What are the Problems and Possibilities of Economic Monetary Union?

University Degree Business and Administrative studies

European Monetary Union (EMU) was first introduced in 1969 at a summit of the European Economic Community in The Hague, the members arranged to endeavour and reduce the fluctuations in their currencies in order to coordinate national policies. (McCormick). Jacques Delores, in 1989 as the president of the Commission decided to introduce a 3 stage plan designed to increase the movement towards EMU, the plan attempts to fix exchange rates and introduce a single currency, the Euro. This plan was not completed until 2002 when the Euro coins and notes began circulating. In order for members of the European Union to join the Euro they were subject to convergence criteria, which confined the levels of government debt and national debt, inflation rates, exchange rates and interest rates the member country is allowed to have. Converging to these criteria and adopting the Euro has provided many different outcomes, some of which are negative and other which will benefit the economies of the member countries. This essay shall examine the problems and possibilities of European Monetary Union in order to determine whether EMU is beneficial to all that have taken part, and to discover where Economic Monetary Union is headed.

In order to be part of the Economic Monetary Union, the member countries adopted the Euro as their currency and became part of the Euro Zone. This increased the power both economically and politically for the European Union, as there are gains in prestige and political power associated with a common monetary policy.(Tsoukalis) The European Union is now compared relatively with America as a large economic power with a single currency; this makes trading with the rest of the world easier as it will “increase the relative political weight of the countries involved with EMU”(p12). The EU can use this new power to become more confrontational in world affairs.

Implementation of Economic Monetary Union means an end to competitive devaluation, as the Euro is used and every country has the same currency there will be no exchange of currency between the member states, this results in the “loss of exchange rate as a policy instrument at national level” (p175). This restricts the ability of a country to use devaluation as an economic policy, enabling the country to revive an economy, when it is in recession. This represents a loss of flexibility within economic policies and so, “without devaluation, differences in competitiveness must be balanced either by falls in living standards, if labour markets are flexible and permit wages to fall in response to a decline in the demand for labour, or by unemployment.” (p323). Competitive devaluation is also prevented, as devaluation can be inflationary, this will help to stabilise the economies within the Eurozone and reduce the uncertainty that surrounds devaluation of other currencies in order to remain competitive. The loss of competitive devaluation, however, is mainly a negative effect, which will cause problems for the European Union if any of the member countries experience recessions or economic downturns in the future.

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A main problem with European Monetary Union within the European Union is that the EU is not an optimal currency area. “An ‘optimal’ currency area would have a high degree of cross-border mobility of capital and labour; it would have high wages and price flexibility” (p306) as defined by Jones. The EU’s labour and capital markets are to inflexible to cope with the economic shocks and strains put on them by EMU. Workers within the EU are reluctant to migrate to areas with employment in other member states; this leads to the rigidity of the market. As there are restricted use of policies such as interest rates, exchange rates and fiscal policies, these economic policies cannot be drawn upon to rescue the economy in times of economic shocks. As this is the case then labour wages and prices have to be used instead. In recent years the “emphasis has shifted to promoting greater flexibility in labour markets and social policies.” (p175). The EU will have to reform these markets to enable them the flexibility they need for EMU to work.

In addition to reforms of the labour and capital markets, the political structure of the EU will have to be amended. Within the EU there are incompatible economies each with their own governing bodies, the EU has a “highly decentralised fiscal policy and even more decentralised political system” (p173), without political unification the consequences of EMU will prove extremely difficult for he separate governmental bodies to cope with. Political unification would bring the Eurozone closer to a supranational power as all the decisions involving monetary and fiscal policies would be made at a national level, above the regional governments. This would also reinforce the Eurozone as a greater political power within the world markets. But there is a huge political cost to the member states because if this occurs the member government will be giving up a significant amount of their power. Without the political unification, however the EMU will be unsuitable and unsustainable in the long run.

The introduction of a single currency removes or lowers transaction costs. This benefits both companies and tourists due to the removal of exchange rates, which are used in changing currencies or importing and exporting goods within the Eurozone area. Lintner states that: “The Economic Monetary Union reduces transaction costs as well as uncertainty and risk for trade and capital movements” (p324), the removal of uncertainty will benefit most economies that adopt the Euro, as this should increase economic growth. In the long run there will be “efficiency gains stemming from the elimination of exchange rate uncertainty and risk for trade and capital movements.” (p120), this should improve resource allocation within the Eurozone.

Along with the removal of transaction costs, there is also a reduced uncertainty for industries and consumers due to the benefits of price stability, which occurs with Economic Monetary Union. As the enlargement of the European Union occurs and more countries join the Euro, the “ Economic Monetary Union might offer vulnerable states the stability and credibility that has been enjoyed by Germany and others over recent years.” (p324), this may prove popular with the citizens in the smaller, poorer countries who want to find employment, and who will benefit from the lower inflation rates and interest rates which will be provided by joining the EMU. As exchange rates are eliminated due to the single currency, the “Removal of exchange rate risk could also improve the return on capital and have a positive impact on investment and growth.” (p12), this increase in investment will stimulate economic growth in the long run and help to expand the struggling economies within the Eurozone area.

As discussed before the implementation of the Euro will cause the loss of control over monetary policy for the regional governments and the removal of their currency from the world market. This makes the adoption of the euro fairly irreversible to all involved, this means that there is, “no easy exit option if things go wrong” (p177), in the early stages of Economic Monetary Union, there is a question of whether it will be a success or a failure, and as there is no get out clause some countries may find this a difficult policy to espouse. This may cause problems between the member countries themselves when it come to deciding who will join EMU, “The proposed Economic Monetary Union might increase regional disparities that is costly to implement and that it is certain to carry substantial risks, especially in initial stages” (p324), this brings up the problems of the implementation costs for any countries wishing to join the EMU, which are substantial for smaller Eastern European countries who are wanting to join the enlarging European Union.

There are many positive and negative effects of joining the Economic Monetary Union, which lead to either problems or possibilities for the member countries. Among the problems the most important one to consider when evaluating the EMU is from a political perspective the irreversibility, this is a very costly and uncertain gamble to make when deciding to join the EMU and which needs to be solved before poorer countries can afford to join the larger members. The structure of the labour markets also proves a fairly large problem to the Eurozone as without reforms in these areas the labour market is to inflexible. One of the main possibilities of EMU is the increase in political power the Eurozone will experience, the area within the EMU will be one of the largest single currency areas, and will enjoy all the political benefits from this, The Eurozone will have more influence over larger political power such as America, this has endless possibilities with regards to new policy areas.

Word Count: 1,457

Bibliography

Giordano, F. & Persaud, S. “The political Economy of Monetary Union” (1998), Routledge
Jones, R. “The Politics and Economics of the European Union” (2001) 2e, Edward Elgar
Lintner, V. “European Monetary Union: Developments, Implications and Prospects” (2001) in Richardson, J (ed.). “European Power and Policy Making” 2e, Routledge
McCormick, J “Understanding the European Union: A Concise Introduction” (2002), 2e, Palgrave
McCormick, J. “Understanding the European Union: A Concise Introduction” (2002) 2e, Palgrave
Swann, D “The Economics of Europe”(2000), 9e Penguin Books
Tsoukalis, L. “Economic and Monetary Union: Political Conviction and Economic Uncertainty” in Wallace, H & Wallace, W. (eds.) “Policy-Making in the European Union” 4e, (2000) Oxford University press
Tsoukalis, L. “The New European Economy Revisited” (1997), Oxford

McCormick, J. “Understanding the European Union: A Concise Introduction” (2002) 2e, Palgrave

Tsoukalis, L. “The New European Economy Revisited” (1997), Oxford

Giordano, F. & Persaud, S. “The political Economy of Monetary Union” (1998), Routledge

Tsoukalis, L. “Economic and Monetary Union: Political Conviction and Economic Uncertainty” in Wallace, H & Wallace, W. (eds.) “Policy-Making in the European Union” 4e, (2000) Oxford University press

Lintner, V. “European Monetary Union: Developments, Implications and Prospects” (2001) in Richardson, J (ed.). “European Power and Policy Making” 2e, Routledge

Jones, R. “The Politics and Economics of the European Union” (2001) 2e, Edward Elgar

Lintner, V. “European Monetary Union: Developments, Implications and Prospects” (2001) in Richardson, J (ed.). “European Power and Policy Making” 2e, Routledge

Giordano, F. & Persaud, S. “The political Economy of Monetary Union” (1998), Routledge

Lintner, V. “European Monetary Union: Developments, Implications and Prospects” (2001) in Richardson, J (ed.). “European Power and Policy Making” 2e, Routledge

Giordano, F. & Persaud, S. “The political Economy of Monetary Union” (1998), Routledge

Lintner, V. “European Monetary Union: Developments, Implications and Prospects” (2001) in Richardson, J (ed.). “European Power and Policy Making” 2e, Routledge

Teacher Reviews

Here's what a teacher thought of this essay

Grace Thomas

26th of Mar 2012

4/5 This essay is informative and well-researched. At my institution (a Russell Group politics department) it would probably receive a 2.1, depending on the syllabus and the level of study). What prevents this from attaining a better mark is the lack of an overriding structure that facilitates a strong, and internally unified, argument. The points are made in a bit of a scattergun fashion so I didn't get the impression that costs and benefits were particularly well summed against each other. Indeed, in many cases the good and bad facets of EMU's design are paradoxical aspects of each other, particularly if the political consideration of who benefits is taken into account. The author touches upon these kinds of ideas, but foregrounding them would provide a stronger framework for the author's research and arguments.

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