Unified European Currency
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Unified European Currency
Monetary System in the European Union
The European Union:
- There are three stages of monetary cooperation in the European Union culminating with adoption of the euro, EU’s single currency.
- All member states in EU participate in the economic monetary union (EMU), 12 have adopted the euro, UK and Denmark have opt-outs from the euro.
- The remaining eleven member states are required to enter the third stage and adopt euro within a given time period (Copenhagen Criteria), and must fist have their currency in the ERM II for two years.
Stage 1:
- European Monetary system (EMS) set up in 1979 under Jenkens European Commission where most nations of (EEC) linked currencies to prevent large fluctuations.
- After collapse of Bretton Woods in 1971 – EEC countries agreed in 1972 to maintain stable exchange rates by preventing fluctuations of more than 2.25%
- In march 1979 this system replaced by EMS and European Currency Unit was defined.
- Basic elements of arrangement were:
- ECU – basket of currencies, preventing movements above 2.25% (6% for Italy) around parity in bilateral exchange rates with other member countries.
- Exchange Rate Mechanism
- European Monetary Cooperation Fund created in October 1972 and allocates ECUs to members’ central banks in exchange for gold and US dollar deposits
- Basic elements of arrangement were:
- In early 1990’s EMS was strained by differing economic policies and conditions of its members, especially Germany and Britain
Stage 2:
- May of 1998 member countries fixed their mutual exchange rates when adopting Euro EMS became no longer functional.
- Replaced by the ERM II in January of 1999, where the ECU basket was discarded and new single currency Euro has become the anchor for other countries participating in ERM II.
- Participation in ERM 2 voluntary and fluctuation bands remain same as ERM, +15%
- ERM 2 sometimes described as waiting room for the EMU (economic monetary union of the European Union)
Stage 3:
- EMU where currencies in participating member states are replaced by Euro banknotes and coins.
Current Status:
- Strong Currency (Dollarization)
- Currency has been adopted by other countries as their national currency (ie. Monaco, The Vatican City, San Marino)
- De facto currency in Andorra, Kosovo, Montenegro
- Strong Currency (Dollarization)
- Unemployment Rate Low
- The unemployment rate in the 12 nations sharing the euro slipped in October to a five-and-a-half year low of 7.7 percent from 7.8 percent in September, the EU's Euro stat data agency has said.
- Unemployment Rate Low
- In first estimates for third quarter of 2006
- Euro area GDP up 0.5%
- EU 25 GDP up 0.6%
- Up 2.7% and 2.9% respectively from the third quarter of 2005
- Inflation estimated at 1.8% for November 2006
- In first estimates for third quarter of 2006
Benefits of a Unified European Currency
Practical Benefits:
- Transaction Costs: Dealing in a single currency reduces the cost of converting one currency into another. This benefits both businesses conducting international trade as well as tourists. Citizens can travel more conveniently within the Euro area without having to deal with currency conversion. Also, because the Euro is an international currency, it is accepted in many places outside the Euro-area.
Single Market Benefits:
- No Exchange Rate Uncertainty: Eliminating exchange rates between European countries eliminates the risks of unforeseen exchange rate revaluations or devaluations. This provides a more stable trading environment in which business no longer have to consider currency movements in their production costs. It also provides a more predictable and stable financial market.
- Elimination of Various Business Transaction Costs: Including the costs of buying and selling currency, hedging operations to protect from rate fluctuations and a reduction in account management costs (there is no longer a need to maintain accounts in multiple currencies)
- Transparency & Competition: The direct comparability of prices and wages increases competition throughout Europe. Competitive market forces lead to lower prices for consumers and improved investment opportunities for businesses.
- Foreign Investment: Foreign investors can conduct business within the Euro-area with little disruption and benefit from a more stable economic environment.
Single Financial Market Benefits:
- Financial Operation: The Euro increases the market size and operation for financial operators such as banks, insurers, investment funds and pension funds.
- Capital Market: The large Euro zone integrates the national financial markets, leading to higher efficiency in the allocation of capital in Europe.
- Financial Market Competition: Savers benefit from a wider and more diversified offer of investment and saving opportunities while investors can spread their risks more easily, and have the opportunity to engage in riskier ventures. Simultaneously, private and corporate borrowers as well as equity issuers benefit from better funding opportunities because money is easier to raise in capital markets.
Macroeconomic Considerations:
- No Competitive Devaluations: Countries can no longer devalue their currency against other countries in an effort to increase the competitiveness of its own exporters. This is a major contributor to one of the primary goals of the Euro- price stability. The European System of Central Banks operates with full independence.
- Sound Public Finances: With all country’s economies dependent on a single currency, responsible governments have an interest in bringing countries with a lack of fiscal discipline into line. The treaty contains provisions that prevent member states from running excessive levels of government deficits or debts in relation to GDP.
- Strength: The Euro is among the strongest currencies in the world, along with the US Dollar. It is the 2nd-most important reserve currency after the US Dollar. Europe’s role in international organizations, such as the International Monetary Fund, the World Bank and Organization for Economic Cooperation and Development, has also been strengthened by a unified economy and currency.
- Low Interest Rates: The level of interest rates benefits from lower inflationary expectations, improved control of government debt (allowing for increased borrowing opportunities in the private sector) and the increased size of Euro securities markets, which improves liquidity. Also, the elimination of exchange rate fluctuations improves intra-Europe trade, thereby applying further downward pressure on interest rates.
- Shelter from External Shocks: Because between 50 and 75% (depending on the country) of trade takes place within the Euro-area, the unified currency is better equipped to deal with external economic shocks and dramatic fluctuations in exchange rates against the US Dollar and other major currencies.
- Economic Growth, Investment and Employment: All of the aforementioned benefits (price stability, sound public finances, lower interest rates) foster an economic environment conducive to economic expansion, investment and employment creation within the Euro community.
Non-Economic Benefits
- European Identity: A European currency strengthens European identity. The Euro is a symbol of shared values and the successful integration of the nations in Europe.
- Political Integration: The Euro has demonstrated shared identity and acted as a stimulus for further unification. Its success has shown that member states acting in concert and produce universal benefits for the Euro community.
Arguments Against a Unified European Currency
- Interest Rates: A single monetary policy cannot deal with the differences, divergences and cyclical variations in the European economies. National currencies provide an adjustment mechanism, and allow governments to use interest rates to respond to events. A single European currency removes these options. Instead, a single European interest rate, set by the European Central Bank in Frankfurt, would apply indiscriminately to the whole single currency area. This creates the problem of how a participating country could adjust to a shock or economic development specific to that country.
- Labor Market: The labor market in the EU is neither mobile enough nor flexible enough to take the strain of adjustment. Indeed the EU spends much of its time legislating to make the European labor market even less adaptable, as shown by the unacceptable level of structural unemployment in the EU.
- Tax Policy: EU governments cannot rely on their national budgets to alleviate a local or cyclical recession. The Treaty lays down strict compulsory borrowing limits. An active policy of cutting taxes or increasing public expenditure could lead to penalties and fines. Even a passive policy of allowing the budget deficit to rise during a recession could breach the limit and require tax increases and expenditure cuts. So instead of stabilizing the situation, the effect would be to compound the problem and create more unemployment.
- Monetary Transfers: With monetary policy given away, and these restrictions on borrowing, countries in a single currency would be left with transfer payments between Member States. At present these transfers, in the form of structural and cohesion funds, are used to subsidize the poorer EU States. The UK is a very substantial net contributor. In a single European currency transfer payments would take on the much larger task of trying to compensate for changes and shocks affecting the various economies of the currency area. The present EU budget, at 1.2% of GDP, is far too small for such a role.
- Budget Limitations: Advocates of a single European currency who point to the success of the US Dollar are in fact making this point. The US federal budget, through its direct taxation and expenditure powers, exerts a powerful stabilizing influence on the varied states and regions of the USA. A single European currency would require an equivalent EU budget, many times larger than has ever been officially recognized.
- Excessive Fiscal Discipline: When other governments exert pressure on a government to reduce borrowing, or even pay fines if the budget deficit exceeds a reference value, this may have the perverse effect of increasing an existing economic imbalance or deepening a recession.
Current Status & Success
- Independent research has shown that since the inception of the Euro, intra-Europe trade has increased significantly.
- Europe’s position in international economic and financial organizations has been considerably strengthened as a result of unifying the European currency.
- A single currency has made Europe as stronger trading partner and offered a more enticing economic environment for foreign businesses that can benefit from trading in Europe at a lower cost.
- As a world currency, the Euro is taking on an important role as an international investment and reserve currency. It has become a major currency in which to borrow money and issues of international securities denominated in Euro now rival dollar denominated issues.
- Analyses by Eurostat, the European Commission’s statistical service, indicate that the Euro changeover led to some price increases in specific sectors, such as restaurants, cafes and hairdressers, but that the overall effect on prices in the Euro area was limited. For the all items Harmonised Index of Consumer Prices, the price increase most likely falls within the range 0.12 to 0.29%.
Works Cited:
"Economy and Finanace." 2006
- http://epp.eurostat.ec.europa.eu/portal/page?_pageid=0,1136173,0_45570698&_dad=portal&_schema=PORTAL
"European Monetary System." 2006
MacDougall, Donald. "Economic and Monetary Union and the European Community Budget." National Institute Economic Review, May 1992
"The EURO: Europe's New Currency." December 7, 2001
"The €uro: Our Currency." 2006
