33. Reply of Mr O'Grady Walshe, chairman of the EC Banking Advisory Committee, to an
enquiry by Mr Tietmeyer in his capacity as chairman of the Monetary Committee, 26
August 1987.
34. In a speech for the European Parliament in Strasbourg on 20 January 1988 Minister Gen-
scher said: 'Wir mtissen das Europllische Wl1hrungssystem weiter entwickeln. Nach den
wichtigen Beschltissen der Zentralbankgouverneure und Finanzminister von Basel und
Nyborg ist zu fragen, wie groB heute noch der Spielraum fUr weitere Fortschritte bei der
Stllrkung des EWS ohne neue institutionelle Vorkehrungen ist. MOglicherweise ist er nur
noch gering, so daB dartiber hinausgehende Zielsetzungen auch die Frage nach der insti-
tutionellen Schwelle aufwerfen. ( ...) Die Krise der internationalen Finanzmllrkte hat in
 217

dramatischer Weise die Notwendigkeit verstilrkter Zusammenarbeit im WlUnungsbereich

unterstrichen. (... ) Hl1tten wir aber schon eine Europl1ische WlUnungsunion und eine
Europl1ische Zentralbank, so wilren wir weit besser gewappnet gewesen. Wir mUssen
deshalb konkret auf die Schaffung der WlUnungsunion und einer Europl1ischen Zen-
tralbank hinarbeiten, die auch in der Logik eines Europl1ischen Binnenmarktes liegen.
Entscheidend ist, daB dies WlUnungsunion zu einer Stabilitlltsgemeinschaft wird'.
35. Monetary Committee (1988), Twenty ninth Activity Report, p. 21.
36. When in 1992 the monetary safeguard clause was reviewed in the Monetary Committee
and the Committee of Governors it was decided to maintain the clause for another year.
The clause, which had not been invoked, would lapse anyway at the start of the second
stage of EMU on 1 January 1994 for which no such clause was provided in the Treaty on
European Union.
37. The weaker member states had been placated earlier by the decision of the European
Council in February 1988 to double the size of the structural funds over the period up to
1993.
38. Article 6.4 states that 'existing national legislation regulating purchases of secondary
residences may be upheld until the Council adopts further provisions' .
39. Council Directive of 24 June 1988, published in Official Journal of the European Com-
munities, No. L178/5, 8 July 1988; see Annex 6.
40. Edouard Balladur in an article in the Financial Times, The EMS: advance or face retreat,
dated 17 June 1987.
41. Giuliano Amato in an interview with Reuters, dated 24 February 1988.
 CHAPTER 9

Towards Economic and Monetary Union

It is the somewhat tragic fate of the central bank to stand more or

less alone in the fight for the value of the money. The main interest
groups in society without any doubt in the abstract are proponents of
stable money. However, they are always just that bit more interested
in other, more pressing matters.
M. W. Holtrop, 1956

9.1 INTRODUCTION

The adoption of the 1988 Directive was greeted with relief by the Commis-
sion. It had been a major accomplishment to agree on the obligation for all
member states to completely liberalize capital movements. In the course of
the following two years the remaining restrictions on short-term capital flows
in Denmark, France and Italy were removed and the dual exchange market,
operated in the Belgium-Luxembourg monetary union, was abolished. These
steps were often taken at an earlier date than was called for under the direc-
tive. But also the countries which had been granted longer transitional periods
generally moved forward in a decisive manner. In the negotiations the latter
had been dragging their feet. But the momentum created by the adoption and
implementation of the directive set spurs to the authorities. In doing so, they
could profit from the generally favourable economic climate in Europe and
the absence of expectations of major exchange rate adjustments. But there
was also an important political consideration: they did not wish to miss the
connection with the other EC members. There was a clearcut move towards
full liberalization within the Community and all countries wanted to be part
of this.
The coming years would be dominated by the discussion which all along
had accompanied the proposals for capital liberalization: European monetary
integration. The French had consistently advocated the closer coordination
of monetary policies, ever since the Community had been created. In the
'monetarist' tradition France had advocated monetary arrangements even
if economic convergence and domestic stabilization had not yet been fully
accomplished. But it had fallen short of demanding monetary unification. In
fact, what France was after up till then, was not the rendering of monetary
sovereignty to a supranational level, but the sharing of policy decisions on
monetary policy with other countries, in practice with the Bundesbank. The

218
 219

latter consistently had been refused by Gennany, which had considered all
French ideas - be it with respect to the ECU or with respect to reserve pooling
or a common dollar policy - inspired by one single goal, impinging on the
autonomy of the Deutsche Bundesbank. The French authorities had come to
the conclusion that the road of monetary coordination, as well as that of finan-
cial integration through the promotion of the ECU, would come to a dead-end,
because it would always clash with the independence of the Bundesbank and
the confidence the financial markets gave to the Deutsche mark above other
currencies, including the ECU. Therefore, France changed its strategy. As
mentioned in Chapter 8, in the course of 1987 the first indications were given
that France no longer would insist on further institutional advances of the
EMS or on official promotion of the ECU, but that it would be interested in
the establishment of an economic and monetary union and in the creation of
a European Central Bank.
After a discussion of the implementation of the 1988 Directive, this chapter
deals with the provisions on capital movements in the Treaty on European
Union. In this Treaty the transition to and the final stage of economic and
monetary union are outlined, with rules to prevent excessive budget deficits
and provisions for the establishment of an independent European Central
Bank. In EMU a number of the traditional tasks of the Monetary Committee
yvill become redundant. Therefore, the Treaty provides for the set-up of a
relabeled committee, with newly defined tasks and, possibly, a modified
composition. The chapter ends with a review of the events in the aftennath of
the adoption of the Maastricht Treaty, when large-scale capital flows seriously
undennined the cohesion of the European Monetary System, leading up to a
substantial widening of the fluctuation margins. This did raise some doubts
as to the wisdom of the full liberalization of capital movements, but some
muted calls for throwing sand in the wheels of free capital flows were finnly
resisted by the member countries.

9.2 THE FOLLOW-UP TO THE 1988 DIRECTIVE

Following the adoption in June 1988 of the directive providing' for the full
freedom of capital movements most countries moved swiftly. The liberal club
in Europe, Gennany, the Netherlands and the United Kingdom, was already in
compliance with the directive and thus did not have to undertake any action.

9.2.1 Full Liberalization in the Leading Group

Denmark was the first of the other 9 member states still maintaining restric-
tions to fully comply with the liberalization directive. On 1 October 1988 the
few remaining regulations were abolished. France in another major overhaul
of its control system lifted most restrictions in March 1989. 1 When the last
220

TABLE 28
The abolition of exchange controls in the EEC.

United Kingdom 1979 Italy 1990

Germany 1981 Spain 1992
The Netherlands 1986 Portugal 1992
Denmark 1988 Ireland 1992
France 1989 Greece 1994
Belgium/Luxembourg 1990

obstacles finally were removed effectively on 1 January 1990, well ahead

of the deadline, France had become the fifth EC member state to have fully
liberalized capital movements. More than twenty years after its first attempt
in the late 1960s to liberalize capital flows and modernize monetary policy,
its second attempt had been completed successfully, without setbacks on the
financial markets.
Although Belgium had earlier insisted on an extension of the deadline for
the abolition of the dual exchange market until end-1992, it proceeded much
earlier when it was clear that other countries would live up to their com-
mitments. Especially the de facto liberalization of all capital movements in
France triggered the move to abolish the dual exchange market in Belgium
and Luxembourg on 5 March 1990. Italy soon was to follow suit. After the
adoption of the liberalization directive Italy had introduced a new exchange
law in October 1988, switching to a positive control system under which all
cross-border transactions were permitted unless explicitely prohibited. This
change had been under debate since the beginning of the 1980s, but its adop-
tion had been delayed for some time because of the fragile economic and
political situation. Under the new law specific restrictions were retained for
the time being for certain short-term transactions. The switch was positively
received in the markets. Upward pressure on the exchange rate, also caused
by the large interest rate differential of 6.5% vis-a.-vis the Deutsche mark,
even necessitated temporary measures to dampen a surge in capital inflows. 2
The ground for full liberalization was prepared by the adoption of the nar-
row fluctuation margins in the ERM for the lira in January 1990 and a few
weeks before the deadline in an atmosphere of much improved confidence
all remaining restrictions were removed. With Italy, the 8 member states,
which President Delors had singled out as capable of fully liberalizing capital
movements, had indeed fulfilled their obligations on time. On 1 July 1990 the
first phase ofEMU started with the full freedom of capital movements firmly
implanted in the heartland of the European Community. When on 8 October
1990 the United Kingdom finally considered the time ripe to take the pound
 221

TABLE 29
Stabilization in Ireland.

in per cent 1979-83 1984-88 1989-93

annual rate of increase

consumer prices 15.9 4.6 3.0
%ofgdp
budget deficit ( - ) -12.1 -8.7 -2.1
currrent account -11.0 -2.6 1.5

Source: International Financial Statistics, IMP; European Econ-

omy 58, European Commission.

sterling in the ERM success seemed complete. All member states which prac-
ticed full freedom of capital movements maintained their exchange rates in
the narrow fluctuation band.

9.2.2 Gradual Progress in Derogation Countries

The other countries which had been granted extensions gradually disman-
tled capital controls as well. Ireland removed those restrictions which still
fell under the safeguard clause of the earlier liberalization directives before
the end of 1988, as foreseen. Therefore, from that time it only maintained
exchange controls relating to short-term capital movements. 3 Its liberalization
measures were as much influenced by the push factor of the EC obligations as
by the perceived pull factor of the beneficial effects of improved confidence
on investment in Ireland. The authorities had noted that investors responded
positively to an economic climate with as little as possible restrictions on
capital movements. 4 At the same time Ireland was an example of a country
in which policy adjustments, especially in the fiscal policy area, and capi-
tal liberalization went hand-in-hand successfully (see Table 29). Its current
account balance had improved from a deficit of 6.8% of gdp in 1983 to a size-
able surplus from 1988 onwards. But it proceeded cautiously with respect to
short-term flows: Ireland did not want to see its fiscal adjustment programme
jeopardized by sudden speculative outflows. It would further relax controls
in the course of the years but would wait until the latest permitted date, 1
January 1993, to fully abolish exchange control. s
Spain, which operated a fairly restrictive exchange control system, notably
with respect to capital outflows, took a series of liberalizing measures in the
course of the years. Under one of those relaxations the French example to
favour the ECU was followed: Spanish residents were free to open current
account or savings deposits denominated in ECU in September 1989. Gen-
erally, liberalization was carried through at an earlier stage than was called
222
for in the Treaty on Accession. Under the influence of relatively high nomi-
nal interest rates and rapid economic growth, spurred by heavy investment,
Spain was confronted with sizeable inflows which, with limited success, were
counteracted by reintroducing certain restrictions on capital inflows.6 The ten-
dency of the peseta to appreciate was dampened after the entering into the
ERM in June 1989, although the peseta continued to be strong. This permitted
an acceleration of the liberalization process. In September 1991 Minister of
Finance Solchaga in a surprise move announced that all remaining exchange
restrictions would be abolished as from 1 February 1992, almost a year ahead
of schedule.7
The announcement was accompanied by plans to grant the Banco de Espana
greater autonomy. Both moves were intended to increase credibility in the
markets.
Portugal had operated a restrictive control system characterized by
detailed, bureaucratic regulations. It had negotiated long transitional periods
up to 7 years for the commitments under the previous directives, including the
1986 directive, in the Treaty on Accession. Its membership of the EC implied
a fundamental reform of its regulatory practices, which were mainly inspired
by the fragility of the external position and the relatively small size of the
Portuguese financial markets. An important motive had been as well to keep
domestic savings for its own economic development and support domestic
credit control. After the adoption of the 1988 Directive Portugal took some
measures to soften the impact of restrictions on basic capital movements. But
it first gave priority to modernizing its domestic financial system and under-
taking a market-oriented reform of monetary policy. To this end the system of
credit rationing and privileged treatment of government debt was abolished,
and in April 1991 the authorities introduced a new system of indirect mon-
etary policy instruments. The domestic banking sector was restructured and
recapitalized as well in order to be able to withstand the foreign competition
which would follow liberalization. These domestic reforms, which virtually
revolutionized the domestic financial market, were regarded by the author-
ities as a necessary precondition for a sustainable liberalization of capital
movements.
Like Spain, Portugal was confronted with substantial capital inflows which
caused problems for monetary policy. In July 1991 restrictions on inflows
were temporarily reintroduced, particularly on purchases of short-term paper
by non-residents. The persistence of high interest differentials and the absence
of expectations of a devaluation acted as a powerful stimulus for capital
inflows in 1991, estimated at a net inflow of autonomous capital of 11.6% of
gdp, of which a substantial part was considered to be of a volatile nature. 8
The substantial interventions of the central bank in order to take the upward
pressure off the escudo blew up domestic liquidity and undermined the efforts
to contain inflation. Portugal did not ask for an extension of the transitional
period but instead it announced in August 1992 the complete liberalization
 223

of all capital movements by the end of the year. From now on, so it was
announced, the conduct of monetary policy would be primarily determined
by the exchange rate target of the escudo, which had entered the ERM in the
spring of 1992.
The progress in Ireland, Spain and Portugal had been impressive. Especially
the Iberian countries came from a situation of a very regulated economy,
witli heavy government involvement. In a few years time, in a catching-
up process which inspired confidence, they had transformed their financial
sector and liberalized capital movements. The currencies were dragged along
in the currency turmoil in the ERM in 1992 and temporarily reintroduced
restrictions after the September crisis, which will be discussed in paragraph
7. Nonetheless, all countries had fully liberalized capital movements on 1
January 1993. Only Greece asked for an extension of the transitional period
with two years, until 1 January 1995 for short-term capital operations. The
Commission was of the opinion that a shorter period would be appropriate,
and the Council eventually granted an extension until 30 June 1994.
Outside the European Community the liberalization drive gained momen-
tum as well. In particular the EFTA countries which sought rapprochement to
the EC aligned their regulations to the standard set by EC legislation. When
on 22 October 1991 agreement was reached on the European Economic Area
the directive on the liberalization of capital movements was accepted as well
together with 12.000 more pages of EC secondary legislation. Some minor
exceptions were formulated, mainly with respect to existing property and
direct investment regulations.

9.2.3 Effects on Capital Flows

Countries experienced a large increase of capital flows, both inward and out-
ward, after they had liberalized capital movements. In most cases on a net
basis a surplus of inflows was registered in the period just following liberaliza-
tion. Therefore, periods after capital liberalization typically were associated
with a virtuous circle of net capital inflows, upward pressure on the exchange
rate, permitting a decrease in domestic interest rates. But not in all cases
this was associated with improved macroeconomic performance, measured
by the size of budget deficits and the rate of inflation. This suggests that other
factors are at work as well. One major factor may be that indeed the removal
of capital controls contributed to the credibility of the exchange rate commit-
ment of the authorities, because the exposure to market forces was perceived
to exert a disciplinary effect on policies. This had been argued all along by
liberal countries, like Germany, but still the proof of the pudding was in the
eating. Bartolini and Bodnar (1992) on the basis of the experiences in Italy
have advanced that 'by raising the potential costs of exchange rate stability,
the removal of capital controls increased the credibility of the commitment to
the EMS and therefore contributed to calming devaluation expectations'. The
224

TABLE 30
Disequilibrium in Italy.

in per cent 1979-83 1984-88 1989-93

annual rate of increase
consumer prices 17.3 7.1 5.7
%ofgdp
budget deficit (-) -10.0 -11.5 -10.0
current account -0.8 -0.4 -1.1

Source: International Financial Statistics, IMF; European Econ-

omy 58, European Commission.

actual stability in the EMS, the publication of the Delors report in May 1989
and the joining of the British pound sterling and the transition of the Italian
lira to the narrow band in January 1990 were instrumental in this stabilizing
of exchange rate expectations. In this sense, capital liberalization in Europe
was instrumental in increasing the trust of financial market operators and
investors in the future course of economic policies in EC member states. The
commitment to domestic price stability played a crucial role.
What was less well understood, however, was that inflows following cap-
ital liberalization were of a fleeting nature. The fact that net capital inflows
occurred was related to portfolio adjustments of non-residents, which were
willing to hold a relatively larger share of the currencies in a liberated
exchange environment. These flows were based on the perception of an
increased commitment to exchange rate stability. When the portfolio adjust-
ments had run their course, financial markets took a fresh look at the macro-
economic fundamentals. The net inflows had, however, given the authorities
the perception of financial ease. In some cases they may have contributed to
continued laxity in fiscal policies. Italy is a case in point. Since the transition
to a positive exchange regime in 1988 the government and the private sector
had increased external borrowing. Thus domestic demand was kept strong and
the current account deficit was easily financed. Interest rates decreased and
thus gave no warning signals. Despite repeated calls by the Banca d'Italia on
the government to decrease the huge public deficit the apparent financial ease
undermined the resolve of the authorities. 9 Paradoxically, the disciplinary
effect of free capital movements thus was lacking (see Table 30).
Portugal and Spain, too, which maintained relatively high interest rates in
order to control inflation, encountered problems for domestic monetary policy
because of increased capital imports. The strong potential for economic catch-
up since the entry in the EC and the opening-up of the domestic markets,
supported by credible policies, attracted massive inflows and permitted the
 225

liberalization of outflows. It proved, however, difficult in these circumstances

to bring the rate of inflation under control, which remained substantially above
the EC average. Also here, tighter fiscal policies might have been warranted to
lower price expectations, which were lagging, and moderate wage demands.

9.2.4 Indirect Barriers

In a discussion in the Monetary Committee in July 1990 satisfaction was

expressed with the progress achieved with respect to capital liberalization.
The committee requested that the Commission now shift its attention to the
identification and reduction of indirect controls, viz. domestic regulations
which still hampered capital flows. In a checkup the Commission identified
a number of country-specific, mainly minor controls which were considered
to be in contravention of the Community obligations. Examples were the
prohibition in Germany of purchases of certain categories of government
bonds by non-residents and the limitations imposed in Italy on physical cross
border movements of bank notes. France and the United Kingdom continued
to maintain certain restrictions regarding direct investment. 10 It brought these
infringements to the attention of the Monetary Committee at the end of 1990,
which urged the member states to take action. Some obliged but in a number
of instances the authorities maintained that the identified restrictions did not
constitute an obstacle for the free flow of capital but were maintained for
other reasons. 11
A number of domestic regulations which hampered the free movement of
capital were identified by the Commission as weU.12 These included measures
in the sphere of (1) tax discrimination, (2) prudential rules for institutional
investors, such as pension funds, and (3) regulations regarding the admis-
sion on domestic markets of securities denominated in a foreign currency.
The latter were governed by 'gentlemen's agreements' where admission was
dependent on authorization of the home country authority. Member states in
a number of cases objected to the inclusion of certain regulations as indirect
controls, disputing the interpretation of the Commission. Obviously indi-
rect controls formed a grey area which left much more room for different
interpretation than direct controls.
The discussion up to a point vindicated the Commission's reluctance to
cede its enforcement powers to the scrutiny of the committee, as discussed
in Chapter 8.6. The Commission's acts, unlike its complacent attitude in the
1970s, now proved its ardour for reaching as complete possible liberalization
of capital movements. After the discussion it was felt within the Commission's
services that the committee was not the best location for debating country
specific problems, since the peer pressure, which was so evident in earlier
years, no longer materialized in the grey areas of indirect controls, once more
so now that the four large member states were put on the rack.
226
9.3 THE FOLLOW-UP IN TAXATION AND SUPERVISION LEGISLATION

During the negotiations on the liberalization directive a strong link had been
laid by the French and the Italians with progress in the hannonization of tax-
ation and supervision legislation. The Commission maintained that the last
major barrier to the creation of a truly integrated European capital market
was the existence of differential taxation systems. The opportunities for tax
evasion being a source of economic distortion, the Commission favoured a
Community-wide approach to fight tax evasion. Actually, in the 1988 Direc-
tive a provision was included that the Commission would come forward
with proposals with respect to taxation before 31 December 1988. Howev-
er, when this date approached President Delors had to inform Ministers that
the Commission would miss the deadline. 13 The Commission was studying
the hannonization of taxation of returns on capital, in particular on income
and interest earnings, where different regimes were disrupting capital flows.
Ministers prodded the Commission to come forward soon with proposals.
But their motives differed. The German Minister Stoltenberg did so because
he wished to speed up the pace of capital liberalization and was fearful that
member states would use the delay as an excuse to postpone moves towards
liberalization. The French Minister Beregovoy was particularly interested in
the hannonization of taxation of returns on capital. In his eyes there was a
link with capital liberalization, if not of a legal nature than at least a moral
one.
The political link France had laid between capital liberalization and fiscal
hannonization was a strong one. At the same time it was clear that there would
be no back-tracking if fiscal hannonization would not come about. Minister
Beregovoy in a forum organized by the French weekly I'Expansion on 5 Jan-
uary 1989 made this perfectly clear: 'En ce qui concerne l'hannonisation de
la fiscalite sur l'epargne, remettrions-nous en cause la liberation des capitaux?
Je vous ai repondu non (... ) Sur la liberation des capitaux la decision est prise,
je croix qu'il est bon de respecter les decisions prises. (... ) La decision de
liberation des capitaux je la considere comme irrevocable.' In the preparation
of the 1988 Directive France had laid an equally strong link with monetary
issues. However, also in that instance, as discussed in Chapter 8, France
did not insist. This behaviour shows that freedom of capital movements for
France indeed constituted an aim in itself.
On 8 February 1989 the Commission presented a draft directive with
respect to a withholding tax on interest income and on mutal assistance
between the tax authorities. The proposed measures were intended to tack-
le tax fraud and tax evasion. At the same time it was clear that this could
not be solely dealt with on a European scale. Fraud and evasion constituted
problems of global dimensions, which should be dealt with in international
negotiations as well. The proposals to hannonize taxation proved to be con-
troversial, as expected. Countries had implemented different regimes, which
 227

they considered to be superior compared to the regimes in other countries.

There was a fundamentally different approach between those countries oper-
ating a withholding tax and those countries which relied on information by
the banks on interest paid. Some were vehemently opposed to a withholding
tax. Among them Luxembourg figured prominently. Its forgiving tax regime
attracted capital evading taxation at a large scale. This had given rise to
a booming financial services industry, which it did not wish to see wither
away, possibly to the benefit of other tax havens outside the territorium of
the European Community. In the coming years it did not prove possible to
reach agreement, except for cooperation among tax authorities in exchanging
information, and at the time of writing the draft directive is still in limbo.
When it became apparent that it would prove to be very difficult to make
progress with respect to fiscal harmonization, France, Spain and other coun-
tries prepared administrative measures providing for the reporting of transfers
to third countries in order to keep open the possibility of fiscal control. There
was a genuine fear of 'delocalisation' of French savings abroad. But in the
course of 1990 it became apparent that these fears had not materialized on any
grand scale, just as the countries which had liberalized before, had predicted. 14
As regards supervision, the other parallel dossier, much more progress
was made. In the framework of the collaboration between the supervisory
authorities in Basle, at the premises of the BIS, agreements were reached
on the harmonization of supervisory arrangements and on the division of
responsibility between the various supervisors, which was partly based on
preparatory work in the EC. The Community in the course of the years adopted
secondary legislation giving effect to the Basle agreements and providing for
transparent rules. In 1989 the Council adopted a directive, which took up
the Basle Agreement's risk weightings for the assets of credit institutions
as well as the requirement for credit institutions to have capital equal to
8% of their risk-weighted assets. IS In the same year the Second Banking
Directive was adopted which made it possible that a single licence was
recognized throughout the Community. In this directive the principle of home
control with respect to supervision was established. There was thus important
parallel progress in the supervisory area, which accompanied the drive for
liberalization of capital movements.

9.4 THE DELORS REPORT

It had been agreed that there would be no preconditions for capital liber-
alization. But the adoption of the 1988 Directive had removed an impor-
tant obstacle for a resumption of the discussion on monetary integration. In
speeches held by president Mitterrand and Minister Balladur in the latter of
half of 1987 France had argued for a progressive approach towards monetary
union and the establishment of a European Central Bank. 16 Apparently such
228

moves were seen as providing an answer to the discontent France at times

had professed with respect to the deflationary bias implied in the functioning
of the ERM as a Deutsche mark based exchange arrangement. The French
initiatives were soon supported by the German Minister of Foreign Affairs
Genscher, who grasped their political significance. His motives were not
mainly of an economic nature. Foreseeing openings to the East, which would
expose Germany, he saw the binding force of monetary unification which
would determine Germany's position as a Western European nation. 17 The
liberalization of capital movements, the relative stability within the Exchange
Rate Mechanism of the EMS and the healthy cyclical position of the European
economies proved to be fertile soil for the warm reception of these ideas.
The European Council on 27 and 28 June 1988 in Hanover stated that,
'in adopting the Single Act, the Member States of the Community confirmed
the objective of progressive realization of economic and monetary union'.
This was a benign form of rewriting histOll as our discussion on the Sin-
gle European Act in chapter 7 has shown. 1 The statement was dictated by
political opportunism and gave an important signal. The political leaders of
Europe wished to take Europe a significant step further. They established a
committee composed of the central bank governors and some independent
experts, chaired by Jaques Delors, President of the European Commission,
with the task of 'studying and proposing concrete stages leading towards this
union'.
The committee presented its re~ort one year later to the European Council
meeting in Madrid in June 1989. 9 The committee could take as its starting
point that one of the necessary conditions for monetary union, namely com-
plete liberalization of capital transactions and full integration of banking and
other financial markets, would be met with the completion of the Internal
Market programme. Incompatible national policies now would quickly trans-
late into exchange rate tensions and put an undue burden on monetary policy.
More intensive and effective policy coordination thus was needed. The Delors
committee particularly called attention to the fact that in the economic field
policy coordination remained insufficient.
The Delors report provided a blueprint for an economic and monetary
union to be implemented in three distinct phases. The report pleaded for the
establishment of an independent system of central banks that would have as
its primary task to ensure the price stability of the new European currency in
the final phase of EMU. The central bank's institutional position was better
secured than in the Werner report. On the other hand the Werner report had
gone further in its plea for a supranational European budgetary authority.
The Delors report confined itself to the formulation of binding rules aimed
at preventing excessive government deficits. The parallel currency strategy
for the ECU was rejected. The committee could merely agree that there
should be no discrimination against the private use of the ECU. The report
was unanimous. But a controversial issue remained on the table: a group of
 229

'monetarist' countries headed by France favoured the early establishment of

a European Reserve Fund in the first phase. This Fund would pool part of
the national central banks' reserves and would as appropriate intervene on
the exchange markets. Others, particularly Germany, rejected this approach
and pointed out that such a proposal would involve an institutional change
which would require a new Treaty in accordance with Article 102a, inserted
by the Single European Act. In the 'economist' vision common interventions
could thwart domestic monetary policy objectives and thus would only be
acceptable in the final phase of EMU, in which they would fit naturally.
Although the European Council in Madrid did not accept the Delors report
in its totality, no more than the European Council earlier had done with the
Werner report, the beginning of the first stage of EMU was declared on 1
July 1990. After extensive preparations in the Monetary Committee and the
Committee of Governors two Intergovernmental Conferences were called on
respectively EMU and the closely linked European Political Union. The IGC
on EMU had at its disposal a blueprint of the statutes of the European System
of Central Banks, prepared in the Committee of Governors, which would
become responsible for the common monetary policy in the final phase of
EMU. The IGC started under Luxembourg presidency in the first half of 1991
and finished its proceedings under Dutch presidency in the second half of the
year.

9.5 PREPARATIONS UNDER THE LUXEMBOURG PRESIDENCY

The drafting of the Treaty on European Union provided a good opportunity

to write the principle of the unconditional and full freedom of capital move-
ments formally into European law. 2o Because of the achievement reached in
the 1988 Directive the matter was not a controversial one and relatively little
time was spent on the drafting of the new texts. The ministerial IGC meet-
ings were prepared at the deputy level in meetings of the so-called personal
representatives. With respect to capital liberalization the Monetary Commit-
tee, too, was involved and prepared an advice for the IGC. 21 Commission
proposals for a draft Treaty suggested that in a new Article 67 the freedom
of capital movements would be established as a direct Treaty obligation and
not one depending on secondary legislation, i.e. through the adoption of
directives. The Commission considered that the logic of the Internal Market,
which would make it practically impossible to enforce controls, would ren-
der intra-European capital controls an anachronism. 22 The new article would
replace all existing directives, including the 1988 Directive, and would sim-
ply provide that all restrictions on capital movements would be prohibited.
The Articles 68 through 73 were considered outdated or redundant in the
final phase of EMU because they either dealt with the gradual liberalization
of capital movements or with exemptions.23
230

Equally uncontested was the Commission proposal that member states

would be allowed to take measures to prevent infringements of their laws
and regulations in the field of taxation and prudential supervision, or to be
able to collect statistical information. Although the principle of full freedom
of capital movements thus would be firmly implanted in the Treaty, some
issues were still left open for discussion which could constitute exceptions
to the principle of freedom of capital movements: (a) should the erga omnes
principle be written in the Treaty; (b) should the Community avail itself of
the possibility to impose restrictions vis-a.-vis third countries for political
reasons, such as financial sanctions; and (c) how long should the transitional
arrangements be and would there remain a need for safeguard clauses in the
third stage?

9.5.1 The Erga Omnes Principle

As to the regime vis-a.-vis third countries a majority was of the opinion that
the EC should apply the principle of full freedom of capital movements even
to those countries which themselves had a less liberal regime. An important
reason was that a number of member states did practice such freedom already.
If other member states were to continue restrictions vis-a.-vis third countries,
these could be easily circumvented via the liberal countries. It was noteworthy,
however, that in the French proposals for a new Treaty text reference was
made only to full freedom of capital movements between EC residents. The
most fervent proponents of the erga omnes principle on the other hand were the
Germans and the Dutch who feared that the threat of exchange restrictions vis-
a.-vis third countries would increase the uncertainties in the financial markets.
The British, while taking a liberal line, were concerned about the link between
full capital liberalization and the freedom to establish in the Community.
They wished to maintain the right to demand reciprocity, especially in the
sphere of financial services. A simple suspension of the procedure to grant an
authorization would still remain possible, it was agreed by the Commission.
But it was a question whether this should be written expressis verbis into the
Treaty. In particular the term reciprocity could form a dangerous precedent
which could weaken the erga omnes principle for capital movements.
But there were more fargoing proposals to take exception to the erga omnes
principle. Spain and Italy were of the opinion that also in cases of seriously
disturbing short-term capital movements or in cases of grave political crises
it should be possible for the Union to curtail capital movements to or from
third countries. The Commission agreed to such temporary measures which in
essence would constitute a continuation of the monetary safeguard clause at
the Community level. The Germans, British and Dutch resisted such dilution
of the erga omnes principle. In their view such disturbances could best be
dealt with by means of interest rate adjustments or by allowing the common
exchange rate to move. In any case the capital and money markets of the
 231

European Union in the final phase would be of such a large size that external
shocks could be absorbed easily.

9.5.2 Sanctions

At the time of the beginning of the discussions in 1991 the Gulf War had just
ended and the issue of financial sanctions vis-a-vis Iraq therefore was a topical
one. The Commission regretted that the provisions of the 1988 Directive did
not equip the Commission with the right to initiate concerted action in such
a case to an individual third country. The only exemption which therefore
should be made on the principle of free capital flows would concern the situ-
ation of a major political, military or economic conflict with third countries.
This should be dealt with on a Community-wide basis, analogous to the EC
competences in the sphere of trade. To this effect a text for a Community
regulation dealing with the imposition of sanctions to third countries was
proposed, which was generally accepted. 24

9.5.3 Transitional Arrangements and Safeguard Provisions

As to the coming into effect of the Treaty obligations it was proposed that
Portugal and Greece would be allowed to maintain the temporary derogations
which were granted to them under the 1988 Directive at the latest until 31
December 1995. For all other countries 1 January 1994, ie the starting date of
the Second Phase of EMU, would be the date on which all capital movements
would have to be completely freed. There were no objections voiced against
this Commission proposal.
On the basis of the discussions the Luxembourg presidency produced a
text which was discussed by the Ministers in the framework of the IGC.2S
Most notably the wishes of some member states to take restrictive measures
vis-a-vis third countries for non-political economic reasons in exceptional cir-
cumstances were retained. A wide definition was proposed for circumstances
which in the third phase could justify the taking of such temporary safeguard
measures by the Union: if capital movements caused or threatened to cause
serious difficulties for the operation of the Economic and Monetary Union
the Council at a proposal of the Commission could take restrictive measures
with a qualified majority. At this early stage there was only a brief discus-
sion among Ministers, mainly to underline specific national interests. Most
noticeably the Danish minister wished to retain the right to take preventive
measures with the aim of avoiding infringement of national tax legislation.
Another theme, reminiscent of the discussion on the 1988 Directive, was that
Denmark did not wish the freedom of capital movements to impair in any way
the existing domestic legislation which prohibited the sale of second homes
to non-residents.
232
The discussions on capital movements showed that caution prevailed.
While the principle of full freedom was confirmed, member states wished to
hedge against unforeseen circumstances, both in the run-up to EMU as well
as in its final phase. It was generally accepted that the existing safeguard
clauses, contained in Articles 108 and 109, were to be maintained in their
essential meaning for the duration of the second stage, i.e. until intra-EC
exchange rates would have been irrevocably locked, unlike the monetary
safeguard clause which would automatically lapse at the start of the second
stage. 26 These provisions gave member states with (threatening) balance-of-
payments difficulties the possibility to take safeguard measures for a limited
period of time, with the consent of the Commission. Also the clause d 'urgence
was retained, giving a member state the right in case of a sudden crisis to
take safeguard measures on its own accord. The Council was to retain the
power to modify or establish the measures with qualified majority. Of course,
in the third phase of monetary unification these articles would have to lapse,
because national balances-of-payments would have lost their meaning and a
common exchange rate policy would be followed by the ESCB. Countries
which would not participate in the monetary union by way of derogation or
would opt-out, and would thus follow their own exchange rate policy, would
retain the right to invoke Articles 108 and 109.

9.6 FINALIZATION UNDER THE DUTCH PRESIDENCY

When on 1 July 1991 the Netherlands took over the presidency of the EC, the
draft text of the Treaty, as forwarded by the Luxembourg presidency, was still
a fairly straightforward one. 27 It contained four articles, stating respectively
the freedom of capital movements; the right to take measures for statistical,
taxation or supervision purposes as long as they did not constitute a disguised
restriction; the right for Greece and Portugal to retain safeguard measures
until end 1995; and, finally, the clause to take safeguard measures when
capital movements to or from third countries (threatened to) cause serious
difficulties for the operation of EMU.
In preparing a new draft, it was decided to deal explicitly with financial
sanctions; in the Luxembourg version this was covered by general provisions.
In the comprehensive draft Treaty text, which would form the basis for
political negotiations, presented on 29 October 1991, the exceptions on the
principle of free capital movements, now including sanctions, were upheld.
It was, however, left open for political negotiation if the general safeguard
clause in the third phase, in which the Union could impose restrictions vis-a-
vis third countries, should be decided upon by qualified majority, as proposed
in the Luxembourg text, or unanimously.
Although the third phase might be way off, in fact this was an important
fight on the principle whether the future European Union would present itself
 233

as an outward-looking open area or, in line with the Commission's proposals

for a European financial area in the mid-1980s, as primarily an internal market
which should be able to shield itself against external shocks. Although a tally
in the ministerial IGC on 11 and 12 November 1991 showed that actually only
a minority of countries favoured such decisions to be taken with a qualified
majority, by way of a compromise this was accepted by the majority with the
proviso that such measures could not exceed a period of six months. As if to
underline the case of the liberal countries, it was added that such safeguard
measures could only be taken 'in exceptional circumstances' and then only
'if such measures are strictly necessary'. This formulation of course would
not stand in the way of any lenient interpretation. Moreover, it was added
that the Council could act only after having consulted the European Central
Bank.
In the final weeks before the Maastricht summit there were further attempts
to impinge on the general liberalization principle, which met with a certain
measure of success. It did not prove easy to uphold the erga omnes principle.
Eventually in Article 73c it was agreed that the Community endeavoured to
achieve the objective of free movement of capital between member states
and third countries to the greatest extent possible (see Annex 7 for all rele-
vant Treaty provisions). But in addition to the Dutch presidency text, coun-
tries would be allowed to continue to apply those restrictions vis-a-vis third
countries which existed on 31 December 1993, i.e. at the eve of the second
phase, with respect to direct investment, establishment, the provision of finan-
cial services and the admission of securities on domestic capital markets. 28
By means of this provision countries could keep in place the few protec-
tive domestic regulations with respect to underlying transactions they had
and could thus negotiate with third countries deregulatory measures, while
demanding reciprocity.29 The Union could also adopt common regimes in
these areas with respect to third countries, but unanimity would be required
if this were to represent a step backwards in Community legislation.
With these remaining departures from the erga omnes principle a latent
micro-economic motive for capital restrictions had again surfaced, as was
earlier the case in the discussions on the 1988 Directive. At earlier stages
macro-economic motives had been advanced for the maintenance of restric-
tions. In Chapter 3 some of these motives have been discussed, and in Chapter
6 a new motive, still of a macro-economic character, had come into play,
namely the wish to avoid an appreciation vis-a-vis the US dollar and for
Germany to temper the development of the Deutsche mark into an interna-
tional reserve currency. But now micro-economic motives were advanced
which carried in essence a protectionist character. The British wished to use
the reciprocity argument in order to extract concessions from third countries.
And the French wished to retain the possibility for positive discrimination of
the establishment in France of European industry.
234
Member states would retain the right to apply a different fiscal regime
with respect to capital depending on the place where it was invested or the
residence of the owner (Article 73d(1)a). This provision was additional to
the clause in the original Luxembourg text for Article 73d which allowed
measures to prevent infringements of national law in the field of taxation
and prudential supervision. It was added that measures could also be taken
which were justified on grounds of public policy or public security, despite
hesitations from the German side as to the precise meaning of such provision.
This was not entirely cleared up, but a provision was added that such measures
should not constitute a means of arbitrary discrimination or a disguised capital
restriction (Article 73d(3».30
Finally Article 73g was agreed upon, which would allow restrictions to be
taken in case of financial sanctions. Such restrictions could be either taken
by the Community as a whole, but on grounds of urgency a member state
could also do so on its own initiative 'for serious political reasons' . However,
the Commission and other member states should be informed immediately
of such measures. The Council could by a qualified majority decide that the
member state should amend or abolish such restrictive measures.
All in all, the Treaty text on capital movements does not unequivocally
embrace the erga omnes principle. The sheer length of the exceptions and
their sometimes vague wording bears testimony of the wish of member states
to retain a margin of manoeuvre vis-a.-vis third countries. The importance of
the Treaty is primarily that the freedom of capital movements now is directly
applicable. Thus the scope of freedom of capital movements is extended
beyond what is 'necessary to ensure the proper functioning of the Common
Market', the escape clause contained in the Treaty of Rome. Now capital
freedom was put on the same footing as the other freedoms foreseen by the
founding fathers. This implied that freedom of capital had direct effect and
conferred legal rights on individuals.
An important element for the effective freedom of capital movements is
that the Treaty on European Union contains stringent provisions to bar the
privileged access of governments to financial markets from 1 January 1994.
This is done via two routes. First, Article 104 forbids central bank financing
of governments. This serves at the same time to underline the independence
of central banks vis-a.-vis governments. Second, according to Article 104a
any regulation which favours government financial instruments or forces
financial institutions to buy government debt instruments is forbidden. On
the basis of these articles decisions were adopted which spelled out in detail
the prohibitions. By putting governments on the same footing as private
credit-takers, governments have a much greater interest in good-functioning
financial markets. It constitutes a powerful argument for the irreversibility of
the liberalization of capital markets.
 235

9.7 THE FUTURE OF THE MONETARY COMMITTEE

In the third and final stage of EMU monetary policy will have been centralized
in the European System of Central Banks. Also there will be a single exchange
rate policy of the Union, under a shared responsibility of the Ecofin Coun-
cil and the European Central Bank. This changed institutional environment
implies that the tasks of the Monetary Committee will undergo important
changes. So as to underline this switch the Treaty on European Union pro-
vides that the committee will be renamed Economic and Financial Committee
at the start of the third stage. In Article 109c important advisory functions
are foreseen, in particular concerning the policy mix between the common
monetary policy and the national economic policies of member states, the
avoidance of excessive budget deficits, the external exchange rate policy and
the situation regarding the movement of capital. Because of the increased
competences of the Ecofin Council in the Union, it is likely that the posi-
tion of the new Economic and Financial Committee in the preparation of the
Council meetings will further increase. In a formal sense, though, elements
of the old advisory function of the Monetary Committee will be maintained.
As to the composition of the Economic and Financial Committee it is only
provided that each member state will appoint at most two persons, as well
as the Commission and the European Central Bank. It is a matter of debate
whether national central bank representatives will be member in the new
committee. In the Committee of Governors, when discussing these matters,
some doubts were expressed as to the wisdom of the participation of the ECB
in the committee, because of its explicit mandate to prepare the work of the
Council with respect to the EMU. The independent position of the Euro-
pean System of Central Banks, so it was felt, might be endangered. These
fears, however, were brushed aside in the Intergovernmental Conference. In
the second stage, however, the Monetary Committee maintains its present
composition, retaining formally its advisory functions. The reprentation of
national central bank officials in the committee during this phase is crucially
important because of the delicate policy mix in the run-up to monetary uni-
fication, the functioning of the EMS and the preparation of the final stage
of EMU. Representatives of the European Monetary Institute were invited to
attend the meetings from the start of the second stage.
In the aftermath of the signing of the Treaty on European Union there were
attempts to infringe on the competences of the Monetary Committee in a study
group of personal representatives of the ministers of foreign affairs, which
was established to make proposals for streamlining the Council's machinery.
In particular it was proposed to subordinate the committee to the Commit-
tee of Personal Representatives (Coreper), i.e. the national ambassadors, and
transfer the secretariat to the General Secretariat of the Council. This drew
indignant reactions of the Monetary Committee, which in a report to the min-
isters, identified five vital points for the unhampered functioning of the com-
236

Index; January 1990=100 (currency against DMark)

110 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

105 --A"'l..-~--?\----------

':: .e'$-;~;;y~~
90 ----------r-"'d'\:.+~--
85 _ _ _ _ _ _ _ _ _ _ _ ~~----~-
80 _ _ _ _ _ _ _ _ _ _ _ _\ ~~~-~~-- "
\/_ _ ~~~-
75 _ _ _ _ _ _ _ _ _ _ _ _ _ , "
...
70 rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrri
90 91 92 93 94

Dutch French Belgian British Spanish Italian

guilder franc franc paund peseta lira

Fig.21. Crises in the EMS.

mittee: it should retain all competences assigned to it by the Treaty; it reports

directly to the Ecofin Council; it chooses its own chairman; the secretariat
works on instructions of its chairman alone; and attendance would remain
limited. These principles were confirmed in an informal Ecofin meeting in
Oporto in May 1992 and indeed existing arrangements were maintained.

9.8 CRISES IN THE EUROPEAN MONETARY SYSTEM

The Treaty on European Union was adopted on 9 and 10 December 1991 in

Maastricht and signed on 7 February 1992. Soon after the signing ceremony
doubts started to arise whether the Treaty would be accepted in all 12 member
states. In the run-up to Maastricht and in the first subsequent months the
sentiment in the market had grown that the Exchange Rate Mechanism of
the EMS in fact had developed into a quasi monetary union, in which the
exchange rates need no longer be adjusted. Some of the authorities embraced
such wishful thinking as well. They increasingly considered an exchange rate
adjustment as an ultimum remedium which should be avoided at any cost,
contrary to the Basle/Nyborg understandings. It was forgotten that economic
developments in a number of countries had begun to diverge again and that
the exchange rates no longer were based on the fundamentals. Investors
considered the exchange risk to be minimal and invested capital in currencies
with the highest interest rate. In this way a high-yielding, but fundamentally
 237

weak currency as the Italian lira traded at the upper end of the fluctuation
band, whereas the Deutsche mark was trading at the lower end (see Figure
21).

9.8.1 The September 1992 Crisis

The sentiment causing this inverse ranking of ERM currencies reversed

abruptly when the Danish population in a referendum on 2 June 1992 reject-
ed the Treaty by a narrow margin. The euphoria which had surrounded the
Maastricht Treaty quickly dissipated. In its slipstream the EMS no longer
was viewed as a quasi-monetary union, but regained its original character as
a system of fixed, but adjustable exchange rates. Strong pressures developed
on the weak currencies, in particular on the Italian lira. But also outside the
EMS, Scandinavian countries which had linked their currency to the ECD
came under fire.
The perils in Scandinavia,leading to a devaluation and subsequent floating
of the Finnish markka and extreme pressures on the Swedish krona, increased
the awareness of an exchange risk within the EMS.
When speCUlative capital flows started to increase, the authorities were
reluctant to increase interest rates because of a generally weak economic situ-
ation at home. On the contrary, the Deutsche Bundesbank was publicly called
upon to lower its interest rates, which in the wake of German unification and
its attendant inflationary consequences were kept relatively high. The Bun-
desbank refused to lower its interest rates out of fear that this would endanger
further domestic price stability. In fact, the controversy which dominated
European monetary arrangements ever since 1973, i.e. whether they should
be operated in a symmetrical or an asymmetrical manner, had surfaced again.
The financial markets could only deduct from this that countries were not
prepared to accept the consequences of the maintenance of the exchange rate
for domestic interest rates. Thus, a one sided exchange risk developed which
made speculation highly attractive.
The principal weapon used by the authorities were large-scale interventions
which, however, were not able to stem the tide. Finally, on 14 September
1992, a devaluation of the Italian lira was agreed, followed-up by a marginal
decrease of interest rates in Germany. This was, however, not considered
credible in the markets and attacks were resumed on the remaining candidates
for devaluation: the British pound sterling and the Spanish peseta. On Black
Wednesday, 16 September, ERM membership of sterling and of the lira, which
had come under renewed attack, were suspended and the Spanish peseta was
devalued. This unlucky episode was followed by repeated speculative attacks
on most other currencies in the ERM. For some countries the pressure was
such that temporary capital restrictions were reintroduced. Some critics of
abolition of exchange controls felt vindicated by these developments.
238
Empirical evidence on the basis of the experiences of Portugal and Spain
suggests that the effect of the reintroduced restrictions was limited and short-
lived. 3 ! Both countries took measures to restrict lending in national curren-
cy to non-residents in order to forestall speculation against their currencies
through the subsequent selling of these holdings in the foreign exchange mar-
kets. In the case of Portugal the domestic market was shielded to a certain
extent from the subsequent sharp rise of the Euro escudo interest rate. Spain,
which used the instrument of non-interest bearing cash reserves for incremen-
tal peseta lending to nonresidents, maintained the linkage between domestic
and Euro markets. But in both cases the restrictions were, apart from a short-
lived positive shock effect on the exchange rate, not effective in containing
speculative pressures, and both currencies were devalued on 23 November
1992. The restrictions were soon lifted, also because of their negative indirect
effects on other capital flows. Non-residents disposed of securities denomi-
nated in peseta and escudo, leading to a sharp drop in domestic bond and share
prices. Both countries were confronted with sales of financial investments by
fund managers who were unable to cover their positions and decided to bring
down the peseta and escudo share in their portfolios. Within two weeks the
Madrid stock exchange had fallen more than 15%, whereas long-term interest
rates had risen substantially. The negative repercussions on long-term capital
flows weighed heavily, because these countries were dependent on exter-
nal finance for economic development. In view of these negative confidence
factors the restrictions were abolished in both countries before the end of
the year. The brief experimentation with controls had not been a success.
Notwithstanding the severe pressures Spain and Portugal therefore did not
renege on their commitment to liberalize. On 1 January 1993 Ireland was the
last country to abolish exchange control. The deadline of the Internal Market
had been adhered to. Only Greece, which was outside the ERM, maintained
restrictions under its agreed derogation position.

9.8.2 The August 1993 Crisis

The discussion on free capital flows once more was opened in the aftermath
of the second wave of speculation in the EMS in the summer of 1993. After
repeated speculative attacks on the French franc and other weak currencies,
and massive intervention by central banks, the Banque de France spending
the equivalent of3% of gdp on 29 July, the fluctuation bands in the Exchange
Rate Mechanism were widened to 15% on 2 August 1993. This sparked off
a host of comments. President Mitterrand commented that 'it was immoral
that speculation could ~o unhampered, disturbing the lives of millions of
powerless individuals'. 2 He called on a speeding-up of the introduction
of EMU in order to fight the 'financial conspiracies'. Also Prime Minister
Balladur rallied against 'the excesses of freedom' and said that there was 'an
economic and moral duty' to find ways to curb such flows. Prime Minister
 239

Dehaene of Belgium went one step further by speaking of an Anglo-Saxon

plot and calling for immediate measures to protect against speculation. 33
Understandable as this Franco-Belgian call for measures was, it became
quickly clear that there was little chance that controls would be reimposed.
The Ministers of Finance of France and Belgium, Alphandery and Maystadt,
quickly silenced suggestions of a reimposition of controls. 34
The debate was reopened by Jacques Delors in a speech before the Euro-
pean Parliament on 15 September 1993.35 It was an ironic turn of fate that
the great proponent of freedom of capital movements now seemed to back-
track. Pointing to the sharply increased level of capital mobility and the size
of turnover in the international markets, dwarfing the ammunition of central
bank reserves, De10rs proposed that capital movements should respond to
certain rules of the game: 'Pour prendre un example routier, les voitures sont
libres de circuler, mais il y a quand meme des limites a la circulation.' He
suggested that the Community take international initiatives to regulate cap-
ital movements. Moreover, he reminded that the monetary safeguard clause
(Article 3 of the 1988 Directive) could still be invoked, permitting restrictive
measures.
The reactions to the Commission's suggestions to think about the re-
imposition of exchange controls drew immediate and forceful rebuttals from
the liberal countries. Bundesbank President Tietmeyer in numerous speeches
forcefully opposed such a step back. In a typical reaction he said: 'There
is a common understanding that freedom of capital movements is a major
and indispensable achievement on the road to monetary integration. So, don't
let us put this important achievement at stake as soon as we experience a
surge of market reactions in the trial-and-error process which finally leads
to sustainable eqUilibrium positions. ,36 Also the Governor of the Bank of
England George held against those commentators who saw the remedy in the
reintroduction of capital controls or other techniques inhibiting the freedom
of capital movements that they 'mistook the symptom for the disease' .37
There were those who favoured a step back. There were also those who
favoured the surge forward and argued that the exchange rate problem posed
by the free movement of capital could only be solved by an early move to a
European single currency. This was opposed by the same commentators. By
the British because the underlying problem of diverging policy needs would
not simply go away. By others, because the problem of diverging economic
performance would not go away. The Maastricht convergence criteria were
not adhered to and thus it was not possible to jump forward in a credible
manner. The only feasible way seemed to be to continue to 'muddle through'
and to turn the liability of a strained EMS into an asset which provided the
opportunity to regain credibility, not by rules but by policy actions. Only
by pursuing stable and sound economic policies the 'incompatible triangle'
could be overcome. This was not to say that markets could not be destabilizing
240

but by creating two-way risks in the exchange market and firm and consistent
policies this should be overcome.

9.9 RESTRICTIONS REVISITED

The discussion on restrictions, sparked of by the currency turmoil in Europe,

centered on two specific types: a tax on foreign exchange turnover, and reserve
requirements on banks' foreign exchange transactions. The pros and cons will
be briefly reviewed.

9.9.1 Taxation of Foreign Exchange Turnover

The fear for speculative capital movements combined with the drawbacks of
capital controls have induced economists to come forward with alternative
plans to shield the economy from undue external pressures. One old plan,
which at the time had received particular attention from policy makers, had
been forwarded by James Tobin as early as 1978, and now was unshelved by
others. Tobin had proposed to 'throw some sand in the well-greased wheels'
of the international money markets through the imposition of a uniform tax on
all foreign exchange transactions. His proposal was launched at a time when
many academics had become disappointed with the functioning of the floating
rate regime. Flexible rates had not been 'the panacea' their more extravagant
advocates, mostly academics as well, had hoped. Starting from the premise
that goods and labor markets move much slower in response to price signals
than the financial markets, Tobin argued that the foreign exchange markets are
adrift without anchors and in the absence of any consensus on fundamentals.
He was sceptical that 'the price signals these unanchored markets give are
signals that will guide economies to their true comparative advantage, capital
to its efficient international allocation, and governments to correct macroeco-
nomic policies'. Tobin saw two ways which could be followed: one toward a
common currency, the other toward financial segmentation between currency
areas. The first route not being an immediately viable one, he 'regretfully'
recommended the second one.
In the original plan of Tobin the tax would be applied world-wide in a
uniform manner to all conversions of one currency into another in the spot
market. By its nature it would discourage especially short-term flows, because
then the interest differential would have to be relatively large in order to over-
come the costs of the conversion tax. For longer-term portfolio investments
or direct investment the cost would be small: in fact 'a permanent investment
in another country or currency area, with regular repatriation of yield when
earned, would need a 2% advantage over domestic investment'. Effectively it
would also have to apply to cross-border trade involving currency exchange,
because there would be no other way to prevent financial transactions to be
 241

disguised in the form of trade. The negative effects on international trade

links could be mitigated by the creation of currency areas within which the
tax would not apply, 'presumably the smaller EEC members and those LDCs
which wished to tie their currency to a key currency'. Tobin hoped to restore
to governments some fraction of the short-run autonomy they had lost with
the increasing efficiency of financial markets.
It is not difficult to see why the proposal attracted attention of some pol-
icy makers, then and now again. The proposal seemed to promise that it
would check financial flows which bore no relation to the real world, by
raising their costs. The lure was that the policy-makers would be seen as
doing something against those money-grubbing speculators who damaged
and sometimes ruined their political reputation. At the same time, it was clear
for most observers that such a proposal would not fly. The objections were
manifold. The most important drawback was that it would damage normal
legitimate financial and trade relations in quiet times, while its effects as to
frightening-off speculation in turbulent times would be doubtful. The gains
to be made by speculators in case of a devaluation of a pegged currency
were a multiple of the tax and would not detract from the need to defend the
currency by other means, including interest rate increases, as well. There was
also the question as to how to reach European or even world-wide consensus
and enforcement of such a tax, not to mention the question what to do with
the proceeds.
As discussed in Chapter 8.2 the disadvantages of the 'traditional' direct
restrictions were (a) the limited and decreasing effectiveness, (b) the high
operational costs and (c) the efficiency losses because of suboptimal alloca-
tion. On the latter two disadvantages the Tobin tax if anything scores worse
than direct restrictions. A tax of 1 or 2% implies a heavy cost with the
increased level of capital flows and does not only harm these flows, but also
potentially affects the underlying flows of trade and services. As postulated
in Chapter 2 taxation is not less harmful to allocation than more direct forms
of restrictions. The advantages of the Tobin tax therefore should lay in its
allegedly easier practicability and greater effectiveness. But it is precisely at
times of large disturbances that the tax has an insufficient deterrent effect.
The proposal of a Tobin-tax therefore was quickly rejected in the late 1970s.
When some politicians, among whom Jacques Delors, advocated a study of
the merits of such tax in the aftermath of the EMS crises, the reception of the
proposal was equally cool.

9.9.2 Reserve Requirements on Foreign Exchange Positions

Eichengreen and Wyplosz (1993) have advocated the temporary establish-

ment of margin requirements on open foreign exchange positions of banks
and other financial institutions. The costs of such non-interest bearing reserve
requirements would raise the costs of speculation, even more so if in-
242
terest rates were hiked as well to discourage speculation. The wish to control
short-term capital movements, e.g. by such margin requirements, is based
on the conviction that speculators use this route for taking short positions
in currencies under attack. There are basically two methods of taking short
positions. The first method is to sell the weak currency in the forward market.
Forward sales ceteris paribus will cause downward pressure in the spot mar-
ket and upward pressure on the interest rate. Under normal circumstances,
this type of position-taking is relatively easy and cheap and does not involve
great recourse to bank credit. However, in crisis situations the forward mar-
ket can easily become illiquid. In that case investors have to sidestep to the
second method of taking a short position: borrowing the weak currency and
converting the proceeds into strong currency deposits.
In practice it is not easily determined whether both types of transactions
are outright speculation or whether they are merely used to cover either
outstanding debts in the strong currency or claims in the weak currency.
However, if the underlying claim serves as collateral for the bank credit it
can be assumed safely that the transaction is a cover operation. Fears of
an imminent currency crisis also can be countered by the outright sale of
claims denominated in the weak currency instead of undertaking hedging
transactions. Also in this case a surge in (international) bank credit is likely
to occur because market makers, who at the time of a crisis probably are the
only buyers, wish to cover their own position in tum. 38
In these circumstances attempts to try to counter speculative movements
through the imposition of reserve requirements can be counterproductive. If
institutional investors find the route for normal hedging operations closed
because of sharply raised costs, it is likely that they will proceed to liquidate
their assets as the only viable way of minimizing possible exchange losses. 39
Institutional investors characteristically try to diversify their risks. Ifthe per-
ception of an exchange risk is increasing, non-resident investors most likely
will react stronger than the domestic investors. Institutional investors will
be particularly concerned if there is concern that their assets could become
trapped because of the reimposition of capital controls. In this way restrictions
on short-term capital movements can work their way through in the long-
term markets. Particularly if the country concerned has a history of switching
on and off capital controls, as is implied in the proposals of Eichengreen
and Wyplosz, this will tend to lessen the attractiveness of the currency for
investors. Therefore, short-term capital controls meant to deter outright spec-
ulators in practice may frighten off long-term investors as well. Furthermore,
they deter potential new foreign entrants on the domestic capital market.
As we have seen in this study the imposition o{ cash reserve requirements
has had only fleeting success in warding off speCUlation. The experiences
of Germany 'and France in the beginning of the 1970s were unsuccessful
(see Chapters 6.6 and 6.7) as was the experiment in Spain in the end of
1992 (Chapter 9.8.1). More in general reserve requirements tend to dislocate
 243
financial activity to other financial centres. Reserve requirements for instance
have contributed to the growth of Deutsche mark deposits in Luxembourg.
For the instrument to be effective it would be necessary that it were applied
on a European if not larger scale. There is no chance that such EC regime
would come about, given the reservations of the monetary authorities in major
financial centres. The risk would be too great that a 'Euromarket' in the EC
currencies would develop in financial centres outside the Community. 40
There are important practical obstacles as well with respect to the impo-
sition of margin requirements. The magnitude of open foreign exchange
positions by commercial banks is limited by prudential supervisory regula-
tions. It is normally not the proprietary trading of banks themselves which
generate large capital movements, but rather transactions on behalf of their
clients or directly from other financial institutions. As to the latter it is not
obvious that the authority exists which could impose requirements on those
non-bank institutions. Moreover, to be effective a very frequent, if not daily
reporting of exchange positions would be required, which in practice would
impose high costs on the institutions and the administrative bodies which are
supposed to monitor this. As elaborated before, it is not possible to develop
an objective method which would distinguish between normal hedging trans-
actions, which are directed precisely towards the closing of open positions,
and the taking of speculative positions. Finally, margin requirements on open
positions would seriously hamper normal uncovered portfolio diversification
operations by institutional investors.

9.9.3 Liberalization in Greece

Freedom of capital movements was not to be obstructed by the exchange

tUlIDoil. When Greece on 16 May 1994 abolished its remaining restrictions,
all member states had fully liberalized capital movements. The Greek move
had been preceded by considerable speculation that the abolition of capi-
tal controls, which had to take place before end-June, would be combined
with a substantial devaluation of the drachma. In defence of the exchange
rate interest rates were hiked up and the abolition of exchange control was
brought forward. The exchange crisis was withstood and the strengthening of
confidence enabled a decrease in interest rates to lower levels than before the
crisis. As other countries Greece embarked on a program of modernization of
its money and capital markets. Combined with full freedom of capital move-
ments this may help attract foreign investment on condition that budgetary
discipline is restored. In any case the disincentive to place capital in Greece,
stemming from uncertainty about the ability to repatriate, had been removed.
244

9.10 CONCLUSION

The 1988 directive which provided for the full liberalization of capital move-
ments had been implemented in a satisfactory manner. Action by member
states to remove restrictions well in advance of the formal deadline was
generally regarded by the financial markets as a sign of strength. Capital
liberalization, decreasing inflation differentials and satisfactory cyclical cir-
cumstances all provided a virtuous circle, mutually reinforcing each other. If
member states which abolished restrictions experienced any problems, these
were mainly caused by capital inflows attracted by relatively high interest
rates, market participants being oblivious of the exchange rate risks involved.
The large inflows pushed up the exchange rates of the former weak-currency
countries in the band of the Exchange Rate Mechanism and thus gave an
unusual sense of comfort to countries where the exchange rate normally
would trade at the lower end of the fluctuation band. The inverse position of
the participating currencies lured some market participants to the conclusion
that Europe was already in a quasi-monetary union.
In this atmosphere of confidence there were no major obstacles to include
the freedom of capital movements as a directly applicable obligation in the
Treaty on European Union. Also other provisions were included in the Treaty,
notably with respect to avoiding excessive budget deficits and banning their
privileged financing, which made the liberalization of capital movements
virtually irreversible. The real breakthrough having taken place with the
adoption of the 1988 Directive, a traditional phenomenon surfaced with the
codification in the Treaty: member states became very cautious when it came
down to the actual drafting of legally binding texts. Thus the Treaty does
not unequivocably embrace the erga omnes principle and leaves open the
possibility for member states and, in the third stage, for the Union to take
temporary safeguard measures in exceptional and serious circumstances. The
wish to retain a margin to manoevre in this respect prevailed over the expe-
rience that precisely in those circumstances capital controls had proved to be
of no avail.
The Treaty on European Union comprised a workable blueprint of a mon-
etary union of which a truly integrated European capital market would form
a constituent part. The transitional second stage of EMU would provide an
opportunity to see whether in an ~nvironment of free capital movements
member states would on their own conduct balanced macro-economic poli-
cies directed towards price and exchange rate stability. Thus the credibility of
policies would be put to the test of the financial markets. As regards monetary
policy central banks in many countries were endorsed with a larger degree of
independence, in anticipation of the third stage of EMU, and a clearly -defined
mandate to pursue domestic price stability in order to remove uncertainties
in the financial markets.
 245

Budgetary policies proved to be the Achilles heel of capital liberalization.

When widened budget deficits in Germany, caused by the costs of unification,
pushed up interest rates in Europe, doubts emerged whether other countries
were prepared to follow suit in a rather subdued cyclical situation. Put to the
test by the markets, countries hesitated to defend the exchange rate through
a hike-up of interest rates. The EMS crises painfully' demonstrated that the
pursuit of exchange rate stability has to be underpinned not only by stability-
oriented macro-economic policies, but also by the willingness to use the
interest rate instrument in defence of the exchange rate, once more if a four-
square track record of the authorities in this respect was lacking. Moreover,
lax budgetary policies outside Germany, which no longer could be financed
by having recourse to the central bank or to privileged access to domestic
markets, added to the uncertainty.
There were nagging doubts about the wisdom of capital liberalization
when the European Monetary System in a sharply changed environment
came under severe pressure. Capital liberalization had increased market dis-
cipline, but this disciplinary effect came late and therefore with all the more
force. Some countries which were still allowed to do so without calling in
the monetary safeguard clause experimented briefly with a reintroduction of
exchange controls. This however, proved to be counterproductive as interna-
tional investors shied away from longer-term investments in these countries
as well. Proposals to impose a Tobin-tax or take other measures to regulate
capital flows were briefly discussed but they were quickly discarded, because
their costs would be high and their effectiveness remained in doubt. It was
recognized that toying with the idea of reintroducing capital controls could
further undermine the confidence in the currency concerned and thus would
be counterproductive. The episode left Europe sadder and hopefully, wiser.
Just as exchange controls had not been able to shield the domestic currency,
their abolition was not a cure which could avoid painful adjustment mea-
sures. The disciplinary effects, which proponents of capital liberalization had
claimed, had come after all, only later than expected. Though painful, these
disturbances had the beneficial effect of forcing authorities to put their house
in order and pursue fiscal consolidation, which sooner or later would have
become unavoidable in any case.
The progress made with respect to capital liberalization has been impres-
sive. The contrast with the situation in the first half of the 1980s is remarkable.
With the liberalization in Greece in May 1994 all EC member states have
abolished all controls and there has been no recourse to the safeguard clauses.
The main remaining obstacles now concern domestic regulations which, in
conformity with Article 73c, have remained in place. Such obstacles relate
intra alia to investment in financial services, where reciprocity requirements
are applied, and to inward direct investment where in most countries govern-
mental authorization is called for in specific sectors, such as communications,
fishing and transport. These obstacles, however, are of minor importance in
246
comparison with the earlier restrictions and are mainly taken for micro-
economic reasons. Their abolition would bring a truly integrated European
financial area closer, to be crowned by monetary unification.

N01ES

1. The remaining restrictions concerned the opening by residents of bank accounts abroad or
of foreign currency deposits. ECU deposits, however, were no longer restricted, as a final
testimony to European favouritism.
2. On 1 March 1989 a reserve requirement on incremental foreign exchange deposits was
reintroduced in order to discourage credit taking in foreign currencies. The latter had
surged under influence of relatively high Italian interest rates.
3. Ireland, which had a tradition of treating capital movements within the EC more liberally
than with non-EC countries, did maintain certain restrictions on outward investment flows
outside the Community.
4. Address by Minister Ray MacSharry to the Institute of Bankers, 11 November 1988.
5. The Irish decision to wait was mainly one of administrative convenience, since the powers
under the Exchange Control Act lapsed at the end of 1992. Thus the simplest course of
action was to let them run their course.
6. In June 1988 authorization requirements were tightened with respect to the taki~-up by
residents of credit abroad, and in 1989 a penal deposit requirement was introduced on
foreign borrowing. Both restrictions were abolished in the first half of 1991.
7. Some minor restrictions were maintained on the export of bank notes and gold, as well as
on the issuing of securities by non-residents in the domestic capital market.
8. Banco de Portugal, Annual Report 1991, p. 87.
9. The Banca d'Italia had warned after the full liberalization of capital movements: 'If we
are to hold our own in the EC, however, there is still much to do (...) if we failed in this,
we would risk ourselves in a position of inferiority in the very edifice we are helping to
build. The urgent tasks facing us are to restore sound public finances and defeat inflation. '
Annual Report 1989.
10. France requires authorization of direct investment by non-EC owned companies, the
United Kingdom maintains powers to restrict direct investment in case of national interest.
11. Germany removed the remaining restriction on purchases of certain categories of govern-
ment bonds by non-residents on 1 January 1991.
12. Memorandum of the Commission on The free movement of capital in the Community,
dated 27 November 1990.
13. Meeting of the Ecofin Council on 12 December 1988.
14. Under the heading 'la d6localisation n'a pas eu lieu', Investir Magazine on 16 June 1992
wrote: 'C'6tait la grande peur de 1989. Accabl6e d'impOts, brim6e par des contraintes
qu'ignoraient nos voisins, 1'6pargne fran~aise sous pression allait s'envoler, aspir6e par la
broche ouverte dans Ie contrOle des changes.' But interviews with commercial banks and
the Banque de France confirmed that such deplacements had not occurred on a significant
scale.
15. Solvency Ratio Directive (EEC/89/647). Earlier the Own Funds Directive (EEC/89/299)
had been adopted in which the Basle definitions of Tier I and Tier II capital for the own
funds of credit institutions were assumed.
16. In a lecture in Frankfurt on 2 July 1987 Minister Balladur stated: 'I do not believe that
such a radical step forward as the establishment of the internal market in 1992 can be taken
without parallel advances in the monetary domain. (...) The EMS has not been conceived
as a simple agreement on fixed exchange rates. Its final objective indeed is an economic
and monetary union equipped with a European currency, issued by a European Central
 247
Bank'. It is significative that Balladur in this wide-ranging lecture did not one single time
mention the ECU. AuszUge aus Presseartikeln, Deutsche Bundesbank, 3 July 1987, p. 4-8.
17. Hans-Dietrich Genscher (1988), Memorandum fUr die Schaffung eines europilischen
WlUmmgsraumes und einer europilischen Zentralbank (Note on the creation of a European
monetary space and a European central bank), Bonn (26 February).
18. Admittedly the preamble of the Single European Act recalled that 'at their Conference
in Paris from 19 to 21 October 1972 the Heads of State or of Government approved the
objective of the progressive realization of economic and monetary union', but this was
history as well, and there had been no meaningful follow-up.
19. Report on Economic and Monetary Union in the European Community, Luxembourg,
1989. The outside experts were Miguel Boyer, Alexandre Lamfalussy and Niels Thyge-
sen. The European Commissioner for Economic and Monetary Affairs Frans Andriessen
was also member of the committee. GUnter Baer and Tommaso Padoa-Schioppa were
rapporteurs.
20. As discussed in Ch. 7, p. 162 the Single European Act had not rendered inoperative the
escape clause of Article 67.
21. The debates on the capital provisions in the Treaty were concentrated in the working group
of the personal representatives. These representatives in the IGC normally were the same
persons as the Treasury representatives in the Monetary Committee. Discussions in the
Monetary Committee ensured that the view of central banks was heard as well, while the
central bank representatives could liaise with the Committee of Governors.
22. Note by the Commission on EMU and capital liberalization, dated 5 February 1991.
23. Articles 68, 69 and 71 dealt with the progressive liberalization of capital movements and
thus became redundant in the context of freedom of capital movements. Articles 70 and 73
contained exemptions and safeguard clauses to the freedom of capital movements which
were considered undesirable. Article 72, which dealt with the collection of statistical
information, became redundant because the ESCB would become responsible for this, cf
Article 5 of the ESCB Statutes.
24. Proposal from the Netherlands delegation for Articles 67-73 (UEMl39/91), dated 2 April
1991.
25. Non-paper from the Luxembourg presidency (UEMl41191), dated 3 April 1991, discussed
in the meeting of the Intergovernmental Conference at ministerial level of 8 April 1991.
26. Articles 108 and 109 have been relabeled 100h and 109i in the Treaty on European Union.
The imposition of capital controls on the basis of these articles would seem to be at odds
with the principle of freedom of capital movements. Its actual use, therefore, will be
very much a matter of interpretation. As regards the monetary safeguard clause, compare
Chapter 8, note 36.
27. In the final Ministerial IGC under the Luxembourg presidency on 10 June 1991 the issue
of capital liberalization was not touched upon at all. The respective non-papers of the
presidency on the articles with respect to capital movements remained, apart from minor
drafting amendments, unchanged from the April 3 text.
28. Even after the agreement reached in Maastricht on the text of the Treaty there still was
a category added in the so-called nettoyage process, in which the texts were screened on
small irregularities of a textual nature. At the request of Greece on 14 January 1992 it was
specified that direct investment could include investment in real estate. Greece wished to
have a legal basis to prevent that real estate in the North of Greece would be acquired by
residents of Macedonia.
29. The Commission had an active hand in the promotion of this provision. The Dutch
Presidency draft text had caused concerns in DG II since no longer a distinction was made
between 'capital movements' and 'transfers in respect of capital movements'. Thus in
the Commission's view the text could have undermined reciprocity conditions in existing
financial services directives and could have abolished in one stroke the few remaining
reservations by member states under the OECD Codes. The Commission felt that member
248

states were not fully aware of the implications the original text might have in areas other
than direct exchange controls.
30. Where the balance will be struck between Articles 73d(1)a and 73(d)3 remains to be seen.
The Commission, concerned about possible intra EU tax discrimination, tried, without
success, to eliminate Article 73d(l)a, which was basically inserted by certain member
states which were worried that they would be obliged to extend tax credits to companies
in tax havens.
31. For a further elaboration see Sleijpen (1994) and Fieleke (1994). Ireland, too, took mea-
sures during the European currency turmoil. It suspended authorization of swap operations
in order to ensure that these were not used to circumvent restrictions on short-term capital
movements still in force.
32. Interview in Sud-Ouest, 16 August 1993.
33. Interview in Le Soir, 13 August 1993.
34. Interview with Reuters, 16 August 1993; respectively in Le libre Belgique, 16 August
1993.
35. Reprinted in Auszllge aus Presseartikelen, Deutsche Bundesbank, no. 64, 21 September
1993.
36. Hans Tietmeyer in a statement at the Frankfurt European Banking Congress on 19 Novem-
ber 1993, as reproduced in Deutsche Bundesbank, Auszllge aus Presseartikeln, 22 Novem-
ber 1993.
37. Eddy George in a statement at the Frankfurt European Banking Congress, see note 36.
38. According to a study of the IMP staff during the September 1992 crisis in the EMS
institutional investors have used the three types of transaction - forward cover (hedging),
'short' sales against collateral and liquidation - roughly in equal proportions.
39. The experience of Ireland in the aftermath of the September 1992 crisis seems to vindicate
the view that a clamp down on possibilities of hedging leads to a wholesale unloading of
the basic instruments. German disinvestment of £ 1 billion accounted for 60% of the total
disinvestment from Irish gilts in the second half of 1992.
40. See also William Lightfoot, Capital controls will only hurt, mr Delors, in: Wall Street
Journal, 30 September 1993.
 CHAPTER 10

Conclusion

10.1 GENERAL OVERVIEW

European countries have taken diverging attitudes vis-a.-vis capital controls

as an instrument of economic policy. In the first post-World War II years
all countries had an extensive array of controls out of sheer necessity. Full
exchange convertibility for trade-related payments was not restored until late
1958. Some countries, in particular Germany, soon liberalized most capi-
tal transactions as well, but the large majority retained exchange controls.
In the Treaty of Rome a limited obligation to liberalize capital movements
was agreed upon, confined by an escape clause providing that such liberal-
ization should only take place to the extent necessary to ensure the proper
functioning of the Common Market. In the first years of the Community of
the Six common obligations were agreed upon requiring member states to
refrain from restrictions on those transactions which were deemed to have
the closest link to trade and direct investment and thus would contribute most
to fostering economic growth in the Common Market. The improved eco-
nomic performance in Europe and the building-up of a comfortable level of
international reserves were conducive to this relaxation of controls. But soon
the momentum was lost and after the adoption of the first two directives on
capital liberalization all subsequent attempts on the part of the Commission to
advance came to nothing. Member states were not willing to dismantle restric-
tions on short-term capital flows and some of them kept in place a number
of controls on long-term capital flows as well, such as issues on domestic
capital markets and cross-border transactions in shares of unit trusts. Also
domestic regulations were maintained which de facto protected the domes-
tic capital market by discriminating against non-residents. Ways parted as to
what member states were prepared to do on an individual basis. G~rmany was
close to full liberalization in the 1960s and France experienced a brief spell
of near-freedom of capital movements. The latter was abruptly interrupted by
the domestic unrest following 'les evenements' in May 1968. Other member
states kept control systems in place throughout the decade. Thus the attitude
among the original six founding members of the European Community varied
along the whole spectrum from a liberal to a dirigistic attitude.
At the beginning of the 1970s, in the changed international environment
characterized by large speculative money flows fleeing out of the US dollar,
there was a move in the opposite direction, culminating in the 1972 Directive
aimed at regulating international capital flows. For some time the regulation

249
250

of capital flows became even one of the proclaimed aims of monetary policy.
The reintroduction and strengthening of capital controls which followed upon
the oil crisis of 1973 was a major further step back. The different policy
responses of the large European member states, now including the United
Kingdom, resulted in large divergences in macro-economic performance. In
this atmosphere the political willingness to work together towards European
integration was lacking. In the transitional phase, following the switch to
floating and preceding the establishment of the EMS, the Community more
or less muddled through, combining a wide variety of exchange arrangements
with capital controls of varying intensity. The newly acceded members, who
lacked the institutional background of the EEC and the common determination
to strive for closer integration, held extensive exchange control systems in
place as well.
The only member states which in the course of the 1970s gradually dis-
mantled controls were Germany and to a lesser extent the Netherlands. These
countries had come to the conclusion that the drawbacks of control systems
weighed heavier than the advantages. But these were individual, uncoordi-
nated actions, where the EEC institutions stood at the sidelines. Within the
Community the attention of the Commission and the Monetary Committee
was diverted to other issues, which were considered to be of greater impor-
tance such as the enlargement of EEC credit facilities in order to support
adjustment. The member states, however, were not very good in imposing
conditions on these loans and in fact, the European economies still diverged
to a considerable extent at the end of the decade. Capital liberalization in a
Community framework was deadlocked for nearly twenty years.
The establishment of the European Monetary System in 1979 marked a
new beginning, as did the switch to liberal policies in the Anglo-Saxon world
under the Reagan and Thatcher administrations. The latter influenced econom-
ic thinking on the Continent. The abolition of exchange control in the United
Kingdom in 1979, the deregulation of capital markets in the Anglo-Saxon
world, together with other market-oriented policies aimed at strengthening
the supply side, fostered economic growth. The rapid development and inte-
gration of financial markets increasingly began to nibble at the effectiveness
of remaining capital controls. The erosion of regulatory powers contributed
greatly to the shift in the balance between the pros and cons of capital con-
trols over time. For the authorities the trade off between the need to protect
the official reserves or the exchange rate against the dead weight efficiency
costs of capital controls increasingly became in favour of abolishing them
altogether.
Official thinking evolved, first in those countries which had steered a middle
course, like the Netherlands and Denmark. They abolished nearly all restric-
tions. It was, however, not until the mid-1980s that a satisfactory degree
of stability had been reached within the EMS, which enabled a resumption
of common attempts towards financial integration and capital liberalization.
 251

Increasingly, the focus of domestic monetary policies in Europe shifted from

attaining internal objectives towards the maintenance of exchange rate sta-
bility vis-a-vis the anchor currency, the Deutsche mark. Especially after the
change of policy direction in France in 1983, the EMS started to operate more
and more as the zone of monetary stability it was intended to be. The funda-
mental reorientation of French policies implied a far-reaching modernization
of the financial system and of the conduct of monetary policy as well. In this
changed financial structure there was no place for exchange control.
The changed vision ofFrance with respect to the freedom of capital move-
ments had important implications for the Community as a whole. After Ger-
many and the United Kingdom, France was the third major country to pursue
such liberalization. This swayed the balance within the Community and other
countries now had to follow suit. In the context of improved convergence
the shielding of domestic financial markets became less important an objec-
tive, whereas the effectiveness of capital controls to safeguard the exchange
rate from speculative pressures had greatly eroded, as experience had shown.
When it was decided to forge ahead a dynamic process was set in motion
which eventually would lead to a resumption of the discussions on economic
and monetary union.
The initiative to resume the drive towards capital liberalization came from
~ithin the Monetary Committee. The initial reaction of the Commission had
been hesitant, but at a later stage under the inspired leadership of Delors the
initiative was vigorously reclaimed. The Commission persisted in its pursuit
of full capital liberalization. It made the strategic deCision to force the issue
of full capital liberalization in the expectation that this would compel the
member states to take the necessary adjustment measures in other areas. The
Commission brushed aside objections of member states which claimed that
tax harmonization should precede full capital liberalization out of fear of tax-
evasion inspired outflows. Ifit would have surrendered to those demands, it
would have gotten nowhere.
In 1988 a directive was agreed upon which provided for the full liberal-
ization of capital movements within a given time schedule. When on 1 July
1990 the first stage of the Economic and Monetary Union started, capital
restrictions had been effectively abolished in 8 out of 12 member states. The
full freedom of capital movements was codified in the Treaty on European
Union and therewith was made directly applicable. Although in the wake
of the EMS crises of 1992 and 1993 suggestions were made to reinstate
measures to regulate speculative capital flows, these were quickly discarded
because of their ineffectiveness and their adverse effect on credibility. When
in May 1994 Greece abolished its exchange control system, the liberalization
of capital movements in Europe was completed.
252
10.2 AN ECONOMIC APPRAISAL OF THE ATTITUDES OF MEMBER
STATES

Germany has been a driving force towards capital liberalization. Traditionally

being inclined to liberal policies, Gennany already had abolished a large
part of its capital controls at a relatively early stage. The liberalization of
capital movements fitted well in the Ordnungspolitik of the post-war Gennan
government. One of the ideological guiding principles was that there needed
to be disciplinary mechanisms which would force the monetary authorities
to stay on a stability-oriented track. In this view large-scale capital outflows
had to be regarded as sign of unbalanced economic policies that called for
adjustment.
The post-war economic institutional structure allowed the independent
Bundesbank to raise interest rates in case of inflationary pressures without
political interference. During the Bretton Woods period, the anti-inflationary
objectives of the Bundesbank were time and again thwarted by inflows of
foreign capital. Faced with monetary expansion at a rate which endangered
price stability, the Bundesbank repeatedly advocated the revaluation of the
domestic currency. Exchange rate policy being in the realm of government,
these requests were frequently opposed, mainly on the ground that this would
weaken the competitive position of Gennan industry. With the demise of
the Bretton Woods System in sight, the Bundesbank advocated the imposi-
tion of controls on capital inflows, but when these controls eventually were
imposed, they could not stem the surge of foreign funds. With the transition
to generalized floating their need vanished and they were soon abolished.
Gennany became a more forceful and more vocal advocate of free cap-
ital movements in the 1980s. There was a strong wish on the part of the
monetary authorities to strengthen financial discipline in the neighbouring
EC countries. Their accommodative monetary policies and lax fiscal policies
frequently caused tensions in the post-Bretton Woods European monetary
arrangements. Capital controls in these countries were circumvented and
Gennany was both faced with liquidity inflows and with requests for finan-
cial assistance under the enlarged European financing mechanisms. Exchange
tensions in these arrangements exerted pressure on the Bundesbank to lower
interest rates more than it found desirable on domestic grounds. All along for
Gennany internal stability came first. But this was not to say that its domes-
tic monetary policy was phrased without any consideration of the external
repercussions. For Gennany, as a relatively open economy the exchange rate
was too important to be indifferent to developments in the exchange mar-
kets. In practice the Bundesbank was prepared to align its policies with a
view to preserving stability within the EMS. However, in case of a conflict
with demands of internal stability the latter would be given precedence. The
decision whether such a conflict existed the Bundesbank wished to make on
its own authority. Any common decision-making with respect to monetary
 253

policy in the Community was rejected. When the obligation to fully liberal-
ize capital movements had been accepted in the Community Germany could
be satisfied with the general outcome. It had not been necessary to make
large concessions, especially not in the most crucial area of monetary policy.
Full freedom of capital movements had been assured and when the Maas-
tricht Treaty was ratified some years later it contained satisfactory provisions
regarding the transitional and final stages of EMU.
France held the balance for a common stance towards capitalliberaliza-
tion in the 1980s. France traditionally had relied on tight control mechanisms,
which mainly were inspired by exchange rate and monetary policy consid-
erations. The monetary authorities were fearful of speculation against the
national currency, especially by residents, and thus kept controls in place to
check cross-border outflows. They also wished to follow a low-interest rate
policy in order to promote domestic investment and did not want to see this
policy jeopardized by the need to raise interest rates in case of speCUlation
against the currency.
For France there was a further ideological, protectionist argument for cap-
ital controls. They fitted well in the post-war dirigistic approach to economic
development, characterized by macro-economic planning, industrialization
policy and sectoral differentiation. Monetary policy was geared to channel
savings to prioritary industrial sectors, often at preferential interest rates. Such
an economic environment called for protective shields at domestic borders,
with respect to capital movements and, albeit at a lesser extent, to trade move-
ments. After a brief experiment with nearly full capital freedom in 1967, which
was to be accompanied by a switch to the use of more indirect instruments
of monetary policy, the subsequent domestic and international disturbances
made the government very apprehensive towards any relaxation of controls.
Throughout this period the French franc remained a currency prone to spec-
ulative attacks. France changed strategy in a major shake-up of policies in
1983 after having become disillusioned about the possibility of following an
independent course, partly because of the inability of exchange controls to
prevent speculative attacks on the currency. Its switch to a hard currency pol-
icy (deflation competitive) needed to be accompanied by a modernization of
the domestic financial structure. The abolition of capital restrictions, through
giving free rein to competitive forces, could contribute to the restructuring of
the financial sector and the advancement of Paris as a financial centre.
The Netherlands in the 1960s stood midway between the liberally-oriented
policies of Germany and the rather restrictive attitude of most other member
states. The main motivation to hold on initially to certain restrictions on
capital outflows was the wish to keep domestic savings for its own use.
At the same time restrictions on inflows were deemed necessary in order
to support the attainment of quantitative monetary targets. The restrictions
were ~ot related to exchange rate considerations, although there may have
been a wish to avoid upward pressure on the exchange rate which could
254
threaten the competitive position. Monetary policy was executed by means
of direct instruments, i.e. credit ceilings for commercial banks. It was feared
that these restrictions would be circumvented by residents taking up credit
with commercial banks in third countries. Restrictions on inward capital
movements thus were regarded as a necessary cap on this loophole. When
the Netherlands after the demise of the Bretton Woods system increasingly
aligned its policies with Germany, it gradually abolished capital controls. In
the 1980s it became a forceful advocate of capital liberalization within the EC
and, after an overhaul of its monetary instruments, deregulated its domestic
financial markets in a decisive manner.
Belgium throughout the discussions did not actively participate. On the one
hand it felt it was in the comfortable position of having de facto free capital
movements, in any case as long as the divergence between the free and the
commercial exchange rate was negligible. On the other hand the dual market
still provided protection against speculative attacks. It came under repeated
pressure to abandon the system because other countries did consider the dual
market as a form of exchange control which would have to be abandoned.
Its continued existence constituted a delaying factor in the move towards full
capital freedom in Europe. A complicating factor from the Belgian standpoint
was that their Luxembourg partners considered the existence of a dual market
as a safeguard against more severe interventions against capital flows. In
practice this meant that Belgium and Luxembourg kept to the sidelines in the
debate and did not play an active role.
Although Italy in the first years of the Community had been an advocate
of capital liberalization because of the contribution this could make to the
financing of the economic development of Southern Italy, its own practice was
one of elaborate controls. Protection of its relatively underdeveloped capital
market and, increasingly, shielding the currency against speculative outflows
were prime motives of the authorities. In the 1970s the economy was seriously
destabilized and a battery of controls was established even with respect to
trade. When in the 1980s the European drive towards capital liberalization
gained momentum Italy, which was in favour of a gradual approach, tried
to decelerate the process. With an overvalued currency and fiscal policies
still out of line it remained vulnerable to speculation. But in the end Italy,
too, came to the conclusion that exchange controls would not be effective to
counter speculative outflows and that the gradualism which it advocated had
as its logical conclusion full liberalization. This left Italy with no choice than
to embark on a process of fiscal consolidation.

10.3 A POLITICAL APPRAISAL

The initiative in the early 1980s to take up again the issue of capitalliberaliza-
tion was mainly taken on political grounds. In the early years of the European
 255

Monetary System the hard-currency countries as Germany and the Nether-

lands were constantly pushed on to the defence by French-inspired proposals
for yearly packages to strengthen the EMS mechanisms. In practice these
proposals aimed at shifting the burden of adjustment to the hard-currency
countries, thus endangering their pursuit of price stability. They went on the
counteroffensive and searched for constructive means of putting pressure on
the other countries to adjust their policies. The nearly forgotten objective of
capital liberalization satisfied this desire because it could be embraced by all
countries as a precondition for whatever long-term ideal of monetary inte-
gration member states might cherish. Discussions on capital liberalization
brought out into the open the initially diverging views as to the ultimate goal
of the strengthening of the EMS and the promotion of the ECU. In the end all
countries rallied around the ultimate goal of monetary unification. Thus the
history of the liberalization of capital movements in Europe to a large extent
coincides with the history of monetary cooperation in Europe.
The 1988 Directive, effectively freeing all capital movements, was a land-
mark in the process of European integration. Fundamental factors had been
at work which heralded the abolition of controls: their effectiveness was in
doubt, their operational costs were high, and they led to suboptimal alloca-
tion. Nevertheless, taking into consideration the endless discussions on their
abolition at earlier instances the move towards full liberalization was quick.
The favourable economic climate in the second half of the 1980s provided a
window of opportunity. At previous occasions the authorities had shied away
from undertaking common obligations in adverse cyclical circumstances.
But also the political climate was favourable. Politicians were once again
prepared to work together towards European integration, as evidenced by the
acceptance of the White Book. The relatively stable situation in the European
Monetary System was conducive to foster this feeling of political well-being.
The relative speed with which agreement was reached on the 1988 Direc-
tive merits further consideration. Some have advanced that capital liber-
alization was the bargaining chip needed to persuade Germany to make
concessions with respect to progress towards monetary unification. It is true
that Germany had made it abundantly clear that it did not wish to contem-
plate any further steps to strengthen or institutionalize the EMS and ECU
mechanisms before capital movements would have been fully liberalized. It
re-enforced its arguments by the unchallenged claim that freedom of capital
movements constituted a sine qua non for European monetary integration.
Both the 'economist' and 'monetarist' schools of thought agreed on this,
although the monetarists would have liked to support the drive for liberaliza-
tion by firmer commitments on monetary cooperation from the hard-currency
countries. It was therefore not surprising that in the course of the negotiations
attempts were made to extract monetary concessions from Germany. But these
all fell short of further-reaching schemes for monetary unification and the cap-
ital directive finally was unconditionally approved. The French initiative to
256
take up again the study of economic and monetary union, which received
political support in Germany, fell in well-prepared ground because its pre-
condition, freedom of capital movements, would be fulfilled and exchange
rates in the EMS had stabilized. But the outcome of these negotiations at
the time could not be predicted and even after adoption of the Treaty on
European Union the establishment of EMU remains uncertain. Therefore this
explanation does not suffice. Other forces have been at work as well.
This study shows that a more likely explanation for the abandonment of
capital controls in Europe is that France, playing apivotal role in Europe, con-
sidered for reasons of its own that it should do away with exchange controls,
following the example of Germany and the United Kingdom. At the same
time France aligned its policies to those of Germany. Other countries now
had to follow suit, sometimes reluctantly, if they did not want to severe the
political and economic links with the mainstream in Europe. France played
a key role in the final steps towards full capital liberalization. Not only the
transition to solid macro-economic policies in 1983, but even more so the
rather radical reform of its financial system and its monetary policy instru-
ments were important elements. The evolution in French thinking provides
an important clue to the question why this attempt to liberalize succeeded
where others had failed. But this success could not have been brought about
without the active support of the Commission.
From the outset of the EEC the Commission had pleaded for capital liberal-
ization. But in the course of the 1970s the Commission had lost its appetite in
the face of large divergences between member states. It needed considerable
prodding, especially from Germany and the Netherlands, to move on with
its quest for capital liberalization. But when the Commission eventually did
move on, it did so with great courage. By proposing full freedom of capital
movements it removed exchange controls as what was considered by some
participants in the Exchange Rate Mechanism as the ultimate line of defence
in case of exchange unrest. The good functioning of this system had been
instrumental in changing Eurosclerosis into Eurodynamism. With its propos-
als for full and unconditional capital liberalization, the Commission seized
the window of opportunity provided by the favourable economic and political
climate, and by the conversion of France. It made the strategic choice to give
absolute priority to capital liberalization, in the end declining a direct con-
ditionallink to other areas, such as taxation, coordination procedures or the
promotion of the ECU. The latter had been demanded as a quid pro quo in the
first operational years of the EMS but these requests had run aground against
stubborn resistance of Germany. The Commission deserves high marks for
its persistence.
 257
10.4 TIIE EFFECTIVENESS OF CONTROLS

In the changing appraisal on the part of the authorities of the pros and cons
of capital liberalization an important consideration was that restrictions, once
they were partially liberalized, were no longer effective. The experiences of
the 1970s had already shown the limited effectiveness of capital controls.
Faced with strong disturbances in the exchange markets they were powerless.
For Germany this was sufficient reason to abolish them. Other countries,
although they acknowledged the limited effectiveness, preferred to play it safe
as long as controls were not considered to be very harmful either. They may
have had some effect to shield domestic monetary policies at times of calm
on the exchange markets. Effectiveness eroded further with the increasing
sophistication of financial markets and the emergence of derivative financial
products which blurred the traditional distinctions between market segments.
The restrictions therefore resembled more and more playing cat and mouse:
as the former president of the Nederlandsche Bank Zijlstra has said, it just
is not possible to put a cat for every hole. This explains why countries, once
they embarked on the process of liberalization, ultimately pushed for full
liberalization.
If capital controls were increasingly considered to be ineffective with
respect to their stated goals, why is it then that authorities have wished to
implement or maintain them anyway? One reason is a factor which might be
called the placebo effect. In the face of wide-spread speculation there is an
imperative political wish for the authorities to be seen as doing something.
They can, in their own view, not be seen as merely standing by. When images
of greedy speculators, making huge fortunes, are displayed for the public
eye, it is difficult to accept the free play of market forces. The imposition of
capital controls can help, so it is hoped, in calming down the markets and
the general public, although experts know they will in the end not achieve
what they are intended for. To this end the authorities wished to keep capital
controls available as an instrument to fall back upon. Therefore they were not
willing to submit them to common EEC obligations even in cases where on
an individual basis member states had liberalized more than was called for
under the directives. More often than not the tightening of capital controls
served as a subsitute for policy adjustments. When authorities in the face
of market pressures and confidence crises repeatedly reached out for capital
controls, the instrument of capital controls became blunt and the country con-
cerned was likely to be worse off. The financial markets would conclude that
the authorities were not willing to administer real medicine, i.e. adjustment
measures, and would withdraw capital.
Capital controls bear fewer political costs than devaluations of the national
currencies. Capital controls are perceived as being aimed at foreign specula-
tors, wishing to bring about a change in the value of the national currency, or
at disloyal tax-evading residents. The authorities may consider it important
258
to be seen as taking decisive actions, even if they realize that the effective-
ness of the measures is rather questionable. The impact of the measures on
domestic market operators is normally not felt directly by the general public
at large. Devaluations, on the other hand, are more visible and they shatter
national pride. Political resistance against devaluations typically is strong.
In this reasoning a political case can be construed for buying time through
the imposition of capital controls. Over time it has increasingly been recog-
nized that exchange control measures do not alter the fundamental causes
of speculation. Evidence has shown that they do not change exchange rate
expectations in a significant and durable way. Therefore they do not provide
a durable relief for speculative pressures on the exchange rate.
The call for capital controls which came up in the wake of the EMS crises
of 1992 and 1993 must be regarded in the same vein as a manifestation of
the wish to do something about perceived speculation. Delors, who faced
with the turbulence gave the Commission's hitherto firm position a disap-
pointing twist, made the analogy with speed controls on highways, where
capital controls should limit excessive movements in financial markets. This
study shows that speed controls are the realm of supervision on financial
institutions and on payment systems. Supervision takes care that financial
transactions are carried out in a sound and transparent environment. Speed
controls are not an instrument to control the flows themselves. Because of the
interlinkages between the short and long segments of the financial market,
the imposition of capital controls implies that sand is thiown not only in the
speculative radar wheels but also in the transactions of bonafide institutional
investors and companies which are deprived of making hedging operations.
The interference in the functioning of the markets may give a serious blow to
confidence and thus have a perverse effect.

10.5 THE OPPORTUNITY COSTS OF CAPITAL CONTROLS

To the extent that capital controls are effective in hindering capital outflows,
the national currency becomes a mousetrap-currency. Investors can put assets
in the trap, but there is no legal way to get them out. Moreover, in so far
as controls are effective, commercial relations and investment decisions are
influenced, increasing the cost of international trade financing. There is not an
easy on-off switch with respect to capital controls. They cannot be restricted
to a limited number of transactions, they have a tendency to spread unchecked
and ultimately may lead to a loss of confidence in the currency concerned.
They could not provide an alibi for not using the interest rate instrument or
other means to defend the exchange rate.
Over time the opportunity costs of capital controls have increased. The
growing advantages of open financial markets have been understood by the
authorities. For France this provided an important motive to pursue liber-
alization. In the Internal Market it was essential for France to remove the
 259
constraints which capital restrictions imposed on its industrial and financial
sector. These constraints risked to place French industry in an unfavourable
competitive position vis-a-vis the industrial sector in other countries. The
position of Paris as a financial centre was at stake as well. The authorities had
already realized that the French currency never could reach the same status
of global currency as the other major currencies - US dollar, Deutsche mark
and Japanese yen - had reached. Therefore in discussions on the international
monetary system it had always put its stakes on the furthering of the SDR,
and in the European context, on the ECU and on monetary integration. These
initiatives all had run aground. It did not prove possible to detract from the
reserve currency status of the US dollar and the Deutsche mark through the
promotion of artificial basket-type currencies. France had to accept that such
a multilateralized system was not attainable and that the continuation of a
multicurrency monetary system was likely. In order for France to play an
influential role on its own, its financial centre had to be enabled to grow
and to innovate. This was only possible in an open environment in which
its financial institutions and its markets were exposed to the fresh wind of
competition. France realized that national financial markets that are heavily
regulated or restricted in their external transactions would lag behind and
eventually would become less important. It recognized that liberalization, if
need be unilaterally, would be to its own advantage.
It felt strengthened by the positive confidence factors in other countries.
And it wished to try to regain some of the lost ground to London which as
a financial centre had greatly gained from the deregulation and liberalization
policies of the Thatcher administration. In fact London eclipsed other financial
centres on the Continent, despite the fact that the pound sterling did not
participate in the European monetary arrangements (apart from the interlude
from 1990-92). Capital liberalization was the crown on the French efforts
to strengthen and modernize its financial system and to switch to market-
oriented instruments of monetary control.
These motives carried validity for other countries as well, but not always
the same policy conclusions were drawn. Italy, for instance, came to another
evaluation, weighing the costs against the perceived benefits of controls. Italy
had a weaker economy, in particular because of its traditionally large fiscal
deficits, whereas France with generally sound fiscal policies was better placed
to liberalize, in conformity with the theory of sequencing. Moreover, France
was more inclined to displaying international ambitions in the monetary field
and letting its financial institutions play a global role than Italy with its
fragmented financial system. In the end countries like Italy, however, had no
choice. By not following the lead Italy risked to be relegated to the second
plan. Italy could not afford that its strong industrial sector would be put at a
financial disadvantage vis-a-vis other countries. In the framework of modem
financial markets capital controls had become an illusion.
260
Some critics considered the currency crises which forced Italy out of the
EMS as proving their case that free capital flows were not compatible with
exchange rate stability. They are misreading the events and forgetting history.
Full freedom of capital movements had been achieved four years earlier and
had not stood in the way of exchange rate stability. Neither had it done so in
other countries with a longer history of capital freedom. The EMS crises were
caused by macro-economic imbalances and insufficient preparedness to adjust
policies accordingly. Signaling out free capital movements is tantamount to
mistaking the symptom for the cause. History shows that capital restrictions
would have been powerless in the face of massive speCUlative flows. The
case of France, which too, despite balanced macro-economic policies, was
hit by speCUlative attacks in 1993, proves that once financial markets are
disturbed the determinedness of the authorities to defend the exchange rate
will be tested. In this they must stand firm, as the French authorities did, with
success. In doing so, the preservation of exchange rate stability must rank
above domestic considerations. In the end, a relatively low interest rate will
provide ample reward for the domestic economy.

10.6 LINKAGES WITH OTHER POLICY DOMAINS

The proposals for capital liberalization have been attended by proposals in

related policy domains. The most important linkages have been to:
(a) a strengthening of coordination procedures, in particular with respect to
monetary policy;
(b) an increase of the financing mechanisms of the EEC, including the
structural funds, and the European Monetary System;
(c) taxation issues.
As far as the first two linkages are concerned, the traditional opposite
positions of the 'monetarists' and the 'economists' came to the fore, largely
boiling down to the question of the distribution of the adjustment burden. The
'monetarist' recipe of relaxing the external constraints for the weak-currency
countries and favouring collective decision-making with respect to monetary
policy had for a while received some support of the Commission. Especially
the promotion of the ECU, introducing symmetrical responses in the EMS,
had been a popular theme. Capital liberalization could be seen as a crowbar to
infringe upon the autonomy of the central bank of the EC's anchor currency,
the Bundesbank. Against this 'monetarist' recipe the 'economist' recipe of
letting work through the disciplinary effects of external constraints on domes-
tic policies was advanced. The latter view prevailed when the Commission
eventually decided to relinquish these linkages and so embark on a dynam-
ic process. This forced policy adjustments on member states, by exposing
the macro-economic policy stance more fully to the judgement of financial
markets. This judgement will be based on the fundamental strength of the
 261

economy and the orientation of monetary policy, relative interest rate levels
and inflation performance being the chief determinants of exchange rates.
Thus capital liberalization increases the importance of sound monetary and
fiscal policies.
Taxation, the third linkage, is a real issue. Differences in fiscal treatment
can disturb the optimal allocation of scarce capital resources. In the nego-
tiations fiscal issues proved to be of such immense political sensitivity that
any demand for tax harmonization to precede capital liberalization would
have boiled down to putting off indefinitely the latter. The opportunity costs
of exchange control having increased, it was a right decision to first reap
the advantages of capital liberalization and see which disturbances actual-
ly evolve because of tax divergences. In some cases, such as France, these
proved to be less serious then initially was feared. If, however, tax arbitration
and tax evasion were to become a real problem of significant proportions,
undermining tax moral, this would provide an important political incentive
to tackle tax divergences within the Community and seek agreement, set-
ting aside national political sensitivities. The Commission's strategy to push
through unconditionally capital liberalization thus may have the positive side-
effect of initiating a dynamic process towards harmonization in the field of
taxation.

10.7 WILL CAPITAL CONTROLS BE REINTRODUCED?

After having analysed the forces which have been behind the accomplishment
of the full freedom of capital movements a tentative answer must be formulat-
ed as to the likelihood that this freedom will hold. Of course, any such answer
is hazardous and, in the ebb and tide of economic history, ideologies, mecha-
nisms and instruments may change. There are major arguments which would
lead to impose the conclusion that reintroduction of capital controls in Europe
in the foreseeable future is not likely. These arguments briefly can be listed
under three headings: (a) formal constraints, (b) political considerations, and
(c) economic considerations.

(AJ Formal Constraints

In the Treaty on European Union formal steps are distinguished which will
lead up to the establishment of EMU. In the final stage, which according to
the Treaty, is to start in any case on 1 January 1999 with those countries which
are considered to have fulfilled the relevant criteria, there will be no capital
controls by definition among the participating countries. In the transitional
phase which started on 1 January 1994 the possibilities to restrict intra-EC
capital flows are severely limited. Derogations remain possible under Articles
109h and 109i, providing for emergency measures in case of severe balance-
of-payments difficulties, but the Treaty's intentions would be rather stretched
262
if such measures were to include capital restrictions. The possibility to do
so is contradicted by the general obligations of Article 73b. The Commis-
sion, however, has the right to propose temporary restrictions vis-a-vis third
countries (under Article 73 f) 'in exceptional circumstances' , and only if there
are serious difficulties which could undermine the operation of EMU. The
Treaty is clear that, if restrictions are allowed, they can only be temporarily
imposed in case of severe disturbances. Experience has shown, as discussed
in this study, that precisely in those circumstances they are least likely to be
effective.

(B) Political Considerations

Reintroduction of capital controls in individual member states would form

a serious if not unsurmountable set-back for the establishment of EMU. It
would carry high political costs for the country concerned as well, by pro-
viding a signal that the country was not able to make it in the first group
entering the final stage of EMU. The creditworthiness of the EMU process,
which has already been damaged by the fragile degree of acceptance among
the populations and the EMS crises, would receive another serious and pos-
sibly final blow, especially if one of the countries perceived to belong to the
core group would set such steps. But also, the reintroduction of controls by
countries which cannot be expected to soon join EMU, would further imprint
the image of a two-speed Europe.

(C) Economic Considerations

The analysis in this book has shown that exchange controls or other disguised
measures aimed at limiting cross-border capital flows have been rather unsuc-
cessful as to the attainment of their goals. They have not been able to ward off
downward or upward pressures on exchange rates in case of imbalances. They
may have provided some protection for domestic capital markets and domestic
monetary policies at quiet times in the early post-war decades of underdevel-
oped markets and direct instruments of monetary control. But in the modem
financial environment of today they have become an anachronism, carrying
significant opportunity costs. Reintroduction of capital controls would deal a
blow to confidence in the currency concerned and most likely would result
in higher domestic interest rates rather than in lower ones. In doing so, they
would impose costs on normal commercial and financial transactions and thus
hamper economic growth.

10.8 CONCLUDING OBSERVATIONS

In many respects the liberalization of capital movements in Europe can be

judged as a vindication of the German body of economic thought. Its market-
 263

oriented ideology has been adopted in all other European countries. The
necessary underpinning by sound macro-economic policies, viz. avoidance
of excessive budget deficits and maintenance of domestic price stability, have
become widely accepted, though not generally implemented. The German
use of indirect instruments of monetary control has become the European
standard. The dialectics of progress have left Germany, however, with some
rigidities in its instruments, such as unremunerated cash reserves. The British
swing to liberal policies in the early 1980s, too, greatly influenced thinking
on the Continent. It has helped refocus attention on the real demands of the
Common Market: open markets and freedom for economic decision-makers.
When, however, the United Kingdom displayed disinterest in the further
integration efforts such as EMU, its influence quickly waned.
France has made a remarkable turnaround, switching-over to a policy of
competitive disinflation, supported by market-oriented monetary instruments,
mainly in the form of open-market operations. What really moved the actual
forces towards liberalization was an endogenous process in the financial mar-
kets and the real economy towards increased internationalization. This was
grasped by the French authorities when they for domestic reasons came to the
conclusion that only in a competitive, open environment French industry and
financial institutions could continue to playa global role. The Commission
grasped the window of opportunity provided by a favourable economic cli-
mate and a positive disposition of these large member states to push through
a programme offull capital liberalization in Europe. Therewith it took a deci-
sion of high political and strategic dimension. Capital liberalization removed
a major obstacle to economic and monetary union. It provided more impetus
to the European integration process than many had foreseen, culminating in
the adoption of the Treaty on European Union. Now it is up to the member
states to attune their policies to the convergence needed for economic and
monetary unification. If in doing so they will have irrevocably locked their
currencies, and thus will have banned exchange rate uncertainty, they will
have removed the main remaining obstacle for the free movement of capital
in Europe.
 Chronology

Chronology of major measures with respect to the regime of capital

movements in the member states of the European Community
(Direction of measures: L - liberalization, T - tightening)

1958 16 January L Germany - Permission for residents to main-

tain foreign currency accounts abroad.
21 June L France - Incorporation of the surcharge of 20%
on the official exchange rate in a new reference
rate for the US dollar.
1 July L Germany - Liberalization of inward invest-
ment by non-residents.
13 August L Germany - Liberalization of transactions
in German bonds denominated in foreign
currency.
27 December L EEC - Liquidation of the European Payments
Union; EEC currencies become externally con-
vertible in current payment transactions.
1959 1 May L Germany - Abolition of all remaining restric-
tions on the import of capital.
5 June L France - Abolition of requirement of a 50%
deposit on foreign exchange purchases by
importers.
24 August L Italy - Easing of regulations concerning invest-
ment abroad by residents.
1960 1 January L France - Monetary reform: introduction of the
'new' franc, abolition of the Exchange Office.
11 May L EEC - Adoption by the Council of the First
Directive on capital movements.
4 June T Germany - Prohibition to pay interest on
Deutsche mark deposits held by non-residents
and to sell money market paper to non-
residents.
16 July L The Netherlands - Issuance of general licences
for a number of outward capital movements.

264
 265
1961 1 September L Germany - Coming into effect of the new For-
eign Trade and Payments Law, establishing a
positive system of exchange regulation.
1 October L The Netherlands - Further relaxation of
exchange controls.
1962 2 January L Italy - Merger of the free market for capital
transactions with the official exchange market.
24 February L France - Easing of foreign exchange
allowances for travel pwposes and other trans-
actions in the personal sphere.
2 April L France - Abolition of the parallel devises-titres
market for cross-border transactions by resi-
dents in foreign securities.
24 April L The Netherlands - Opening-up of the Nether-
lands capital market for the issuance of foreign
guilder loans up to a ceiling.
18 December L EEC - Adoption by the Council of the Sec-
ond Directive on capital movements (Directive
63/21IEEC).
21 December L France - Further relaxation of exchange
controls.
1963 28 March L Italy - Abolition of restrictions on investments
in foreign securities by residents.
10 April T France - Prohibition of payment of interest on
French franc deposits held by non-residents.
7 August T France - Curtailment of loans by non-residents
to residents.
1965 25 March T Germany - Introduction of a withholding tax
('coupon tax') on interest income on assets held
by non-residents.
15 October L France - Abolition of restriction for commer-
cial banks to engage in forward transacions.
1966 22 January L Italy - Extension of permission of outward
direct investment to the OECD area (previous-
ly only EEC).
1 October L The Netherlands - Abolition of the "free mar-
ket" for cross-border transactions in securities.
1967 31 January L France - Introduction of a positive system of
exchange regulation. Substantial relaxation of
exchange controls. Abolition of the prohibition
to pay interest on French franc deposits held by
non-residents.
266
10 November L Italy - Easing of limitations on export of bank
notes and of settlement requirements.
1968 29 May T France - Reintroduction of temporary
exchange control and of restrictions on
allowances for foreign travel by residents.
23 July T EEC - France is authorized by the Commis-
sion to invoke safeguard measures (Decision
68/30 1IEEC}.
4 September L France - Abolition of the exchange control
measures introduced in May 1968.
25 November T France - Reintroduction of essentially the same
exchange control measures of May 1968.
1 December T Germany - Imposition of a minimum reserve
requirement on the growth of external bank
liabilities.
1969 11 August T France - Reintroduction of the devises-titres
market.
31 October L Germany - Abolition of the minimum reserve
requirement on the growth of external bank
liabilities.
1970 1 April T Germany - Reintroduction of the minimum
reserve requirement on the growth of external
bank liabilities.
4 August L France - Easing of restrictions on outward
direct investment and abolition of the camet
de change for foreign travel allowances.
1971 1 April T France - Imposition of a minimum reserve
requirement on external bank liabilities.
10 May T Germany - Prohibition of payment of inter-
est on bank deposits of non-residents and of
purchases by non-residents of money market
paper.
11 May T Belgium - Complete separation of the official
and the free exchange market.
23 August T France - Establishment of a dual exchange
market, comprising an official market for
import and export transactions and trade-
related invisibles, and a financial franc market
for all other transactions.
6 September T The Netherlands - Introduction of a free market
for bond transactions ("O-circuit").
 267

20 October T France - Merger of the devises-titres market

into the dual exchange market.
1972 1 March T Germany Imposition of a cash
reserve requirement ('Bardepot') for liabilities
incurred vis-A-vis non-residents.
9 March T The Netherlands - Prohibition of payment
of interest on guilder deposits held by non-
residents.
21 March T EEC - Adoption by the Council of the Direc-
tive on regUlating international capital flows
and neutralizing their undesirable effects on
domestic liquidity (Directive 72/156/EEC).
27 June T Italy - Introduction of measures aimed at
restricting capital outflows; ban on net external
credit position of banks; suspension of external
convertibility of Italian banknotes.
1 July T Germany - Prohibition of sales of fixed inter-
est securities to non-residents. Tightening of
minimum reserve and Bardepot requirements.
17 July T The Netherlands - Further tightening of
exchange controls, affecting leads and lags and
the taking up of foreign credit by residents.
7973 22 January T Italy - Establishment of a dual exchange
market.
1 February T Germany - Prohibition of sales of all credit
instruments and of borrowing to non-residents.
16 March T France - Prohibition of payment of interest
on bank deposits of non-residents and raising
of the minimum reserve requirement on the
growth of external bank liabilities to 100%.
19 March L Denmark - Liberalization of inward and out-
ward portfolio and direct investment.
22 June T Germany - Further tightening of the minimum
reserve and Bardepot requirements.
27 July T Italy - Introduction of a 50 per cent compul-
sory non-interest bearing deposit scheme with
respect to most capital outflows.
8 October L France - Abolition of the prohibition of pay-
ment of interest on bank deposits of non-
residents and abolition of the minimum reserve
requirement on the growth of external bank
liabilities.
268

1974 1 January L Germany - Abolition of the minimum reserve

requirement on the growth of external bank
liabilities.
19 January T France - Prohibition of French franc borrowing
by non-residents, restriction of forward trans-
actions by residents, relaxation of borrowing
abroad by residents.
1 February L The Netherlands - Abolition of the closed bond
"O-circuit" .
1 February L Germany - Reduction of the Bardepot require-
ment and abolition of authorization require-
ments for sales to non-residents of credit instru-
ments other than domestic fixed interest secu-
rities with a maturity of less than 4 years.
21 March T France - Abolition of the dual exchange mar-
ket. Severe tightening of controls on capital
outflows and relaxation of controls on capital
inflows.
22 March L Italy - Abolition of the dual exchange market.
7 May T Italy - Introduction of a temporary compul-
sory non-interest bearing deposit scheme with
respect to imports, excluding raw materials, oil
and investment goods. Italy is authorized by
the Commission to invoke safeguard measures
(Decision 741287IEEC).
15 September L Germany - Abolition of the Bardepot
provisions.
1975 1 September L Germany - Abolition of the prohibition to
pay interest on Deutsche mark deposits held
by non-residents. Abolition of authorization
requirements for sales to non-residents of secu-
rities with a maturity of 2 to 4 years.
1976 1 January L The Netherlands - Abolition of the prohibition
to pay interest on guilder deposits held by non-
residents.
18 March T Italy - Reintroduction of compulsory bank
financing in foreign exchange for advance set-
tlement of imports.
6 May T Italy - Reintroduction of the non-interest bear-
ing import deposit scheme.
 269

1 October T Italy - Imposition of a temporary special tax on

purchases of foreign currency and payments
abroad. Extension of the compulsory import
deposit scheme.
1977 18 February L Italy - Expiration of the special tax on foreign
currency purchases.
15 April L Italy - Abolition of the compulsory import
deposit scheme.
24 June T Ireland - Reimposition of reserve requirement
(of 50%) on capital inflows with commercial
banks.
1 September L The Netherlands - Switch-over to a positive
system of exchange control. Further easing of
regulations concerning capital outflows.
15 December T Germany - Reintroduction of authorization
requirements for sales to non-residents of secu-
rities with a maturity less than 4 years.
1978 1 January T Germany - Reintroduction of a minimum
reserve requirement on the growth of external
bank liabilities.
1 June L Germany - Abolition of the minimum reserve
requirement on the growth of external bank
liabilities.
18 December T Ireland - In consequence of Ireland's decision
to participate in the EMS exchange controls
were extended to the United Kingdom. Aboli-
tion of the investment currency market.
1979 6 February T Denmark - Restriction of purchases by non-
residents of Danish bonds. Denmark is autho-
rized by the Commission to invoke safeguard
measures.
18 July L United Kingdom - All restrictions on out-
ward direct investment are abolished and
outward portfolio investment is significantly
liberalized.
4 September L Ireland - Easing of restrictions on acquirement
of foreign securities.
23 October L United Kingdom - The Exchange Control Act
of 1947 is suspended and all remaining barri-
ers to inward and outward flows of capital are
removed.
1980 17 March L Germany - Relaxation of restrictions on the
sale of short-term paper to non-residents.
270
11 July L France - Restrictions on inward and outward
direct investment are relaxed.
3 December T EEC - Ireland is authorized by the Commission
to invoke safeguard measures.
1981 12 March L Germany - All restrictions on the sale of short-
term Deutsche mark paper to non-residents are
abolished.
1 May L The Netherlands - Coming into force of the
External Financial Relations Act, which super-
sedes the Exchange Control Decree of 1945.
21 May T France - Reintroduction of the devises-titres
market. Limitations on leads and lags in trade
settlements. Limitations on direct investment
abroad.
28 May T Italy - Reintroduction of the non-interest bear-
ing deposit scheme with respect to purchases
of foreign currency by residents.
1982 8 February L Italy - Abolition of the advance deposit
scheme.
25 March T France - Further restrictions on the surrender
of export proceeds and on direct investment
abroad.
1983 28 March T France - Further reduction of foreign travel
allowances, a ban on the use of personal credit
cards abroad and introduction of the 'camet de
change' , a booklet in which foreign exchange
purchases were recorded.
1 May L Denmark - Easing of restrictions on purchas-
es of foreign securities and direct investment.
Abrogation of the safeguard measures.
1 July L The Netherlands - Abolition of all remaining
restrictions on capital inflows.
17 December L Italy - Certain direct investment abroad is
exempted from the 50 per cent non-interest-
bearing deposit requirement.
2.3 December L France - Some easing oflimits on foreign trav-
el allowances and foreign direct investment;
abolition of the 'camet de change'.
1984 1 January L Denmark - Abolition of restrictions on the pur-
chase of foreign shares by residents.
31 July L France - Abolition of the ban on use of personal
credit cards abroad.
 271

1 August L Germany - Abolition of the coupon tax on

interest income on assets held by non-residents.
14 November L France - Easing of controls on direct
investment.
3 December L Italy - Reduction of compulsory zero-deposit
requirements on portfolio investment abroad.
19 December L EEC - The Commission sets an expiry date
for the existing safeguard clauses for France (2
years), Italy and Ireland (3 years), and limits the
safeguards to existing restrictions (Decisions
85/14,15 and 16IEEC).
1985 25 February L France - Easing of inward direct investment
orginating from non-EEC countries.
3 April L France - Authorization of Eurobond issues
denominated in French francs.
11 June L Denmark - Further liberalization measures.
1 September L France - Easing of financing rules for outward
direct investment outside the EC.
23 October L Italy - Abolition of the· compulsory deposit
requirement for direct investment abroad. Res-
idents' foreign exchange deposits are freely
convertible into other currencies and the ban on
transfer of foreign securities and loans between
residents is lifted. Reduction of compulsory
deposit requirements on other transactions.
22 November T EEC - Greece is authorized by the Commission
to take certain safeguard measures for a period
of three years (Decision 85/594/EEC).
2 December L France - Easing of regulations for outward
portfolio and direct investment.
20 December L EEC - Adoption by the Council of the Directive
(85/583IEEC) on Undertakings for collective
investments in transferable securities (UCITS).
1986 26January L France - Easing of foreign travel allowances.
16 April L France - Elimination of requirement of prior
authorization of direct foreign investment.
22 May L France - Abolition of the devises-titres mar-
ket; liberalization of purchases of secondary
residences abroad; easing of forward foreign
exchange operations; easing of authorization
procedures for tlirect investment abroad.
272
23 May L EEC - The Commission presents a Programme
for the liberalization of capital movements in
the Community.
4 June L EEC - Abrogation of the safeguard clause with
respect to France.
27 June L Spain - Liberalization of inward direct invest-
ment and the right of establishment.
8 August L Italy - Restoration of external convertibility of
Italian banknotes.
1 October L The Netherlands - Abolition of all remaining
restrictions on capital outflows. Fullliberaliza-
tion of all capital transactions.
7 November L Spain - Relaxation of controls on outward
direct investment.
17 November L EEC - Adoption by the Council of the Third
Directive on capital movements (Directive
86/566/EEC).
18 November L France - Partial liberalization of bank lending
in French francs to non-residents; abolition of
administrative control through the commercial
banks of import and export settlements ('domi-
cialiation' regime).
1987 25 February L EEC - Modification of the existing safeguard
clauses with respect to Greece, Ireland and Italy
in order to accommodate the extension ofliber-
alization obligations under the 1986 Directive.
20 March T Italy - Introduction of reserve requirement on
bank deposits in foreign currency.
13 May L Italy - Abolition of the non-interest-bearing
deposit requirement for investment abroad in
securities and real estate.
21 May L France - Substantial easing of exchange con-
trols for commercial enterprises; liberalization
of trade in gold.
1 June L Germany - German residents are allowed to
incur ECU-denominated liabilities.
1 July L EEC - Abrogation of the safeguard clause with
respect to Italy.
8 July L France - Abolition of limits on tourist travel
allowances.
13 September T Italy - Shortening of holding periods offoreign
currencies.
 273
20 October L Spain - Relaxation of controls on foreign-
currency operations by commercial banks.
16 December T EEC - The safeguard clause for Ireland is
extended with one year (Decision 88/121EEC).
1988 1 January L Ireland - Easing of re!!trictions on long-term
outflows.
1 June L France - Permission for domestic enterprises
to operate foreign currency accounts; abolition
of restrictions on borrowing abroad.
13 June L Italy - Restrictions on tourist spending are
eased.
24 June L EEC - Adoption by the Council of the Fourth
Directive on capital movements (Directive
88/361IEEC).
1 October L Italy - Introduction of a positive system of
exchange control. Significant relaxation of
controls.
1 October L Denmark - Abolition of all remaining
exchange control regulations.
4 November L EEC - Abrogation of the safeguard clause for
Ireland.
29 November T EEC - The authorization for Greece to take
safeguard measures is extended until end 1989
(Decision 88/600IEEC).
22 December L Spain - Liberalization of outward direct invest-
ment and trade in medium and long-term for-
eign securities.
1989 1 January L Ireland - Liberalization of purchases of
medium and long-term foreign securities by
residents.
31 January T Spain - Imposition of a non-remunerated
reserve requirement on financial credits taken
up abroad.
9 March L France - Full liberalization of bank lending in
French francs to non-residents.
28 March L Portugal - Relaxation of foreign travel
allowances.
1 June L France - Liberalization of commercial banks'
foreign exchange positions, from now on
only to be regulated by prudential provisions;
permission for all residents to open ECU-
denominated accounts.
274

20 September L Portugal- Relaxation of controls on purchases

of foreign securities by residents.
26 September L Spain - Permission for residents to open
accounts denominated in ECUs.
17 December T EEC - Further extension of the derogation
enjoyed by Greece for six months (Decision
89/6441EEC).
31 December L Portugal - Abolition of prior authorization
requirement of inward direct investment.
1990 1 January L France - Abolition of all remaining exchange
control regulations (Decree 89/938).
19 January L Italy - Abolition of restrictions on purchases
of foreign securities by residents.
5 March L Belgium-Luxembourg - Abolition of the dual
exchange market.
28 March L Portugal - Easing of restrictions on acquire-
ment of foreign securities.
1 April L Ireland - Further relaxations and easing of
administrative requirements.
4 April L Spain - Further relaxation measures.
14 May L Italy - Abolition of all remaining exchange
control regulations.
1991 16 April L Spain - Abolition of restrictions on the opening
of foreign-currency accounts.
14 June L Portugal- Liberalization of direct and portfolio
investment abroad.
1992 1 January L Ireland - Easing of restrictions on purchases
of foreign securities, borrowing in foreign cur-
rency and extending loans to non-residents.
1 February L Spain - Abolition of all remaining exchange
control regulations.
1 September L Portugal - Abolition of compulsory deposit
requirement against foreign currency.
24 September T Spain - Reintroduction of certain restrictions,
mainly with respect to short-term financial
credits.
24 November L Spain - Abolition of all remaining exchange
control regulations.
16 December L Portugal- Abolition of all remaining exchange
control regulations.
 275
1993 1 January L Ireland - Abolition of all remaining exchange
control regulations.
1994 16 May L Greece - Abolition of all remaining exchange
control regulations.
 Chronology

Chronology of the coordination of economic and monetary policies in

Europe and major general events

1957 25 March Signing of the Treaty of Rome.

1958 1 January The Treaty on the European Economic Com-
munity becomes effective.
4 June Constituent meeting of the Monetary
Committee.
1964 8 May Establishment of the Committee of Gover-
nors (Decision 641300IEEC). Obligation to
consult the Monetary Committee with respect
to international monetary issues (Decision
641301IEEC).
1965 30 June Empty chair policy of France until February
1966.
1969 1-2 December The European Council in the Hague expresses
the readiness to establish economic and mone-
tary union.
1970 6 March The Werner Committee is established by the
Council with a view to prepare a report on the
attainment of economic and monetary union.
1971 22 March Adoption by the Council of a Resolution on the
attainment of economic and monetary union in
stages, of a Decision on the strengthening of the
cooperation between the national central banks
(7111421EEC) and of a Decision on medium-
term financial assistance (711143IEEC).
1972 10 April Establishment of the snake.
1973 1 January Enlargement of the EEC with Denmark, Ireland
and the United Kingdom.
3 April Establishment of ..the European Monetary
Cooperation Fund (Regulation 907173IEEC).

276
 277
1974 18 February Adoption of the Decision on the attainment of
a high degree of convergence of the econom-
ic policies of member states (741120IEEC).
Establishment of the Economic Policy Com-
mittee (Decision 7411221EEC).
1978 7 July The European Council in Bremen agrees on
the broad outlines of the European Monetary
System.
5 December The European Council in Brussels agrees on
the establishment of the European Monetary
System.
1979 13 March Establishment of the European Monetary
System.
1981 1 January Greece becomes the tenth member of the EEC.
1984 3 and 4 December The European Council in Dublin agrees that
steps should be taken to complete the Internal
Market.
1985 28 June Publication of the White Book on the Comple-
tion of the Internal Market.
1986 1 January Portugal and Spain join the EEC.
28 February Signing of the Single European Act which pro-
vides for the completion of the Internal Market
in 1992.
11987 1 July The Single Europese Act becomes effective.
1988 24 June Establishment of a single facility providing
medium-term financial assistance for member
states' balance of payments.
28 June The European Council in Hannover establishes
the Delors Committee with a view to propose
concrete stages leading to economic and mon-
etary union.
1989 17 April Presentation of the Delors Report on Eco-
nomic and Monetary Union in the European
Community.
1990 8 January Adoption of the narrow fluctuation margin in
the exchange rate mechanism of the EMS for
the Italian lira.
12 March Adoption of the Decision on multilateral
surveillance (9011411EEC) and of the Decision
on the Committee of Governors (90/1421EEC).
1 July Start of the first stage of the Economic and
Monetary Union.
278
8 October Entry of the British pound sterling in the
exchange rate mechanism of the EMS.
1991 10 December Adoption of the Treaty on European Union in
Maastricht.
1992 2 June Rejection of the Treaty on European Union in
a referendum in Denmark.
17 September Suspension of the participation of the British
pound sterling and the Italian lira in the
exchange rate mechanism of the EMS.
20 September Adoption by a narrow margin of the Treaty on
European Union in a referendum in France.
1993 18 May Ratification of the Treaty on European Union
in Denmark.
21 July Adoption of the Treaty on European Union in
the British House of Commons.
1 August Widening of the fluctuation bands in the
exchange rate mechanism of the EMS to 15%.
1 November The Treaty on European Union becomes
effective.
1994 1 January Start of the second stage of the Economic and
Monetary Union. Establishment of the Euro-
pean Monetary Institute.
 Annex 1

Extracts from the Treaty establishing the European Communities

concerning capital movements and the balance ofpayments

Capital

Article 67
1. During the transitional period and to the extent necessary to ensure the
proper functioning of the common market, Member States shall progressive-
ly abolish between themselves all restrictions on the movement of capital
belonging to persons resident in Member States and any discrimination based
on the nationality or on the place of residence of the parties on the place
where such capital is invested.
2. CUI rent payments connected with the movement of capital between
Member States shall be freed from all restrictions by the end of the first stage
at the latest.

Article 68
1. Member States shall, as regards the matters dealt with in this Chapter, be
as liberal as possible in granting such exchange authorizations as are still
necessary after the entry into force of this Treaty.
2. Where a Member State applies to the movements of capital liberalized in
accordance with the provisions of this Chapter the domestic rules governing
the capital market and the credit system, it shall do so in a non-discriminatory
manner.
3. Loans for the direct or indirect financing of a Member State or its regional
or local authorities shall not be issued or placed in other Member States unless
the States concerned have reached agreement thereon. This provision shall
not preclude the application of Article 32 of the Protocol on the Statute of the
European Investment Bank.

Article 69
The Council shall on a proposal from the Commission, which for this purpose
shall consult the Monetary Committee provided for in Article 105, issue the
necessary directives for the progressive implementation of the provisions of
Article 67, acting unanimously during the first two stages and by a qualified
majority thereafter.

279
280

Article 70
1. The Commission shall propose to the Council measures for the progressive
coordination of the exchange policies of Member States in respect of the
movement of capital between those States and third countries. For this purpose
the Council shall issue directives, acting by a qualified majority. It shall
endeavour to attain the highest possible degree of liberalization. Unanimity
shall be required for measures which constitute a step back as regards the
liberalization of capital movements. l
2. Where the measures taken in accordance with paragraph 1 do not permit
the elimination of differences between the exchange rules of Member States
and where such differences could lead persons resident in one of the Member
States to use the freer transfer facilities within the Community which are
provided for in Article 67 in order to evade the rules of one of the Member
States concerning the movement of capital to or from third countries, that
State may, after consulting the other Member States and the Commission,
take appropriate measures to overcome these difficulties.
Should the Council find that these measures are restricting the free move-
ment of capital within the Community to a greater extent than is required
for the purpose of overcoming the difficulties, it may, acting by a qualified
majority on a proposal from the Commission, decide that the State concerned
shall amend or abolish these measures.

Article 71
Member States shall endeavour to avoid introducing within the Communi-
ty any new exchange restrictions on the movement of capital and current
payments connected with such movements, and shall endeavour not to make
existing rules more restrictive.
They declare their readiness to go beyond the degree of liberalization of
capital movements provided for in the preceding Articles in so far as their
economic situation, in particular the situation of their balance of payments,
so permits.
The Commission may, after consulting the Monetary Committee, make
recommendations to Member States on this subject.

Article 72
Member States shall keep the Commission informed of any movements of
capital to and from third countries which come to their knowledge. The
Commission may deliver to Member States any opinions which it considers
appropriate on this subject.

Article 73
1. If movements of capital lead to disturbances in the functioning of the
capital market in any Member State, the Commission shall, after consulting
the Monetary Committee, authorize that State to take protective measures
 281

in the field of capital movements, the conditions and details of which the
Commission shall determine.
The Council may, acting by a qualified majority, revoke this authorization
or amend the conditions or details thereof.
2. A Member State which is in difficulties may, however, on grounds of
secrecy or urgency, take the measures mentioned above, where this proves
necessary, on its own initiative. The Commission and the other Member
States shall be informed of such measures by the date of their entry into
force at the latest. In this event the Commission may, after consulting the
Monetary Committee, decide that the State concerned shall amend or abolish
the measures.

Balance o/payments

Article 104
Each Member State shall pursue the economic policy needed to ensure the
equilibrium of its overall balance of payments and to maintain confidence in
its currency, while taking care to ensure a high level of employment and a
stable level of prices.

Article 105
1. In order to facilitate attainment of the objectives set out in Article 104,
Member States shall coordinate their economic policies. They shall for this
purpose provide for cooperation between their appropriate administrative
departments and between their central banks.
The Commission shall submit to the Council recommendations on how to
achieve such cooperation.
2. In order to promote coordination of the policies of Member States in the
monetary field to the full extent needed for the functioning of the common
market, a Monetary Committee with advisory status is hereby set up. It shall
have the following tasks:
- to keep under review the monetary and financial situation of the Member
States and of the Community and the general payments system of the
Member States and to report regularly thereon to the Council and to the
Commission;
- to deliver opinions at the request of the Council or of the Commission
or on its own initiative, for submission to these institutions.
The Member States and the Commission shall each appoint two members of
the Monetary Committee.

Article 106
1. Each Member State undertakes to authorize, in the currency of the Member
State in which the creditor or the beneficiary resides, any payments connected
with the movement of goods, services or capital, and any transfers of capital
282
and earnings, to the extent that the movement of goods, services, capital and
persons between Member States has been liberalized pursuant to this Treaty.
The Member States declare their readiness to undertake the liberalization
of payments beyond the extent provided in the preceding subparagraph, in
so far as their economic situation in general and the state of their balance of
payments in particular so permit.
2. In so far as movements of goods, services and capital are limited only
by restrictions on payments connected therewith, these restrictions shall be
progressively abolished by applying, mutatis mutandis, the provisions of the
Chapters relating to the abolition of quantitative restrictions, to the liberal-
ization of services and to the free movement of capital.
3. Member States undertake not to introduce between themselves any new
restrictions on transfers connected with the invisible transactions listed in
Annex illto this Treaty.
The progressive abolition of existing restrictions shall be effected in accor-
dance with the provisions of Articles 63 to 65, in so far as such abolition is
not governed by the provisions contained in paragraphs 1 and 2 or by the
Chapter relating to the free movement of capital. 2
4. If need be, Member States shall consult each other on the measures to
be taken to enable the payments and transfers mentioned in this Article to be
effected; such measures shall not prejudice the attainment of the objectives
set out in this Chapter.

Article 107
1. Each Member State shall treat its policy with regard to rates of exchange
as a matter of common concern.
2. If a Member State makes an alteration in its rate of exchange which is
inconsistent with the objectives set out in Article 104 and which seriously
distorts conditions of competition, the Commission may, after consulting the
Monetary Committee, authorize other Member States to take for a strictly
limited period the necessary measures, the conditions and details of which it
shall determine, in order to counter the consequences of such alteration.

Article 108
1. Where a Member State is in difficulties or is seriosly threatened with
difficulties as regards its balance of payments either as a result of an overall
disequilibrium in its balance of payments, or as a result of the type of currency
at its disposal, and where such difficulties are liable in particular to jeopardize
the functioning of the common market or the progressive implementation of
the common commercial policy, the Commission shall immediately investi-
gate the position of the State in question and the action which, making use of
all the means at its disposal, that State has taken or may take in accordance
with the provisions of Article 104. The Commission shall state what measures
it recommends the State concerned to take.
 283

If the action taken by a Member State and the measures suggested by the
Commission do not prove sufficient to overcome the difficulties which have
arisen or which threaten, the Commission shall, after consulting the Monetary
Committee, recommend to the Council the granting of mutual assistance and
appropriate methods therefor.
The Commission shall keep the Council regularly informed of the situation
and of how it is developing.
2. The Council, acting by a qualified majority, shall grant such mutual
assistance; it shall adopt directives or decisions laying down the conditions
and details of such assistance, which may take such forms as:
(a) a concerted approach to or within any other international organizations
to which Member States may have recourse;
(b) measures needed to avoid deflection of trade where the State which is
in difficulties maintains or reintroduces quantitative restrictions against
third countries;
(c) the granting of limited credits by other Member States, subject to their
agreement.
During the transitional period, mutual assistance may also take the form of
special reductions in customs duties or enlargements of quotas in order to
facilitate an increase in imports from the State which is in difficulties, subject
to the agreement of the States by which such measures would have to be
taken.
3. Ifthe mutual assistance recommended by the Commission is not granted
by the Council or ifthe mutual assistance granted and the measures taken are
insufficient, the Commission shall authorize the State which is in difficulties to
take protective measures, the conditions and details of which the Commission
shall determine.
Such authorization may be revoked and such conditions and details may
be changed by the Council acting by a qualified majority.

Article 109
1. Where a sudden crisis in the balance of payments occurs and a decision
within the meaning of Article 108 (2) is not immediately taken, the Member
State concerned may, as a precaution, take the necessary protectiv.e measures.
Such measures must cause the least possible disturbance in the functioning of
the common market and must not be wider in scope than is strictly necessary
to remedy the sudden difficulties which have arisen.
2. The Commission and the other Member States shall be informed of such
protective measures not later than when they enter into force. The Commission
may recommend to the Council the granting of mutual assistance under Article
108.
3. After the Commission has delivered an opinion and the Monetary Com-
mittee has been consulted, the Council may, acting by a qualified majority,
284

decide that the State concerned shall amend, suspend or abolish the protective
measures referred to above.

NOTES

1. Paragraph 1, as amended by Article 16(4) of the Single European Act. The original
text of the Treaty establishing the European Economic Community provided after the first
identical sentence: 'Por this purpose the Council shall issue directives, acting unanimously.
It shall endeavour to attain the highest possible degree of liberalization. '
2. Articles 63 to 65 refer to the liberalization of services.
 Annex 2

Members of the Monetary Committee

Belgium
1958-1968 Franz de Voghel Bank
1958-1966 Maurice Williot Finance
1966-1975 Marcel D'Haeze Finance
1968-1975 Cecil de Strycker Bank
1975-1988 Georges Janson Bank
1975-1983 Jacques van Ypersele Finance
1983-1984 Erniel Kestens Finance
1985-1988 Ren6 Lauwerijns Finance
1988 Louis Meulernans Finance
1988-1989 Alfons Verplaetse Bank
1988-1990 Edgard van de Pontsele Finance
1989- Guy Quaden Bank
1990- Gr6goire Brouhns Finance

France
1958-1961 JeanSadrin Finance
1958-1964 Pierre Calvet Bank
1962-1965 Andr6 de Lattre Finance
1964-1973 Bernard Clappier Bank
1965-1967 M. Perouse Finance
1967-1971 Raymond Larre Finance
1971-1973 C. Pierre-Brossolette Finance
1973-1978 Jean-Yves Haberer Finance
1974 Andre de Lattre Bank
1974-1979 R. de la Geniere Bank
1978-1984 Michel Camdessus Finance
1980 M. Th6ron Bank
1980-1984 Alain Prate Bank
1983-1984 Philippe Jurgensen Finance
1984-1993 Philippe Lagayette Bank
1984-1987 Daniel Lebegue Finance
1987-1993 Jean-Claude Trichet Finance
1992-1993 Ariane Obolensky Finance

285
286
1993 - Herve Hannoun Bank
1993 - Christian Noyer Finance

Germany
1958-1967 Rolf Gocht Economic Affairs
1958-1977 Otmar Emminger Bank
1967-1970 W.Hanemann Economic Affairs
1970--1972 W. Henkel Economic Affairs
1972-1973 D. Hiss Finance
1974 H.H. Weber Finance
1976-1979 Karl-Otto Pohl Finance/Bank
1980--1989 Leonhard GIeske Bank
1980 M. Lahnstein Finance
1980--1982 Horst Schulmann Finance
1982-1993 Hans Tietmeyer Finance/Bank
1982 K. Wesselkock Finance
1985-1987 W. Muller-Enders Finance
1989 Helmut Schlesinger Bank
1990--1993 Horst Koehler Finance
1993- Gert Haller Finance
1993 - Helmut Schieber Bank

Italy
1958-1964 Amadeo Gambino Finance
1958-1959 Paride Formentini Bank
1959-1960 Guido Carli Bank
1960--1963 Paolo Baffi Bank
1963-1964 A. Vemucci Bank
1964-1970 G. Stammati Finance
1964-1975 Rinaldo Ossola Bank
1970--1975 G. Miconi Finance
1975-1980 G. Magnifico Bank
1975-1980 S. Palumbo Finance
1980--1981 F. Ruggiero Finance
1980--1994 Lamberto Dini Bank
1981-1982 L. Izzo Finance
1982-1991 Mario Sarcinelli Finance
1989-1991 Augusto Zodda Finance
1991- Mario Draghi Finance

Luxembourg
1958-1959 Rene Franck Bank
1958-1969 Paul Bastian Finance
1959-1966 J. Heinen Economic Affairs
 287
1966-1971 R. Weber Bank
1969-1974 J. Schmitz Finance
1971-1974 C.Lamboray Bank
1975-1977 A. Dondelinger Bank
1975-1989 R. Kirsch Finance
1977-1990 Pierre Jaans Bank
1989- Yves Mersch Finance
1990- Jean Guill Bank

The Netherlands
1958-1969 Emile van Lennep Finance
1958-1964 S. Posthuma Bank
1964-1968 J.H.O. graafv.d. Bosch Bank
1968-1972 A.W.R. baron Mackay Bank
1969-1971 Willem Drees Finance
1971-1976 CoenOort Finance
1973-1994 Andre Szasz Bank
1977-1981 Nout Wellink Finance
1982-1986 Piet Korteweg Finance
1986-1992 CeesMaas Finance
1991-1992 Pieter Stek Finance
1992- Henk Brouwer Finance
1994- Nout Wellink Bank

Denmark
1973-1982 Svend Andersen Bank
1973-1979 Kurt Hansen Economic Affairs
1979-1987 Niels U ssing Economic Affairs
1982-1990 Richard Mikkelsen Bank
1988- Jens Thomsen Economic Affairs
1990- Bodil Andersen Bank

Ireland
1973-1976 Bernard Breen Bank
1973-1974 Sean Murray Finance
1974-1976 Tomas O'Cofaigh Finance
1976-1982 Michael Horgan Finance
1976-1982 TlIDOthy O'Grady-Walshe Bank
1982-1983 David McCutcheon Finance
1982-1985 Padraig McGowan Bank
1983-1987 Maurice Doyle Finance
1985- George Reynolds Bank
1987-1990 Michael Somers Finance
1991-1994 Maurice O'Connell Finance
288
1994- Noel o 'Gorman Finance

United Kingdom
1973-1975 Christopher Fogarty Finance
1973-1974 Christopher McMahon Bank
1974-1985 Michael Balfour Bank
1976-1979 Nicolas Jordan-Moss Finance
1980-1983 Sir Kenneth Couzens Finance
1983-1988 Geoffrey Littler Finance
1985-1989 Anthony Loehnis Bank
1988 David Peretz Finance
1989- Nigel Wicks Finance
1989-1993 Andrew Crockett Bank
1993-1994 Paul Gray Finance
1994- Alastair Clark Bank
1994- Gus O'Donnell Finance

Greece
1981 G. Drakos Bank
1981-1982 C. Mavraganis Finance
1981-1984 D. Chalikias Bank
1982 T. Dimopoulos Finance
1983-1984 S. Thomadakis Finance
1984-1985 P. Korliras Bank
1984-1985 L. Katseli Finance
1987-1989 J annis Papanikolaou Finance
1989 D. Mavragannis Finance
1985-1988 Lucas Papademos Bank
1985-1987 Nicholas Garganas Finance
1988 Papageorgiou Bank
1989-1990 Sidiropoulos Finance
1989-1990 Lucas Papademos Bank
1990-1993 G. Provopoulos Bank
1990-1992 I. Papadakis Finance
1992-1993 Miranda Xafa Finance
1993-1994 George Katiforis Finance
1994- Nicholas Garganas Bank
1994 Anastassios Giannitsis Finance
1994- Ioannis Stournaras Finance

Spain
1986-1988 Juan Ruiz de AIda Bank
1986 Jose Garcia Alonso Finance
1986-1988 Pedro Martinez Mendez Finance
 289
1988-1992 L. Rojo Bank
1988- Manuel Conthe Finance
1992- Miguel Martin Bank

Portugal
1986 Manuel de Melo Finance
1986 Alexandre Pinto Bank
1986-1987 Brito Da Silva Girao Finance
1986-1989 V. Marques Bank
1987-1989 Gomes Moreno Finance
1990-1993 Antonio Borges Bank
1990-1991 Carlos Tavares Finance
1992-1993 Jose Braz Finance
1993 - Joao Costa Pinto Bank
1994- Manuel Pinho Finance

EEC
1958-1964 Leonhard GIeske
1958-1967 F. Bobba
1964-1968 Tom de Vries
1967-1979 U. Mosca
1968-1981 F. Boyer de la Giroday
1979-1983 Tomasso Padoa-Schioppa
1982-1989 J.P. Mingasson
1983-1987 Massimo Russo
1987-1990 Antonio Costa
1989-1994 Jean-Fran~ois Pons
1990- Giovanni Ravasio
1994- Herve Carre

Secretaries Monetary Committee

1958-1961 Alain Prate France
1962-1969 R. de Kergorlay France
1969-1978 Giampietro Morelli Italy
1978-1993 Andreas Kees Germany
1993 - Gunter Grosche Germany

NOTE
For Italy members originating from the Ufficio dei Cambi have been registered as representa-
tives of the central bank. For Luxembourg, where the Luxembourg Monetary Institute was only
established later, members originating from the ContrOie des Banques or from the state-owned
Caisse d 'Epargne have been registered as Bank representatives.
 Annex 3

Statutes of the Monetary Committee l

The Council
Having regard to Article 105(2) of the Treaty establishing the European
Economic Community which sets up a Monetary Committee in order to
promote coordination of the policies of Member States in the monetary field
to the full extent needed for the functioning of the common market,
Having regard to Article 153 of the Treaty pursuant to which the Council
determines the rules governing the committees provided for in the Treaty,
Having obtained the Opinion of the Commission,
has decided that the Rules governing the Monetary Committee shall be as
follows:

Article 1
The Committee shall keep under review the monetary and financial situation
of Member States and of the Community and also the general payments
system of Member States, and shall report regularly to the Council and to the
Commission thereon.

Article 2
When examining the monetary and financial situation of Member States, the
Committee shall endeavour in particular to foresee any difficulties which
may affect their balance of payments. It shall address to the Council and to
the Commission any suggestions designed to avert these difficulties while at
the same time preserving the internal and external financial stability of each
Member State.

Article 3
In respect of the general payments system of Member States, the Committee
shall, in particular, keep under review the implementation of the provisions
of Article 106(1) to (3) of the Treaty. Where necessary, it shall address to the
Council suggestions concerning measures to be taken by Member States in
accordance with Article 106(4). It shall inform the Commission thereof.

Article 4
The Opinion of the Monetary Committee must be obtained either by the

290
 291

Council or, in the cases provided for in Article 69, in the last subparagraph
of Article 71, in the first subparagraph of paragraph 1 of Article 73 and in
paragraph 2 thereof, in Article 107(2), in the second subparagraph of Article
108(1), and in Article 109(3), by the Commission.
The Opinion of the Committee may also be obtained in other cases by the
Council or the Commission.
In any event, the Committee has the power and the obligation to draw
up Opinions on its own initiative whenever it considers it necessary for the
proper fulfilment of its task.

Article 5
Member States and the Commission shall each appoint two members of the
Committee. They may also appoint two alternate members of the Committee.
The members of the Committee and the alternates must be selected from
among experts possessing outstanding competence in the monetary field. As
a general rule, each Member State shall select one member from among senior
officials of the administration and the other member on the proposal of the
central bank; the alternates may be selected in the same way.
Members of the Committee and alternates shall be appointed in their per-
sonal capacity and shall, in the general interests of the Community, be com-
pletely independent in the performance of their duties.
The term of office of the members of the Committee and of the alternates
shall be two years. It shall be renewable. It shall end on death, voluntary
resignation, or compulsory retirement. In such cases the new member or
alternate shall be appointed for the remainder of the term of office.
A member of the Committee or an alternate may be compulsorily retired
against his wishes only by the authority which appointed him and then only
if the member or alternate no longer fulfils the conditions required for the
performance of his duties.

Article 6
Each member of the Committee shall have one vote.

Article 7
The Committee shall appoint from among its members a Chairman and three
Vice-Chairmen to be elected by a majority of 11 votes for a period of two
years. If a Chairman or Vice-Chairman ceases to hold office before his full
term has expired, the vacancy thus caused shall be filled for the remainder of
the term of office.

Article 8
Unless the Committee decides otherwise, alternates may attend meetings of
the Committee. They shall not take part in the discussions and shall not vote.
292
A member who is unable to attend a meeting of the Committee may
delegate his functions to one of the alternates; he may also delegate them to
another member.

Article 9
The Committee shall meet not less than six times a year.
It shall be convened by the Chairman on his own initiative or at the request
of the Council or of the Commission or of two members of the Committee.

Article 10
Opinions of the Committee, within the meaning of Article 4, shall be adopted
by a majority of 11 votes. The minority may set out its views in a document
attached to the Opinion of the Committee.
Where a majority within the meaning of the preceding subparagraph is not
obtained, and in the case of any other decision, suggestion or communication
intended for the Council or the Commission, the Committee shall submit a
report setting out either the unanimous opinion of its members or the various
opinions expressed in the course of the discussion.

Article 11
The Committee may propose to the Council or to the Commission that one
or more of its members be attached to these institutions in order to comment
orally on any document which may be addressed to them by the Committee.

Article 12
The Committee may entrust the study of specific questions to working parties
composed of members of the Committee or alternates. The Committee and
the working parties may call upon experts to assist them.

Article 13
In important cases the Committee may, before drawing up a report or deliv-
ering an Opinion on a specific country, request all necessary information.

Article 14
The Committee shall establish close cooperation with the Managing Board
of the European Payments Union or, if the case should arise, with the Board
of Management of the European Monetary Agreement, on all questions of
common interest. To this end, the Committee may in particular invite the
Managing Board of the European Payments Union or, if the case should
arise, the Board of Management of the European Monetary Agreement, to be
represented at its meetings, or may propose that joint meetings be arranged.

Article 15
Discussions of the Committee and of the working parties shall be confidential.
 293

Article 16
The Committee shall be assisted by a secretariat. The staff needed for this
shall be supplied by the Commission.
The expenses of the Committee shall be included in the estimates of the
Commission.

Article 17
The Committee shall adopt its own rules of procedure.

Consultation of the Monetary Committee by the Council and the Commis-

sion
Translation of an extract from the minutes of the second meeting of the
Council of the European Communities held in Brussels on 25 February 1958

With regard to Article 4 (of the Statutes of the Monetary Committee), the
Council and the Commission declared that they propose, as a general rule, to
consult the Monetary Committee before taking any of the decisions provided
for in Article 70(2), paragraph 2; Article 73(1), paragraph 2; or Article 108(3)
paragraphs 1 or 2; and before making any of the recommendations or pro-
posals provided for in Article 70(1); Article 108(1), paragraph 1; or Article
109(2) of the Treaty establishing the EEC.

NOTE

1. Council Decision of 18 March 1958 amended by Council Decision of 2 April 1962, by

Article 29 of the Act of Accession of 22 January 1972 and by Council Decision of 25
March 1976 (76/332JEEC).
 Annex 4

First Council Directive of 11 May 1960

for the implementation ofArticle 67 of the Treatyl

The Council of the European Economic Community,

Having regard to the Treaty, and in particular Articles 5, 67(1), 69, 105(2)
and 106(2) thereof,
Having regard to the proposal from the Commission, which consulted the
Monetary Committee for this purpose,
Having regard to the Decision of 11 May 1960 on the application to
Algeria and to the French overseas departments of the provisions of the
Treaty concerning capital movements,
Whereas the attainment of the objectives of the Treaty establishing the
European Economic Community requires the greatest possible freedom of
movement of capital between Member States and therefore the widest and
most speedy liberalization of capital movements,
Has adopted this Directive:

Article 1
1. Member States shall grant all foreign exchange authorizations required
for the conclusion or performance of transactions or for transfers between
residents of Member States in respect of the capital movements set out in List
A of Annex I to this Directive.
2. Member States shall enable such transfers of capital to be made on the
basis of the exchange rate ruling for payments relating to current transactions.
Where such transfers are made on a foreign exchange market on which
the fluctuations of exchange rates are not officially restricted, this obligation
shall be taken to mean that the exchange rates applied must not show any
appreciable and lasting differences from those ruling for payments relating to
current transactions.
The Monetary Committee shall watch closely the trend of exchange rates
applied to such transfers of capital, and shall report thereon to the Commis-
sion. If the Commission finds that these rates show appreciable and lasting
differences from those ruling for payments relating to current transactions, it
shall initiate the procedure provided for in Article 169 of the Treaty.

294
 295
Article 2
1. Member States shall grant general permission for the conclusion or perfor-
mance of transactions and for transfers between residents of Member States in
respect of the capital movements set out in List B of Annex I to this Directive.
2. Where such transfers of capital are made on a foreign exchange market on
which the fluctuations of exchange rates are not officially restricted, Member
States shall endeavour to ensure that transfers are made at rates which do
not show appreciable and lasting differences from those ruling for payments
relating to current transactions.
The Commission may, after consulting the Monetary Committee, make
recommendations in this connection to Member States.
3. Where the transfers are made either on the same foreign exchange
market as payments relating to current transactions, or on a market on which
exchange rate fluctuations are kept within limits applicable to such market as
aforesaid, the application of paragraph 1 of this Article may, as a temporary
measure, be confined - as regards the acquisition of foreign securities by
residents - to the financial institutions and to the undertakings which acquire
securities of foreign companies established for a like purpose.
The Commission may, after consulting the Monetary Committee, make
recommendations in this connection to the Member States.

Article 3
1. Subject to paragraph 2 of this Article, Member States shall grant all for-
eign exchange authorizations required for the conclusion or performance of
transactions and for transfers between residents of Member States in respect
of the capital movements set out in List C of Annex I to this Directive.
2. When such free movement of capital might form an obstacle to the
achievement of the economic policy objective of a Member State, the latter
may maintain or reintroduce the exchange restrictions on capital movement
which were operative on the date of entry into force of this Directive (in
the case of new Member States, the date of accession). It shall consult the
Commission on the matter.
The Commission shall examine the measures for coordinating the eco-
nomic policies of Member States which will enable these difficulties to be
overcome and, after consulting the Monetary Committee, shall recommend
their adoption by the Member States.
3. The Commission may recommend that the State in question abolish the
exchange restrictions which are maintained or reintroduced.

Article 4
The Monetary Committee shall examine at least once a year the restrictions
which are applied to the capital movements set out in the lists contained
in Annex I to this Directive; it shall report to the Commission regarding
restrictions which could be abolished.
296

Article 5
1. The provisions of this Directive shall not restrict the right of Member States
to verify the nature and genuineness of transactions or transfers, or to take all
requisite measures to prevent infringements of their laws and regulations.
2. The Member States shall simplify as far as possible the authorization and
control formalities applicable to the conclusion or performance of transactions
and transfers and shall where necessary consult one another with a view to
such simplification.
3. The restrictions on capital movements under the rules for establishment
in a Member State shall be abolished pursuant to this Directive only in so far
as it is incumbent upon the Member States to grant freedom of establishment
in implementation of Articles 52 to 58 of the Treaty.

Article 6
Member States shall endeavour not to introduce within the Community any
new exchange restricion affecting the capital movements that were liberalized
at the date of entry into force of this Directive (in the case of new Member
States, the date of accession) nor to make existing provisions more restrictive.

Article 7
Member States shall make known to the Commission, not later than three
months after the entry into force of this Directive (in the case of new Member
States, three months after the date of accession):
(a) the provisions governing capital movements at the date of entry into force
of this Directive which are laid down by law, regulation or administrative
action;
(b) the provisions adopted in pursuance of the Directive;
(c) the procedures for implementing those provisions.
They shall also make known, not later than the time of entry into force thereof,
any new measures going beyond the obligations of this Directive, and any
amendment of the provisions governing the capital movements set out in List
D of Annex I to this Directive.

Article 8
Deleted

Article 9
This Directive shall apply without prejudice to the provisions of Articles
67(2),68(3) and 221 of the Treaty.

Article 10
List A, B, C and D contained in Annex I, together with the Nomenclature of
Capital Movements and the Explanatory Notes in Annex II, form an integral
part of this Directive.
 297
ANNEXl

LIST A

Capital movements referred to in Article 1 of the Directive

Direct investments
excluding purely financial investments made with a view only to giving the
persons providing the capital indirect access to the money or capital market
of another country, through the creation of an undertaking of participation
in an existing undertaking in that country
Liquidation of direct investments

Investiments in real estate

Personal capital movements

Gifts and endowments

Dowries

Inheritances

Settlement of debts in their country of origin by immigrants

Transfers of capital belonging to residents who emigrate

Transfers of capital belonging to emigrants returning to their country of

origin

Transfers of workers' savings during their period of stay

Transfers by instalment of blocked funds belonging to non-residents by

the holders of such funds in case of special hardship

Annual transfers of blocked funds to another Member State by a non-

resident account holder, up to an amount or a percentage of the total assets,
fixed uniformly by the Member State concerned for all applicants

Transfers of minor amounts abroad

Granting and repayment of short and medium-term credits related to commer-
cial transactions or to provision of services in which a resident is participating

Sureties, other guarantees and rights of pledge and transfers connected with
them
298

related to short and medium-term credits in respect of commercial trans-

actions or provisions of services in which a resident is participating

related to long-term loans with a view to establishing or maintaining lasting

economic links
Transfers in performance of insurance contracts
as and when freedom of movement in respect of services is extended to
those contracts in implementation of Article 59 et seq. of the Treaty
Operation in securities
Acquisition by non-residents of domestic securities not dealt in on a stock
exchange and repatriation of the proceeds of liquidation thereof

Acquisition by residents of foreign securities not dealt in on a stock

exchange and use of the proceeds of liquidation thereof

Acquisition by non-residents of units in domestic unit trusts dealt in on a

stock exchange and repatriation of the proceeds of liquidation thereof

Acquisition by residents of units in foreign unit trusts dealt in on a stock

exchange and use of the proceeds of liquidation thereof

Acquisition by residents of foreign bonds dealt in on a stock exchange,

issued on a foreign market and denominated in national currency

Physical movements of the securities mentioned above

Granting and repayment of long-term credits related to commercial transac-
tions or to the provisions of services in which a resident is participating

Granting and repayment of medium and long-term credits related to com-

mercial transactions or to the provision of services in which no resident is
participating

Granting and repayment of medium and long-term loans and credits not
related to commercial transactions or to the provisions of services

Sureties, other guarantees and rights of pledge and transfers connected with
them and relating to:
long-term credits in respect of commercial transactions or provision of
services in which a resident is participating

medium and long-term credits in respect of commercial transactions or

provision of services in which no resident is participating
 299
medium and long-tenn loans and credits not related to commercial trans-
actions or to provision of services
The use of the proceeds of liquidation of assets abroad belonging to residents
must be permitted at least within the limits of the obligations as regard liber-
alization accepted by Member States.

Death duties

Damages (where these can be considered as capital)

Refunds in the case of cancellation of contracts and refunds of uncalled-

for payments (where these can be considered as capital)

Authors' royalties
Patents, designs, trade marks and inventions (assignments and transfers aris-
ing out of such assignments)

Transfers of the moneys required for the provision of services

The use of the proceeds of liquidation of assets abroad belonging to resi-

dents must be pennitted at least within the limits of the obligations as regards
liberalization accepted by Member States.

LISTB

Capital movements referred to in Article 2 of the Directive Operations in

securities
Acquisition by non-residents of domestic securities dealt in on a stock
exchange (excluding units of unit trusts) and repatriation of the proceeds
of liquidation thereof

Acquisition by residents of foreign securities dealt in on a stock exchange

and use of the proceeds of liquidation thereof

(I) excluding the acquisition of bonds issued ona foreign market and
denominated in national currency
(II) excluding units of unit trusts
Physical movements of the securities mentioned above
The use of the proceeds of liquidation of assets abroad belonging to residents
must be pennitted at least within the limits of the obligations as regards
liberalization accepted by Member States.
300

LlSTC

Capital movements referred to in Article 3 of the Directive

Issue and placing of securities of a deomestic undertaking ona foreign capital
market
Issue and placing of securities of a foreign undertaking on the domestic capital
market

LlSTD

Capital movements referred to in Article 4 of the Directive

Short-term investments in Treasury bills and other securities normally dealt
in on the money market
Opening and placing of funds on current or deposit accounts, repatriation or
use of balances on current or deposit accounts with credit institutions
Granting and repayment of short-term credits related to commercial transac-
tions or to provision of services in which no resident is participating
Granting and repayment of short-term loans and credits not related to com-
mercial transactions or to provisions of services
Personal capital movements
loans
Sureties, other guarantees and rights of pledge and transfers connected with
them
related to short-term credits in respect of commercial transactions or to
provision of services in which no resident is participating
related to short-term loans and credits not connected with commercial
transactions or to provision of services
related to private loans
Physical import and export of financial assets
Other capital movements: Miscellaneous

NOTE

1. Text incotpOrating the amendments contained in the Second Directive of 18 December

1962 (63/21!EEC) and in Article 29 of the Act of Accession of 12 January 1972.
 Annex 5

Council Directive 0/21 March 1972 on regulating international capital

flows and neutralizing their undesirable effects on domestic liquidity
(721156IEEC)

The Council of the European Communities,

Having regard to the Treaty establishing the European Economic Community,
and in particular Articles 70 and 103 thereof,
Having regard to the proposal from the Commission,
Whereas exceptionally large capital movements have caused serious distur-
bances in the monetary situation and in economic trends in Member States;
whereas these disturbances may hinder the establishment by stages of an
economic and monetary union; whereas the Council, in its resolution of 9
May 1971, agreed to discuss before 1 July 1971 the adoption of appropriate
measures to deal with this situation;
Whereas, so that contingencies of comparable character and magnitude
do not recur, the Member States should supplement the instruments that are
available for regulating domestic liquidity;
Whereas to this end it is imperative that Member States adopt measures
immediately in order to have available, should occasion arise, the appropri-
ate instruments for the purpose of discouraging exceptionally large capital
movements, in particular to and from third countries, and of neutralizing their
effects on the domestic monetary situation, thereby creating the conditions
required for concerted action on the part of the Member States in those fields
in order to ensure smooth trading conditions within the Community and the
achievement of economic and monetary union;
Whereas exceptionally large capital movements can produce serious stress-
es on the exchange markets of the Member States, the smooth operation of
which constitutes the object of the policy with regard to rates of exchange
which each Member State must, by virtue of Article 107(1), treat as a matter
of common concern;
Whereas, in order to ensure the efficacy of the measures to be taken to
prevent exceptionally large capital movements, the regulation of loans and
credits not related to commercial transactions or to provision of services and
granted by non-residents to residents must be extended to medium and long-
term loans and credits; whereas for this purpose a derogation from Article

301
302

3(1) of the First Directive for the implementation of Article 67 of the Treaty,
as amended by the Directive of 18 December 1962, should be permitted,
Has adopted this Directive:

Article 1
The Member States shall take all necessary steps to ensure that the monetary
authorities have available the following instruments and are able, where
necessary, to put them into operation immediately without further enabling
measures:
(a) for effective regulation of international capital flows:
(i) rules governing investment on the money market and payment of
interest on deposits by non-residents;
(ii) regulation of loans and credits which are not related to commercial
transactions or to provision of services and are granted by non-
residents to residents, if need be by derogating from Article 3(1)
of the First Directive for the implementation of Article 67 of the
Treaty;
(b) for the neutralization of those effects produced by international capital
flows on domestic liquidity which are considered undesirable:
(i) regulation of the net external position of credit institutions;
(ii) fixing minimum reserve ratios, in particular for the holdings of
non-residents.

Article 2
1. The Member States shall forthwith adopt the necessary measures to comply
with this Directive.
2. Each Member State shall, where necessary, and taking account of the
interests of the other Member States, apply all or some of the instruments
mentioned in Article 1. To this end the Commission, in cooperation with the
Monetary Committee and the Committee of Governors of Central Banks, shall
ensure close coordination between the competent authorities of the Member
States.
3. The Commission, after consulting the Monetary Committee and the
Committee of Governors of Central Banks, shall keep the Council informed
of the situation and its development.
 Annex 6

Council Directive of24 June 1988for the implementation ofArticle 67 of

the Treaty (8813611EEC)

The Council of the European Communities,

Having regard to the Treaty establishing the European Economic Community,
and in particular Articles 69 and 70( 1) thereof,
Having regard to the proposal from the Commission, submitted following
consultation with the Monetary Committee,
Having regard to the opinion of the European Parliament,
Whereas Article 8a of the Treaty stipulates that the internal market shall
comprise an area without internal frontiers in which the free movement of
capital is ensured, without prejudice to the other provisions of the Treaty;
Whereas Member States should be able to take the requisite measures to
regulate bank liquidity; whereas these measures should be restricted to this
purpose;
Whereas Member States should, if necessary, be able to take measures
to restrict, temporarily and within the framework of appropriate Community
procedures, short-term capital movements which even where there is no
appreciable divergence in economic fundamentals, might seriously disrupt
the conduct of their monetary and exchange-rate policies;
Whereas in the interests of transparency, it is advisable to indicate the
scope in accordance with the arrangements laid down in this Directive, of the
transitional measures adopted for the benefit of the Kingdom of Spain and
the Portuguese Republic by the 1985 Act of Accession in the field of capital
movements;
Whereas the Kingdom of Spain and the Portuguese Republic may, under
the terms of Articles 61 to 66 and 222 to 232 respectively of the 1985 Act
of Accession, postpone the liberalization of certain capital movements in
derogation from the obligations set out in the First Council Directive of 11
May J960 for the implementation of Article 67 of the Treaty, as last amended
by Directive 86/566/EEC; whereas Directive 86/5661EEC also provides for
transitional arrangements to be applied for the benefit of those two Member
States in respect of their obligations to liberalize capital movements; whereas
it is appropriate for those two Member States to be able to postpone the
application of the new liberalization obligations resulting from this Directive;

303
304
Whereas the Hellenic Republic and Ireland are faced, albeit to differ-
ing degrees, with difficult balance-of-payments situations and high levels of
external indebtedness; whereas the immediate and complete liberalization of
capital movements by those two Member States would make it more difficult
for them to continue to apply the measures they have taken to improve their
external positions and to reinforce the capacity of their financial systems to
adapt to the requirements of an integrated financial market in the Community;
whereas it is appropriate, in accordance with Article 8 of the Treaty, to grant
those two Member States, in the light of their specific circumstances, further
time in which to comply with the obligations arising from this Directive;
Whereas, since the full liberalization of capital movements could in some
Member States, and especially in border areas, contribute to difficulties in
the market for secondary residences; whereas existing national legislation
regulating these purchases should not be affected by the entry into effect of
this Directive;
Whereas advantage should be taken of the period adopted for bringing this
Directive into effect in order to enable the Commission to submit propos-
als designed to eliminate or reduce risks of distortion, tax evasion and tax
avoidance resulting from the diversity of national systems for taxation and to
permit the Council to take a position on such proposals;
Whereas, in accordance with Article 70(1) of the Treaty, the Community
shall endeavour to attain the highest possible degree ofliberalization in respect
of the movement of capital between its residents and those of third countries;
Whereas large-scale short-term capital movements to or from third coun-
tries may seriously disturb the monetary or financial situation of Member
States or cause serious stresses on the exchange markets; whereas such devel-
opments may prove harmful for the cohesion of the European Monetary Sys-
tem, for the smooth operation of the internal market and for the progressive
achievement of economic and monetary union; whereas it is therefore appro-
priate to create the requisite conditions for concerted action by Member States
should this prove necessary;
Whereas this Directive replaces Council Directive 721156/EEC of 21
March 1972 on regulating international capital flows and neutralizing their
undesirable effects on domestic liquidity; whereas Directive 72/156/EEC
should accordingly be repealed,
Has adopted this Directive:

Article 1·
1. Without prejudice to the following provisions, Member States shall abolish
restrictions on movements of capital taking place between persons resident in
Member States. To facilitate application of this Directive, capital movements
shall be classified in accordance with the Nomenclature in Annex 1.
2. Transfers in respect of capital movements shall be made on the same
exchange rate conditions as those governing payments relating to current
 305

transactions.

Article 2
Member States shall notify the Committee of Governors of the Central Banks,
the Monetary Committee and the Commission, by the date of their entry
into force at the latest, of measures to regulate bank liquidity which have a
specific impact on capital transactions carried out by credit institutions with
non-residents.
Such measures shall be confined to what is necessary for the purpose of
domestic monetary regulation. The Monetary Committee and the Committee
of Governors of the Central Banks shall provide the Commission with opin-
ions on this subject.

Article 3
1. Where short-term capital movements of exceptional magnitude impose
severe strains on foreign-exchange markets and lead to serious disturbances
in the conduct of a Member State's monetary and exchange rate policies,
being reflected in particular in substantial variations in domestic liquidity, the
Commission may, after consulting the Monetary Committee and the Commit-
tee of Governors of the Central Banks, authorize that Member State to take,
in respect of the capital movements listed in Annex II, protective measures
the conditions and details of which the Commission shall determine.
2. The Member State concerned may itself take the protective measures
referred to above, on grounds of urgency, should these measures be necessary.
The Commission and the other Member States shall be informed of such
measures by the date of their entry into force at the latest. The Commission,
after consulting the Monetary Committee and the Committe of Governors of
the Central Banks, shall decide whether the Member State concerned may
continue to apply these measures or whether it should amend or abolish them.
3. The decisions taken by the Commission under paragraphs 1 and 2 may
be revoked or amended by the Council acting by a qualified majority.
4. The period of application of protective measures taken pursuant to this
Article shall not exceed six months.
5. Before 31 December 1992, the Council shall examine, on the basis of
a report from the Commission, after delivery of an opinion by the Monetary
Committee and the Committee of Governors of the Central Banks, whether
the provisions of this Article remain appropriate, as regards their principle
and details, to the requirements which they were intended to satisfy.

Article 4
This Directive shall be without prejudice to the right of Member States
to take all requisite measures to prevent infringements of their laws and
regulations, inter alia in the field of taxation and prudential supervision of
306
financial institutions, or to lay down procedures for the declaration of capital
movements for purposes of administrative or statistical information.
Application of those measures and procedures may not have the effect of
impeding capital movements carried out in accordance with Community law.

Article 5
For the Kingdom of Spain and the Portuguese Republic, the scope, in accor-
dance with the Nomenclature of capital movements contained in Annex I, of
the provisions of the 1985 Act of Accession in the field of capital movements
shall be as indicated in Annex ill.

Article 6
1. Member States shall take the measures necessary to comply with this Direc-
tive no later than 1 July 1990. They shall forthwith inform the Commission
thereof. They shall also make known, by' the date of their entry into force
at the latest, any new measures or any amendment made to the provisions
governing the capital movements listed in Annex I.
2. The Kingdom of Spain and the Portuguese Republic, without prejudice
for these two Member States to Article 61 to 66 and 222 to-232 of the 1985
Act of Accession, and the Hellenic Republic and Ireland may temporarily
continue to apply restrictions to the capital movements listed in Annex V,
subject to the conditions and time limits laid down in that Annex.
If, before expiry of the time limit set for the liberalization of the capi-
tal movements referred to in Lists ill and IV of Annex IV, the Portuguese
Republic or the Hellenic Republic considers that it is unable to proceed with
liberalization, in particular because of difficulties as regards it balance of pay-
ments or because the national financial system is insufficiently adapted, the
Commission, at the request of one or other of these Member States, shall in
collaboration with the Monetary Committee, review the economic and finan-
cial situation of the Member State concerned. On the basis of the outcome
of this review, the Commission shall propose to the Council an extension of
the time limit set for liberalization of all or part of the capital movements
referred to. This extension may not exceed three years. The Council shall act
in accordance with the procedure laid down in Article 69 of the Treaty.
3. The Kingdom of Belgium and the Grand Duchy of Luxembourg may
temporarily continue to operate the dual exchange market under the conditions
and for the periods laid down in Annex V.
4. Existing national legislation regulating purchases of secondary resi-
dences may be upheld until the Council adopts further provisions in this area
in accordance with Article 69 of the Treaty. This provision does not affect the
applicability of other provisions of Community law.
5. The Commission shall submit to the Council, by 31 December 1988,
proposals aimed at eliminating or reducing risks of distortion, tax evasion
 307

and tax avoidance linked to the diversity of national systems for the taxation
of savings and for controlling the application of these systems.
The Council shall take a postition on these Commission proposals by 30
June 1989. Any tax provisions of a Community nature shall, in accordance
with the Treaty, be adopted unanimously.

Article 7
1. In their treatment of transfers in respect of movements of capital to or from
third countries, the Member States shall edeavour to attain the same degree
of liberalization as that which applies to operations with residents of other
Member States, subject to the other provisions of this Directive.
The provisions of the preceding subparagraph shall not prejudice the appli-
cation to third countries of domestic rules or Community law, particulary
any reciprocal conditions, concerning operations involving establishment,
the provisions of financial services and the admission of securities to capital
markets.
2. Where large-scale short-term capital movements to or from third coun-
tries seriously disturb the domestic or external monetary or financial situation
of the Member States, or of a number of them, or cause serious strains in
exchange relations within the Community or between the Community and
third countries, Member States shall consult with one another on any mea-
sure to be taken to counteract such difficulties. This consultation shall take
place within the Committee of Governors of the Central Banks and the Mon-
etary Committee on the initiative of the Commission or of any Member State.

Article 8
At least once a year the Monetary Committee shall examine the situation
regarding free movement of capital as it results from the application of this
Directive. The examination shall cover measures concerning the domestic
regulation of credit and financial and monetary markets which could have a
specific impact on international capital movements and on all other aspects of
this Directive. The Committee shall report to the Commission on the outcome
of this examination.

Article 9
The First Directive of 11 May 1960 and Directive 721156/EEC shall be
repealed with effect from 1 January 1990.
 Annex 7

Extracts from the Treaty on European Union concerning capital movements

Capital and payments

Article 73a
As from 1 January 1994, Articles 67 to 73 shall be replaced by Articles 73b,
c, d, e, f and g.

Article 73b
1. Within the framework of the provisions set out in this Chapter, all restric-
tions on the movement of capital between Member States and between Mem-
ber States and third countries shall be prohibited.
2. Within the framework of the provisions set out in this Chapter, all restric-
tions on payments between Member States and between Member States and
third countries shall be prohibited.

Article 73c
1. The provisions of Article 73b shall be without prejudice to the application
to third countries of any restrictions which exist on 31 December 1993 under
national or Community law adopted in repect of the movement of capital to
or from third countries involving direct investment - including investment in
real estate - establishment, the provision of financial services or the admission
of securities to capital markets.
2. Whilst endeavouring to achieve the objective of free movement of capi-
tal between Member States and third countries to the greatest extent possible
and without prejudice to the other Chapters of this Treaty, the Council may,
acting by a qualified majority on a proposal from the Commission, adopt
measures on the movement of capital to or from third countries involving
direct investment - including investment in real estate - establishment, the
provision of financial services or the admission of securities to capital mar-
kets. Unanimity shall be required for measures under this paragraph which
constitute a step back in Community law as regards the liberalization of the
movement of capital to or from third countries.

308
 309

Article 73d
1. The provisions of Article 73b shall be without prejudice to the right of
Member States:
(a) to apply the relevant provisions of their tax law which distinguish
between tax-payers who are not in the same situation with regard to
their place of residence or with regard to the place where their capital is
invested;
(b) to take all requisite measures to prevent infringements of national law
and regulations, in particular in the field of taxation and the prudential
supervision of financial institutions, or to lay down procedures for the
declaration of capital movements for purposes of administrative or sta-
tistical information, or to take measures which are justified on grounds
of public policy or public security.
2. The provisions of this Chapter shall be without prejudice to the applica-
bility of restrictions on the right of establishment which are compatible with
this Treaty.
3. The measures and procedures referred to in paragraphs 1 and 2 shall not
constitute a means of arbitrary discrimination or a disguised restriction on the
free movement of capital and payments as defined in Article 73b.

Article 73e
By way of derogation from Article 73b, Member States which, on 31 Decem-
ber 1993, enjoy a derogation on the basis of existing Community law, shall
be entitled to maintain, until 31 December 1995 at the latest, restrictions on
movements of capital authorized by such derogations as exist on that date.

Article 73/
Where, in exceptional circumstances, movements of capital to or from third
countries cause, or threaten to cause, serious difficulties for the operation of
economic and monetary union, the Council, acting by a qualified majority
on a proposal from the Commission and after consulting the ECB, may take
safeguard measures with regard to third countries for a period not exceeding
six months if such measures are strictly necessary.

Article 73g
1. If, in the cases envisaged in Article 228a, action by the Community is
deemed necessary, the Council may, in accordance with the procedure pro-
vided for in Article 228a, take the necessary urgent measures on the movement
of capital and on payments as regards the third countries concerned. 1
2. Without prejudice to Article 224 and as long as the Council has not taken
measures pursuant to paragraph 1, a Member State may, for serious political
reasons and on grounds of urgency, take unilateral measures against a third
country with regard to capital movements and payments.2 The Commission
310

and the other Member States shall be informed of such measures by the date
of their entry into force at the latest.
The Council may, acting by a qualified majority on a proposal from the
Commission, decide that the Member States concerned shall amend or abol-
ish such measures. The President of the Council shall inform the European
Parliament of any such decision taken by the Council.

Article 73h
Until 1 January 1994, the following provisions shall be applicable:
(1) Each Member State undertakes to authorize, in the currency ot the Mem-
ber State in which the creditor or the beneficiary resides, any payments
connected with the movement of goods, services or capital, and any
transfers of capital and earnings, to the extent that the movement of
goods, services, capital and persons between Member States has been
liberalized pursuant to this Treaty.
The Member States declare their readiness to undertake the liberalization
of payments beyond the extent provided in the preceding subparagraph,
in so far as their economic situation in general and the state of their
balance of payments in particular so permit.
(2) In so far as movements of goods, services and capital are limited only by
restrictions on payments connected therewith, these restrictions shall be
progressively abolished by applying, mutatis mutandis, the provisions
of this Chapter and the Chapters relating to the abolition of quantitative
restrictions and to the liberalization of services.
(3) Member States undertake not to introduce between themselves any new
restrictions on transfers connected with the invisible transactions listed
in Annex illto this Treaty.
The progressive abolition of existing restrictions shall be effected in
accordance with the provisions of Articles 63 to 65, in so far as such
abolition is not governed by the provisions contained in paragraphs 1
and 2 or by the other provisions of this Chapter. 3
(4) If need be, Member States shall consult each other on the measures to
be taken to enable the payments and transfers mentioned in this Article
to be effected: such measures shall not prejudice the attainment of the
objectives set out in this Treaty.

Article l09c
1. In order to promote coordination' of the policies of Member States to the
full extent needed for the functioning of the internal market, a Monetary
Committee with advisory status is hereby set up ...
It shall have the following tasks:
- to keep under review the monetary and financial situation of the Member
States and of the Community and the general payments system of the
 311

Member States and to report regularly theron to the Council and to the
Commission;
- to deliver opinions at the request of the Council or of the Commission,
or on its own initiative for submission to those institutions;
- without prejudice to Article 151, to contribute to the preparation of the
work of the Council referred to in Articles 73f, 73g, 103(2), (3), (4) and
(5), 103a, 104a, 104b, 104c, 10ge(2), 109f(6), 109h, 109i, 109j(2) and
109k(1);4
- to examine, at least once a year, the situation regarding the movement of
capital and the freedom of payments, as they result from the application
of this Treaty and of measures adopted by the Council; the examination
shall cover all measures relating to capital movements and payments;
the Committee shall report to the Commission and to the Council on the
outcome of this examination.
The Member States and the Commission shall each appoint two members of
the Monetary Committee.
2. At the start of the third stage, an Economic and Financial Committee
shall be set up. The Monetary Committee provided for in paragraph 1 shall
be dissolved.
The Economic and Financial Committee shall have the following tasks:
- to deliver opinions at the request of the Council or of the Commission,
or on its own initiative for submission to those institutions;
- to keep under review the economic and financial situation of the Member
States and of the Community and to report regularly thereon to the
Council and to the Commission, in particular on financial relations with
third countries and international institutions;
- without prejudice to Article 151, to contribute to the preparation of the
work of the Council referred to in Articles 73f, 73g, 103(2), (3), (4) and
(5), 103a, 104a, 104b, 104c, 105(6), 105a(2), 106(5) and (6),109, 109h,
109i(2) and (3), 109k(2), 1091(4) and (5), and to carry out other advisory
and preparatory tasks assigned to it by the Council;
- to examine, at least once a year, the situation regarding the movement
of capital and freedom of payments, as they result from the application
of this Treaty and of measures adopted by the Council; the examination
shall cover all measures relating to capital movements and payments;
the Committee shall report to the Commission and to the Council on the
outcome of this examination.
The Member States, the Commission and the ECB shall each appoint no more
than two members of the Committee.
3. The Council shall, acting by a qualified majority on a proposal from
the Commission and after consulting the ECB and the Committee referred to
in this Article, lay down detailed provisions concerning the composition of
the Economic and Financial Committee. The President of the Council shall
inform the European Parliament of such a decision.
312

4. In addition to the tasks set out in paragraph 2, if and as long as there are
Member States with a derogation as referred to in Articles 109k and 1091, the
Committee shall keep under review the monetary and financial situation and
the general payments system of those Member States and report regularly
thereon to the Council and to the Commission.

Article 109h
1. Where a Member State is in difficulties or is seriously threatened with
difficulties as regards its balance of payments either as a result of an overall
disequilibrium in its balance of payments, or as a result of the type of currency
at its disposal, and where such difficulties are liable in particular to jeopardize
the functioning of the common market or the progressive implementation of
the common commercial policy, the Commisssion shall immediately investi-
gate the position of the State in question and the action which, making use of
all the means at its disposal, that State has taken or may take in accordance
with the provisions of this Treaty. The Commission shall state what measures
it recommends the State concerned to take.
If the action taken by a Member State and the measures suggested by
the Commission do not prove sufficient to overcome the difficulties which
have arisen or which threaten, the Commission shall, after consulting the
Committee referred to in Article 109c, recommend to the Council the granting
of mutual assistance and appropriate methods therefor.
The Commission shall keep the Council regularly informed of the situation
and of how it is developing.
2. The Council, acting by a qualified majority, shall grant such mutual
assistance; it shall adopt directives or decisions laying down the conditions
and details of such assistance, which may take such forms as:
(a) a concerted approach to or within any other international organizations
to which Member States may have recourse;
(b) measures needed to avoid deflection of trade where the State which is
in difficulties maintains or reintroduces quantitative restictions against
third countries;
(c) the granting of limited credits by other Member States, subject to their
agreement.
3. Ifthe mutual assistance recommended by the Commission is not granted
by the Council or if the mutual assistance granted and the measures taken are
insufficient, the Commission shall authorize the State which is in difficulties to
take protective measures, the conditions and details of which the Commission
shall determine.
Such authorization may be revoked and such ~onditions and details may
be changed by the Council acting by a qualified majority.
4. Subject to Article 109k(6), this Article shall cease to apply from the
beginning of the third stage. 5
 313

Article 109i
1. Where a sudden crisis in the balance of payments occurs and a decision
within the meaning of Article 109h(2) is not immediately taken, the Member
State concerned may, as a precaution, take the necessary protective measures.
Such measures must cause the least possible disturbance in the functioning of
the common market and must not be wider in scope than is strictly necessary
to remedy the sudden difficulties which have arisen.
2. The Commission and the other Member States shall be informed of such
protective measures not later than when they enter into force. The Commission
may recommend to the Council the granting of mutual assistance under Article
109h.
3. After the Commission has delivered an opinion and the Committee
referred to in Article 109c has been consulted, the Council may, acting by a
qualified majority, decide that the State concerned shall amend, suspend or
abolish the protective measures referred to above.
4. Subject to Article 109k(6), this Article shall cease to apply from the
beginning of the third stage.

NOTES

1. Article 228a refers to the interruption or reduction of economic relations with third coun-
tries in the framework of the common foreign and security policy.
2. Article 224 refers to consultations among member states in order to prevent the functioning
of the common market being affected by measures taken to cope with serious internal
disturbances (law and order, (threat of) war, etc.).
3. Articles 63 to 65 refer to the liberalization of services.
4. Article 151 refers to the Committee of Permanent Representatives as being responsible
for preparing the work of the Council.
5. Article l09k(6) provides that Articles l09h and l09i shall continue to apply to a member
state with a derogation.
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 Subjects

active gradualism 159, 166 see also sequencing

administrative controls 11-12,15-18,84,91,94-96,176,188,205-
06 see also domestic regulations
approval procedures see administrative controls
Article VIII obligation 49c see also International Monetary Fund
AussenwirtsclwJtsgesetz see exchange control acts
Australia 25
authorization procedures see administrative controls

balance of payments Treaty provisions 40-42, ~4

Banca d'Italia 90,129-30,142,176,224
Banco de Espana 222
Bank: of England 139-40
Banque de France 59, 101, 115, 124-27, 134, 160
Bardepot 115,122
BaslelNyborg agreement 202,210, 213, ·236
Belgian-Luxembourg Economic Union 12, 94 see also dual exchange market
Belgium 12, 18,24,35-36,54,84,88,90-94, 115,
134-36, 142, 149, 158, 164, 169, 174, 196,
205-06,210,213,220,254
Benelux 31,115-16
Bretton Woods system tensions 20, 109, 115-16 and capital con-
trols 48, 53 collapse 118-20, 136
Brugnoni and Ruffinengo case 14, 46, 215n
budgetary policy see fiscal policy

Canada 11
capital controls costs 23-24, types of 11-14 and IMF 48-
50, 55 coordination of 117 Werner report
on 111-13 opportunity costs 258-62 see
also administrative controls, effectiveness
of capital controls
capital inflows 18-22,37,83,114,120-25,132,172,197,
222-25,252

319
320
capital liberalization definition 2, 46c in Treaty of Rome 40-47
subordination to freedom oftrade 42-44 see
also escape clause role of Monetary Com-
mittee 61-62,74-75 disciplinary effect 36-
39,161,172, 193,223-24,245,252 no pre-
conditions 194,204,207,212 and financ-
ing mechanisms 211 in Treaty on European
Union 244, 261 quid pro quos in negotia-
tions 6-7, 85, 93-94, 158, 171, 193, 204,
212, 256 see also sequencing
capital market see domestic capital market, efficiency of
capital markets, European capital market
capital outflows 18-22,36-37,53,120,124,132
carnet de change see travel allowances
Casaticase 46-47,51
central banks independence 3-4, 59-60, 73, 120,244,260
and capital controls 141-42, 181 objective
ofprice stability 203,228,244
clause d' urgence 35,39,42,102,129,232
cloisonnement 134
codes of liberalization see Organisation for Economic Cooperation
and Development
cohesion 200,204
commercial banks operation of exchange control 11-12, 170,
188 cooperation in Germany 123 in France
125,170 in Netherlands 132
commercial exchange rate see dual exchange market
Committee on Capital Movements and Invisi- 52-53
ble Transactions
Committee of Governors and Monetary Committee 58, 71-73 and
Commission 163-65, 167-68,201
Committee of Permanent Representatives 59,235
Common Market 31-33,36,41,53,87, 110 see also Internal
Market
competitive devaluation 41,62
conditional liberalization regime 86-87,99,184n
Conference of Messina 30
Congo (Belgian) 90-92,134
convergence (program) 64,136,191,203,212,239
conversion tax see Tobin-tax
convertibility of current account 33, 40, 43, 80, 249 and
the IMF 50 of US dollar 115
coordination of economic policies 43,47,60,110,136,228
Coreper see Committee of Permanent
Representatives
Council of Ministers and Monetary Committee 59-60, 235
 321

coupon tax see Kuponsteuer

credit control see monetary policy
credit facility (BEe) see financing mechanisms
cross-currency holdings 82, 192, 215n

Delors report 73,113,165,212,214,224,228

Denmark 14, 136, 145n, 156, 158, 169, 174-75, 177,
180-81,191,196,199,208,211,219,231,
237,250
deregulation see financial deregulation
derivatives see financial innovations
derogation see safeguard provisions
Deutsche Bundesbank 4,59, 81, 89, 109, 114, 118, 121-24, 141,
157,164,192,202,218-19,252
developing countries 16, 23, 100-01
devises-titres market 13,93,101,115,169
direct investment 33,35,80,85-87,90,169,225,233,245,
249
direct monetary instruments see monetary policy
Directives
- First directive 62,85-89,150,167,294-97
- Second directive 90-94
- Third directive 94-101, 166
- 1972 directive 116-18, 140, 150, 198, 205-06, 21~12,
249,301-02
- 1986 directive 166-80, 187, 198
- 1988 directive 140,189-214,218-25,226,229,231,244,
255,304-07
discrimination 16, 46, 159, 179, 199, 233 see also erga
omnes principle
disintermediation 3, 189
domestic capital market protection of 36-39, 42, 53, 92, 95, 104,
198,251,254,262
domestic regulations 13-15, 26, 38, 94-97, 111, 134-36, 199,
201,225,233,245
domiciliation see commercial banks in France
dual exchange market 12, 15-18 in Belgium 24, 36, 84, 86, 88,
90-94,112,115,134-36,169,174,205-06,
211, 220, 254 in France 114- 15, 125 in
Italy 118, 128-29 and the IMF 50

Economic and Financial Committee 235

322
economic and monetary union 111, 119, 141, 150, 163-65,203,210--14,
218,228-29,251,256,263 first stage 2, 73,
220, 229, 251 second stage 231-34, 244,
261, third stage 235, 261 see also Delors
report, Werner report
economic cycle and capital liberalization 5-6, 80, 97, 99,
189,212,218,228,255
economic policy see coordination of economic policies
economist school 7,141,148,179,195,213,229,255,260
ECU 63, 147, 149, 155, 203 promotion of 156-
60,219,221,255,259 as a parallel curency
228 acceptance obligations 149, 160
effectiveness of capital controls 22-23, 130, 141-42, 171-73, 179-81, 188-
89,212,250--51,257-58
efficiency of capital markets 156,176,187,212,241
erga omnes principle 14,81,85,88,112,118,156,172,179,198-
99,205,210,230,233-34,244
escape clause 42-44,47,51,80,162,168,211,234,249
European Banking Association 44-45
European capital market 8,112,156,226,244
European Central Bank 210,218,227-29
European Coal and Steel Community 30--31,53
European Commission in Treaty provisions 41-42 and Monetary
Committee 64-66, 70--71, 80, 88-89, 94,
160--61, 202 anitude towards floating 117-
18 anitude towards capital liberalization
80--81, 88, 90- 99, 104-05 117-18, 140,
154-56, 161-63, 167-69, 179-80, 189-91,
206-07,212,239,256
European Court of Justice 14,28n,46-47,51,154,201
European Currency Unit seeECU
European Economic Area 223
European Economic Community establishment 31-32, see also Treaty of
Rome
European Free Trade Association 31,223
European Investment Bank 54
European Monetary Cooperation Fund 164,203
European Monetary Fund 149,164
European Monetary Institute 66,72-73,235
 323
European Monetary System and capital controls 20, 138,201 and Mon-
etary Committee 63, 69 and Committee of
Governors 73 establishment 137-38, 147-
48, 250 strengthening of mechanisms 155-
60, 166, 171, 179, 192, 195,202,255 effect
of capital liberalization 168 realignments
148,153,177,187,202crisesin223,236-
40, 245, 258 credibility 223, 244
European Parliament 154, 177
European Payments Union 30,33,40
European Political Union 229
European Reserve Fund 229
European System of Central Banks see European Central Bank
examinations 62,68,88,90,150,159-61,202
excessive deficit procedure 64,228,244
exchange control acts Italy 175-76, 220 Netherlands 131 United
Kingdom 138-40 Germany 143n
Exchange Rate Mechanism see European Monetary System
exchange rate policies and capital restrictions 18, 20, 155, 260
common concern 53, 59 role of Monetary
Committee 61-64 see also European Mon-
etary System

Federal Reserve 111

financial capital 56n, see also Thompson case
financial centre 23,155 position ofAmsterdam 174 of Lux-
embourg 94, 206 of London 139, 259 of
Paris 101, 170,212,253,259
financial deregulation definition 2, and sequencing 25 in France
153-54, 160, 171,256 in Germany 172 in
Netherlands 173 in United Kingdom 140,
259
financial innovations 188,209,257
financial integration 61,154-56,189,206,250
financial exchange rate see dual exchange market
financial repression see domestic regulations
financial services 42,51,54,165,199,210,230,233,245
financing mechanisms (BEC) 64, 128-29, 149, 157, 177, 199, 204-06,
211,213,250,252,260
fiscal policy budgetary discipline 25, 36-39, 136, 245
coordination 53, lll-13, 195 European
budgetary authority Ill, 228
fixed exchange rates see Bretton Woods system
floating exchange rates attitude ofCommission Ito start ofl19 and
monetary policy 120
324
fluctuation margins narrowing 112-16, 220 flexible use
202 widening 238-40 see also snake
arrangement
foreign ownership 15,17,21,81,102, 134
France 12,21,24,31-35,44,54,79,81-82,84-93,
96-97,101-03,109-10, 114- 17, 119, 124-
28, 133-34, 142, 148-55, 157-61, 163-64,
167,169-71,177-81,188,191-93,195-96,
198-200, 203-05, 208, 210, 212-13, 218-
20, 225-30, 233, 238, 242, 249-51, 253,
255-56,259-60,263

GAIT 50
Germany 4, 10, 14, 34, 39, 44, 54, 61, 81, 84-86,
89-91,96-97,103,109,113-24,142,148-
51, 154-59, 164, 168-69, 171-73, 179-80,
191, 196, 198, 201-03, 205, 210-13, 219,
225,228-30,242,249-53,255-56,262-63
government debt see fiscal policy
Greece 50, 169, 177-78, 180, 196, 199,200,223,
231-32,243,251
hard-currency policy 175,253
hedging 11-12,242,258
hot money see speculative capital movements

import deposit scheme see trade policy

incompatible triangle 3-4,21,194,239
indirect capital controls see domestic regulations
indirect monetary instruments see monetary policy
industrial policy 95,171,253
inflows see capital inflows
innovations see financial innovations
institutional investors 15,21,95, Ill, 189,242
institutional changes 192,194,203,213,229,255
insurance companies see institutional investors
interest equalization tax 13,27n
interest rate policy prohibition of payment of interest 97, 114
negative rates 131 use of instrument 134,
175,191,200,202,258
Intergovernmental Conference on Single Act 162, 165 on EMU 229-34
Internal Market 16,161-63,168,200,233,255
International Chamber of Commerce 44-45
International Monetary Fund 47-50, 55, 68, 134
international monetary system see Bretton Woods system
international organizations (borrowing by) 91-92,101
 325

intramarginal interventions 149, 190-92

investment currency market 13
investment trusts see undertakings for collective investment
in securities
Iraq 231
Ireland 13, 19, 136, 145n, 158-59, 161, 169, 180,
196,199-200,208,221,223
issuance calendriers 95, 101, 174
Italy 12,35,54,82,84-93,115,118-20,128-30,
142,149,154,157-59,161,164,169,175-
81,192-93, 196,198-99,2~08,210,213,
220,224-25,230,254,259-60

Japan 150, 199,210

Koffergeschiifte 123
Kuponsteuer 143n, 14411, 185n

Latin America 50
leads and lags 12, 123
legal action see prosecution
liberalization code seeOECD
long-term capital flows 16-22,53,177 see also direct investment
Luise and Carbone case 46
Luxembourg 12,18,35-36,54,84,93-94,134-36,169,
174, 196,205-06 211, 220, 227, 243, 254

Maastricht Theaty see Theaty on Economic and Monetary

Union
margin requirements see reserve requirements
monetarist school 7, 141, 148, 152, 192, 213, 218, 229, 255,
260
monetary capital 56n, see also Thompson case
Monetary Committee role of 7-8, 58-78 establishment 40-41,
6O-61members 65-66, 285-89 chairman
66-68 Statutes· 66, 290- 93 Bureau 67-68
Alternates 68-69 Secretariat 70-71 and the
Committee of Governors 71-72, 78n and
Commission 64-65,70-71,80,88- 89, 94,
160-61, 202future 235-36
monetary dimension (in 1i'eaty) 163-65
monetary financing prohibition of 45-46, 234 see also privi-
leged access
monetary integration 61, 164, 210, 218, 227, 255, 259 see also
economic and monetary union
326
monetary policy use o/direct instruments (credit control) 3,
21, 37-39, 100, 126, 133, 160, 170, 173-
75,262 use o/indirect instruments 3, 101,
140, 198,200,222,253,263 autonomy 0/
3-4, 53, 191, 194, 213 and capital restric-
tions 18,21,97,104,132-33,142,192,197,
224,257 Treaty provisions 59-61 coordina-
tion 82, 171, 190,218,252-53,260 trans-
mission mechanism 188 EC·wide monetary
aggregate 190
monetary safeguard clause 196-98,211,213,230,232,239,245
monetary targets 124, 127
money market transactions 114, 118, 168
monitoring see examinations
mousetrap-currency 258
multi-speed Europe 168,180,262
multiple exchange rates see dual exchange market
mutual recognition 165,209

National Bank of Belgium 134,205

Nederlandsche Bank 37,39,132-33,141,198
negative exchange regime 14 see also positive exchange regime
Netherlands 31, 36-39, 44, 54, 83-86, 91-93, 96, 99,
101, 114-16, 130-34, 142, 149-50, 154-
159, 169, 173-74, 179, 191-92, 197-98,
212-13,230,250,253-56
New Zealand 25
non-discrimination 53, 82 see also erga omnes principle

'0' -circuit 13, 115, 130-31

Organisation for Economic establishment 32, role in capital Coopera-
tion and Development liberalization 50-53,
55 liberalization codes 51-53, 57n, 114
Organisation for European Economic 30-32
Cooperation
off-shore centres 22
official market see dual exchange market
oil crisis 119, 136, 139,250
opt-out provision 232
outflows see capital outflows

parallel currency 228

parallelism 96,177,204,208,212,227
payments freedom 0/56n
pension funds see institutional investors
 327

Phillips curve 18
political considerations 7-8,11,19,26,47,140,218,250,254-58,
261-62
portfolio adjustments 224,243
Portugal 169,180,196,201,222-24,231-32,238
positive exchange regime 14,101,132,173,175-76,220
preferential interest rates see selective credit policy
privileged access 196, 234, 244, see also monetary financing
proprietary trading 243
prosecution of violations 12, 144, 173, 175
prudential rules see supervision

quid pro quos see capital liberalization

real capital 56n, see also Thompson case

realignments see European Monetary System
reciprocity 199,210,230,233,245
regime conditionnel see conditional liberalization regime
regime severe 86
reserve currency 10-11, 259 internationalization ofDeutsche
mark 54, 124, 157, 172 ECU as 150, 157
reserve requirements 21, 27n, 101, 103, 115, 118, 140, 201 on
foreign exchange positions 241-43 see also
Bardepot
right of establishment 45
right of initiative 42,62

safeguard provisions 35,39-42,51,60,62-65,85-86,102,138,

150-51, 154, 158, 160-61, 166, 168-69,
173, 177, 192, 202, 206, 232, 244-45 see
also monetary safeguard clause
sanctions 52,231-32,234
Second Banking Directive 227
secop,d homes 169,211,231
secondary legislation 40-42, 59, 62-64, 163, 209, 229 see also
directives
securities trade in33, 80, 85-86, 93-94, Ill, 168,233
security currency market see devises-titres market
Segre report 99
selective credit policy 126,129,170,253
sequencing 11,17,24-26,54,160,171,177,179,200-
01,259 see also active gradualism
services trade in 93
328
short-tenn capital flows 16-22, 83, 86-88, 97, 104, 114, 177, 180,
188,230,242
Single European Act 162-65,167,228
Smithsonian agreement 116-18
snake arrangement 113-20,126,129,138,141,147
Spaak report 31-33,80
Spadolini report 2
Spain 14, 169, 180, 196, 199-200, 221-24, 230,
238,242
speculative capital movements 12, 15, 17-20, 48, 53, 82, 90, 104, 202,
237, 2~3, 251, 257-260 see also Bretton
Woods system, European Monetary System,
short-tenn capital flows
standstill clause 41,52,55,85
supervision 96,201,207,209,225-227,230,243,258
Switzerland 11, 27n, 122,208

taxation 13,85,91,225,230-31,234,261 and spec-

ulation 15-16, 21-22, tax evasion 32, 208
tax harmonization 207-09, 226-27, 251 of
foreign exchange turnover see Tobin-tax
technological developments 171,187
third countries see erga omnes principle
Thompson case 46,56n
Tindemans report 2
Tobin-tax 2~1,245

tourism see travel allowances

trade policy restrictions 7, 10, 103, 120, 129-30 in
Treaty provisions 40-43, see also Common
Market
transitional arrangements 39-42, 138, 145n, 168-69, 176, 179, 194,
199, 202, 204, 206-07, 211, 218, 221-23,
231
travel allowances 17,115, 169-70
Treaty of Rome 31-33, capital provisions 40-44, 279-84
and the Monetary Committee 58-61 dual-
istic character 59-60, 81 see also balance
of payments
Treaty on European Union 236-37 capital provisions 305-10 see also
economic and monetary union, Intergovern-
mental Conference
two-tier exchange market see dual exchange market

unconditional liberalization regime 86-87,90,159, 184n

 329
undertakings for collective investment in 87,90-91,162,167
securities
United Kingdom 25,27, 31, 97, 109-11, 119, 136-40, 142,
145n, 150-151, 154- 56,158-59, 164, 166,
169,179,180-81,196,198-200,208,213,
220,225,230,233,250,259,263
United States 10, 13, 28, 48, 89, 97, 100, 109, 113-18,
140, 189

Walters effect 25-26

Werner report 2, 110-13, 116, 119, 136, 141, 147, 161,
228
White Book see Internal Market
withholding tax 13, 208, 216n, 226
World Trade Organization 51

Zaire see Congo (Belgian)

 Persons

Adams Charles 16,314 Carli Guido 286

Adenauer Konrad 34, 79 Carre Herv6 289
Alesina Alberto 27n, 35, 314 Chalikias D. 288
Alpbandery Edmond 239 ChiracJacques 171
Alworth J.S. 15,314 Ciampi Carlo 207
Amato Giuliano 216n, 217n Clappier Bernard 67, 285
Andersen Bodil 287 Clark Alastair 288
Andersen Svend 287 Cockfield Lord 161,208, 216n
Andriessen Frans 247n Conthe Manuel 289
Artis Michael 140, 314 Costa Antonio 289
Costa Pinto Joao 289
Baer GUnter 78n, 247n, 314 Couzens Sir Kenneth 288
Baffi Paolo 286 Crockett Andrew 288
Bakker Age 314, 316, 317
Balfour Michael 288 D'Haeze Marcel 285
Balladur Edouard 177, 187, 195,210,213, Debr6 Michel 101, 108n
215n,217n, 227,238,246n, 247n Dehaene Jean-Luc 239
Bastian Paul 286 Delors Jacques 153, 161, 167c, 177, 179c,
Baquiast Henry 68 183n, 186n, 191, 195,203,206c,212,
Bartolini Leonardo 223, 314 214,215n,220,226,228,239,241,251,
B~govoy Pierre 164,171, 185n, 226 258
Beyen Joban 30, 31, 55n, 314 Dimopoulos T. 288
Bhagwati Jagdish 23,314 Dini Lamberto 214n, 286, 315
Bird Graham 314 Dondelinger A. 287
Bishop Graham 314 Dornbusch Rudiger 16,26,315
Blommestein Hans 314 Doyle Maurice 287
BobbaF.289 Draghi Mario 286
Bodnar Gordon 223,314 Drakos G. 288
Boissieu Christian de 314,315,317 Drees Wtllem 287
Borges Antonio 289 Duisenberg Wim 132, 147, 315
Bosch J.H.O. graafv.d. 287
Boyer Miguel 247n Edwards Sebastian 29n, 315
Boyer de la Giroday F. 289 Eichengreen Barry 28n, 55n, 241, 242, 315
Brandt Willy 109 Eizenga Wietze 315,317
BrazJo~289 Emminger Otmar 76n, 90, 100n, 109, 143n,
Breen Bernard 287 286,315
Brouhns Gregoire 285 Erhard Ludwig 31,34,81
Brouwer Henle 287 Eyskens Marc 195

Cairncross Alec 27n, 28n, 314 Fabius Laurent 171

Cairncross F. 316 Fabra Paul214n
Calvet Pierre 285 Fair Donald 315, 317
Camdessus Michel 67, 159,285 Favier Pierre 185n, 315

330
 331
Fieleke Noonan 248n. 315 Hommes P.M. 55n. 314. 316
Flandorffer Werner 68 Horgan Michael 287
Fogarty Christopher 288 Horsefield J. Keith 57n. 316
Fonnentini Paride 286 Howe Geoffrey 139. 146n
Franck Ren6 286
Freiberg-Jensen Carsten 186n. 315 Icard Andre 108n. 183n. 316
Fr~re Maurice 45 IzzoL.286
Fugmann Henrik 68
Jaans Pierre 287
Galy Michel 170. 315 Jager Henk 316.317
Gambino Amadeo 286 Janson Georges 285
Garcia Alonso Jos6 288 Jong Eelke de 316. 317
Garganas Nicholas 288 Jordan-Moss Nicolas 288
Gaspar Vitor 68 Jurgensen Philippe 285
Gaulle Charles de 32. 79. 103. 109. 147
Genim R. de la 285 Kapteyn P.J.G. 56n. 57n. 316
Genscher Hans-Dietrich 210.213. 216n. Katiforis George 288
228. 247n Katseli L. 288
George Eddy 239. 248n Kees Andreas 61. 64. 76n. 77n. 289. 316
Giannitsis Anastassios 288 Kergorlay R. de 289
Giovannini Alberto 315 Kestens Emiel 285
Giscard d'Estaing Val6ry 137 Keynes John Maynard 48
GIeske Leonhard 172. 184n. 214n. 286. 289. Kiesinger Kurt 109
315 Kirsch R. 287
Gocht Rolf 143n. 286 Klasen Karl 121. 143n
Godeaux Jean 186n Koehler Horst 286
Goedhart C. 318 Koenig Reiner 185n. 316
Gold Joseph 50. 57n. 315 Korliras P. 288
Goodman John 144n. 315 Korteweg Piet 287
Goria Giovanni 178
Gray Paul 288 Lagayette Philippe 285
Greenwood Jeremy 16.314 Lahnstein M. 286
Grilli Vittorio 314. 315 Lamboray C. 287
Groeben Hans von der 315. 317 Lamfalussy Alexandre 145n. 247n. 316
Gros Daniel 28n. 315. 316 Larre Raymond 285
Grosche GUnter 289 Lattre Andre de 285
Gruijters Noud 28n. 316 Lauwerijns Ren6 285
Guill Jean 287 Lawson Nigel 138. 146n, 184n. 316
Le~gue Daniel 285
Haberer Jean-Yves 67. 285 Ledig Michael 185n, 316
Haberler Gottfried 10.24. 29n. 316 Lennep Emile van 58,66,67. 77n, 90, 92,
Halberstadt Victor 316. 317 98,99,100,287,316
Hald Jens 186n. 315 Lightfoot William 248n
Haller Gert 286 Littler Geoffrey 67, 68, 207. 210, 288
Hanemann Wilhelm 286 Loehnis Anthony 288
Hannoun Herv6 286 Louis Jean-Victor 183n. 184n. 316
Hansen Kurt 287 Ludlow Peter 181n. 316
Heinen J. 286
Henkel W. 286 Maas Cees 67. 287
Hewson John 316 Mackay A.W.R. baron 68. 287
HissD.286 MacSharry Ray 246n
Holtrop Marius 36c. 56n. 71. 77n. 105n. Magnifico G. 286
145n, 173. 198.218.316 Mansholt Sicco 77n
332
Marchais Georges 144n Padoa-Schioppa Tommaso 194, 214n, 247n,
Marion Nancy 28n, 128,316 289,314,317
Marjolin Robert 30, 35, 56n, 57n, 80, 85, 87, Palumbo S. 286
108n, 126,316 Papadakis I. 288
Marois William 316 Papademos Lucas 288
Marques V. 289 Papageorgiou 288
Martin Miguel 289 Papanikolaou Jannis 288
Martin-Roland Michel 185n, 315 Park Jae Won 315
Martinez Mendez Pedro 288 Peretz David 288
Matthieson Donald 27n, 28n, 316, Perouse M. 285
Mauroy Pierre 171 Peyrelevade Jean 29n
Mavraganis C. 288 Pierre-Brossolette C. 285
Mavragannis D. 288 Pinho Manuel 289
Maystadt Philippe 239 Pinto Alexandre 289
McCutcheon David 287 POhl Karl-Otto 67, 78n, 286
McGowan Padraig 287 Pompidou Georges 109, 110
McKinnon Ronald 29n, 317 Pons Jean-Fran~is 289
McMahon Christopher 288 Pontsele Edgard van de 285
Meerssche Paul van de 317 Posthuma S. 37, 77n, 95, 287, 317
Melo Manuel de 289 Prate Alain 285, 289
Mersch Yves 287 Provopoulos G. 288
Mertens de WilmarsJ. 68, 317
Meulemans Louis 285 Quaden Guy 285
Miconi G. 286
Micossi Stefano 68 Ramadier Paul 35
Mikkelsen Richard 287 Ravasio Giovanni 289
Milesi-Ferretti Gian Maria 314 Reagan Ronald 150, 250
Mingasson J.P. 289 Rey Jean-Jacques 68, 159
Mitterrand Fran~ois 144n, 153, 171,227, Reynolds George 287
238 Rojas-Sum-ez Liliana 27n, 28n, 316
Mollet Guy 34, 35 ROjoL.289
Monnet Jean 30, 32 ROpke Wilhelm 34
Morelli Giampietro 289 Ruding Onno 1,8,43, 56n, lOOn, 195,317
Moreno Gomes 289 Ruggiero F. 286
MoscaU.289 Ruiz de Alda Juan 288
Mtlller-Enders W. 286 Russo Massimo 185n, 289
Murray Scm 287
SadrinJeanlOSn, 126,285
Neme Colette 29n, 317 Sakakibara Eisuke 316
Noyer Christian 286 Sarcinelli Mario 67, 286
Schieber Helmut 286
O'Cofaigh Tom4s 287 Schiller Karl 121, 143n
O'Connell Maurice 287 Schlesinger Helmut 286
O'Donnell Gus 288 Schmidt Helmut 121, 137
o'Gorman Noel 288 Schmitz J. 287
O'Grady-Walshe Timothy 216n, 287 Scholten Bram 317
O'Kelly Ann 314 Schrevel Geoffrey de 317
Obolensky Ariane 285 Schulmann Horst 67, 286
Oort Coen 67, 77n, 287, 317 Schuman Robert 30, 32
Ortoli Fran~ois 155, 182n Segre Claudio 99
Ossola Rinaldo 286 Sidiropoulos 288
Silva Girao Brito da 289
SleijpenOlaf248n, 317
 333
Smith Anthony 317 Tutty Michael 68
Smits Rene 317
Solchaga Carlos 222 Ussing Niels 287
Somers Michael 287
Spaak Paul-Henri 31 Vanthoor Wim 56n, 318
Stammati G. 286 Verloren van Themaat P. 316
Stee van der Alfons 150 Vernucci A. 286
Steinherr Alfred 317 Verplaetse Alfons 285
Stek Pieter 68, 287, 317 Verrijn-Stuart G.M. 55n
Stoltenberg Gerhard 184n, 195,226 Voghel Franz de 285
Stournaras Ioannis 288 Vries Tom de 289
Strycker Cecil de 144n, 285
Swoboda Alexander 27n, 28n, 29n, 143n, Walters Alan 29n, 318
145n, 146n, 317 Warris Harm 318
Szasz Andre 28n, 77n, 143n, l45n, l46n, Weber H.H. 286
150, 166, l8ln, l82n, l84n, 287, 317 WeberR.287
Wellink Nout 287,318
Tavares Carlos 289 Werner Pierre 111
Taylor Mark P. 140,314 Wesselkock K. 286
Tesauro Giuseppe 317 White Harry Dexter 48, 63
Teyssier Louis-Georges 108n, 317 Wicks Nigel 67, 288
Thatcher Margaret 138, 140, 184n, 250, 259, Williot Maurice 285
317 Wilson Harold 138
Theron M. 285 Wormser Olivier 108n, 126, 144n
Thomadakis S. 288 Wyplosz Charles 28n, 241, 242, 315, 318
Thomsen Jens 287
Thygesen Niels 28n, 247n, 315, 316, 317 Xafa Miranda 288
Tietmeyer Hans 67, 2l6n, 239, 248n, 286
Tinbergen Jan 317 Ypersele Jacques van 67, 285
Tindemans Leo l83n
Tobin James 10, 27n, 28n, 240, 241,318 Zijlstra Jelle 79, 257,318
Trichet Jean-Claude 67, 285 Zodda Augusto 286
Tulp Alfred 314
FINANCIAL AND MONETARY POLICY STUDIES

*1. J.S.G. Wilson and C.F. Scheffer (eds.): MultiTUltioTUlI Enterprises. Financial and
Monitary Aspects. 1974 ISBN 90-286-0124-4
*2. H. Fournier and J.E. Wadsworth (eds.): Floating Exchange Rates. The Lessons of
Recent Experience. 1976 ISBN 90-286-0565-7
*3. J.E. Wadsworth, J.S.G. Wilson and H. Fournier (eds.): The Development of Fi1UlnCial
Institutions in Europe, 1956-1976. 1977 ISBN 90-286-0337-9
*4. J.E. Wadsworth and F.L. de Juvigny (eds.): New Approaches in Monetary Policy.
1979 ISBN 90-286-0848-6
*5. J.R. Sargent (ed.), R. Bertrand, J.S.G. Wilson and T.M. Rybczynski (ass. eds.):
Europe and the Dollar in the World-Wide Disequilibrium. 1981 ISBN 90-286-0700-5
*6. D.E. Fair and F.L. de Juvigny (eds.): Bank MaTUlgement in a Changing Domestic and
InterTUltioTUlI Environment. The Challenges of the Eighties. 1982
ISBN 90-247-2606-9
*7. D.E. Fair (ed.) in cooperation with R. Bertrand: InterTUltioTUlI Lending in a Fragile
World Economy. 1983 ISBN 90-247-2809-6
8. P. Salin (ed.): Currency Competition and Monetary Union. 1984
ISBN 90-247-2817-7
*9. D.E. Fair (ed.) in cooperation with F.L. de Juvigny: Government Policies and the
Working of FiTUlncial Systems in Industrialized Countries. 1984 ISBN 90-247-3076-7
10. C. Goedhart, G.A. Kessler, J. Kymmell and F. de Roos (eds.): Jelle Zijlstra, A Central
Banker's View. Selected Speeches and Articles. 1985 ISBN 90-247-3184-4
11. C. van Ewijk and J.J. Klant (eds.): Monetary Conditions for Economic Recovery. 1985
ISBN 90-247-3219-0
*12. D.E. Fair (ed.): Shifting Frontiers in FiTUlncial Markets. 1986 ISBN 90-247-3225-5
13. E.F. Toma and M. Toma (eds.): Central Bankers. Bureaucratic Incentives, and
Monetary Policy. 1986 ISBN 90-247-3366-9
*14. D.E. Fair and C. de Boissieu (eds.): InterTUltioTUlI Monetary and FiTUlncial Integra-
tion. The European Dimension. 1988 ISBN 90-247-3563-7
15. J. Cohen: The Flow of Funds in Theory and Practice. A Flow-Constrained Approach
to Monetary Theory and Policy. 1987 ISBN 90-247-3601-3
16. W. Eizenga, E.F. Limburg and J.J. Polak (eds.): The Quest for NatioTUlI and Global
Economic Stability. In Honor of Hendrikus Johannes Witteveen. 1988
ISBN 90-247-3653-6
*17. D.E. Fair and C. de Boissieu (eds.): The InternatioTUlI Adjustment Process. New
Perspectives, Recent Experience and Future Challenges for the Financial System.
1989 ISBN 0-7923-0013-0
18. J.J. Sijben (ed.): FiTUlncing the World Economy in the Nineties. 1989
ISBN 0-7923-0090-4
FINANCIAL AND MONETARY POLICY STUDIES

19. I. Rizzo: The 'Hidden' Debt. With a Foreword by A.T. Peacock. 1990
ISBN 0-7923-0610-4
* 20. D.E. Fair and C. de Boissieu (eds.): Financial Institutions in Europe under New
Competitive Conditions. 1990 ISBN 0-7923-0673-2
21. R. Yazdipour (ed.): Advances in Small Business Finance. 1991 ISBN 0-7923-1135-3
* 22. D.E. Fair and C. de Boissieu (eds.): Fiscal Policy, Taxation and the Financial System
in an Increasingly Integrated Europe. 1992 ISBN 0-7923-1451-4
23. W.C. Boeschoten: Currency Use and Payment Patterns. 1992 ISBN 0-7923-1710-6
24. H.A. Benink: Financial Integration in Europe. 1993 ISBN 0-7923-1849-8
25. G. Galeotti and M. Marrelli (eds.): Design and Reform of Taxation Policy. 1992
ISBN 0-7923-2016-6
* 26. D.E. Fair and R. Raymond (eds.):· The New Europe: Evolving Economic and
Financial Systems in East and West. 1993 ISBN 0-7923-2159-6
27. 1.0. de Beaufort Wijnholds, S.C.W. Eijffinger and L.H. Hoogduin (eds.): A
Framework for Monetary Stability. Papers and Proceedings of an International
Conference (Amsterdam, The Netherlands, 1993). 1994 ISBN 0-7923-2667-9
* 28. D.E. Fair and R. Raymond (eds.): The Competitiveness of Financial Institutions and
Centres in Europe. 1994 ISBN 0-7923-3131-1
29. A.F.P. Bakker: The Liberalization of Capital Movements in Europe. The Monetary
Committee and Financial Integration, 1958-1994. 1996 ISBN 0-7923-3591-0
30. H.A. Benink: Coping with Financial Fragility and Systemic Risk. 1995
ISBN 0-7923-9612-X

*Published on behalf of the Societe Universitaire Europeenne de Recherches Financieres

(SUERF), consisting the lectures given at Colloquia, organized and directed by SUERF.

Kluwer Academic Publishers - Dordrecht / Boston / London