Discuss the benefits and problems of the European single currency, the Euro

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Discuss the benefits and problems of the European single currency, the Euro

The Euro was launched in 1999, replacing a wide range of currencies throughout continental Europe with a single currency of equal value in all nations. The main aim of the single currency was to assist in the movement of trade and labour, by making it easier for businesses and individuals to compare costs, prices and salaries across the entire EU. However, as will be shown below, the Euro has not always had the desired benefits, and has in fact led to some serious issues due to the lack of structural flexibility in many of the Eurozone countries.

The major benefit of the Euro is that it offered common stability across a large portion of the European Union, helping weaker currencies such as the Franc and Lira by coupling them to the stronger ones such as the DeutscheMark. As such, this prevented the previous swings in currency value which periodically affected several European currencies, and thus helped stabilise the value of the high volume of trade within the European single market. Indeed, until the launch of the Euro, it was argued that the common market in the EU has delivered very few gains in productivity or efficiency, as trade in the market still had to take place with different currencies and the same exchange rate exposure risks. However, the Euro has made it easier to compare wages, prices and costs across the entire Eurozone and know that, if a supply chain is set up to profitably move goods from one part of the EU to another, exchange rate fluctuations will not act to undermine this profitability (Economist, 1998).

In addition, the creation of a European Central Bank to oversee monetary policy across the entire Eurozone, with a commitment to ensuring low inflation and consistent pricing throughout the zone, offers significant benefits. In particular, it offers significant benefits to nations which have poor track records in attempting to manage their internal inflation, as the connection to the other Eurozone economies will allow them to benefit from shared inflation pressures. As such, this also allows Europe a significant gain in macroeconomic stability, which the continent has arguably never experienced before. In addition, the overall level of microeconomic benefits were argued to be vast, with the EU estimating that the Eurozone could save 0.5% of its total GDP each year thanks to lower hedging and transaction costs; an initial saving of around $40 billion (Prati and Schinasi, 1998).

Indeed, these hedging and transaction cost savings offer significant benefits to the capital market as well, with the Euro facilitating a single capital market across Europe, with substantially lower costs of capital. Indeed, the ability of companies to borrow from a central and sophisticated source of finance will be much simpler than attempting to tap small and underdeveloped domestic markets. This has a significant benefit for small businesses in some of the weaker economies in Europe, who would find it difficult to find suitable finance packages when the capital allocation process is weak. It will also open up the securities markets for investors, offering them a wider choice of investments and a significant reduction in costs (Askari and Chatterjee, 2005). As such, the combination of the removal of exchange rate uncertainty; low levels of inflation; easier trade terms; and more efficient markets give the potential of big benefits.

In addition, the previous policy driven currency shocks which have hit Europe in the past will have less of an impact under a single currency. Whilst the ECB’s monetary policy will have different impacts on the various Eurozone economies; they will at least tend to act in the same direction. As such, this will help avoid issues such as the monetary crisis in the 1990s, when the UK left the ERM and central banks across Europe reacted in different ways to defend their own currencies. As such, this concerted movement, combined with an increase in trade, should help business cycles to converge across Europe, as consumer strength in one area of the Eurozone is transmitted to all other areas through trade (Koozman and Azevedo, 2008). This will help keep economic growth steady and balanced throughout the entire zone, and ideally eliminate the need for sudden monetary policy shifts. (This is Timothy Ijoyemi work)

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However, the introduction of the Euro also involves risks for the individual economies; who have given up the ability to change their domestic interest rates and to allow their currency to appreciate or depreciate against other Euro members. This will result in a significant loss of flexibility for these economies, which may prove critical if their economies fail to adjust in line with each other, as Smith (2008) has argued is now happening, with the ‘PIGS’ economies falling far behind their partners. As such, it is possible that the Eurozone will fail to function as an optimal currency area, and ...

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