Eco 360 - Economics for Business

ECO 360 - Economics for Business I

June 7, 2005

The Euro is the common currency of the European Monetary Union (EMU). The national currencies of the participating countries were replaced with Euro coins and bills on January 1, 2002. The countries that participate in the Euro Monetary Union (EMU) are Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland (http://europa.eu.int/eoro/entry.html). These countries irrevocably established the conversion rates between their respective national currencies and the euro and created a monetary union with a single currency, giving birth to the euro. Euro banknotes and coins entered circulation on 1st January 2002. (http://europa.eu.int/comm/economy_finance/euro/origins/origins_main_en.htm). Euro area financial markets switched to the euro, including foreign exchange, share and bond markets. New euro area government debt was exclusively issued in euro as from that day. "Around 7.8 billion euro notes and 40.4 billion euro coins, together worth Ђ144 billion, were put into general circulation by the central banks of the twelve participating countries of the euro area. Euro notes were distributed by bank machines and shops started to give customers change in euro cash. At the same time, each country started to withdraw national currency notes and coins from circulation. Each Member State adopted a transition period of dual circulation during which the public could spend their remaining national currency notes and coins in shops or exchange them for euros at banks" (http://europa.eu.int/comm/economy_finance/euro/origins/origins_main_en.htm).

Several other countries including the Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungry, Malta, Poland, Slovenia, and Slovakia plan to enter into the EMU in the future. These countries have to meet the Maastricht convergence criteria before they can become members of the EMU and began use of the Euro.

The Maastricht Criteria

"The Maastricht Treaty stipulates five criteria that countries must meet to become eligible for the single European currency, the euro. These criteria must be achieved over the year before the date of examination. As membership will be determined in early 1998, the criteria thus apply to 1997. They are as follows:

Price Stability

To qualify, a country's inflation rate must not exceed the average inflation rate of the three best performing Member States by more than 1-1/2 percent. (Inflation is measured by means of the consumer price index.)

Fiscal Prudence

To qualify, a country must not exceed either of the following two reference values relative to its gross domestic product at market prices:

 3 percent for the ratio of the planned or actual government deficit to GDP;

 60 percent for the ratio of government debt to GDP.

Successful EMS Membership

To qualify, a country must have stayed within the normal fluctuation margins provided for by the Exchange Rate Mechanism of the European Monetary System, for at least two years, without devaluing against the currency of any other Member State.

Interest-Rate Convergence

To qualify, the durability of convergence must be reflected in the long-term interest rate levels. A Member State must have had an average nominal long-term interest rate that does not exceed by more than 2 percentage points that of, at most, the three best performing Member States in terms of price stability. (Interest rates are measured on the basis of long term government bonds or comparable securities.)"

(http://web.ask.com/redir?u=http%3a%2f%2ftm.wc.ask.com)

"2004 was a monumental year in the currency markets. Dollar weakness was the predominant theme as the world's premiere reserve currency slid to a fresh all-time low against the euro, a nine-year low against the Swiss franc and a 12-year low against the British pound. 2004 also marked the beginning of the global tightening cycle, with many central banks raising rates for the first time since reducing them to extremely accommodative levels. The US current account deficit became a primary point of focus, along with increasing pressure on China to revalue the Renminbi. We expect these themes to resonate into 2005, especially the earlier half. However, growth should also become a primary focus as the world monitors the strength of the US economic recovery" (http://www.refcofx.com/currency-forecast-2005.html). "The euro fell 3% last week against the U.S. dollar and has dropped about 10% since January. A weaker euro is good for U.S. importers but bad for exporters because it makes products more expensive overseas. Member countries gave to the European Central Bank their power to set interest rates and control the amount of cash in circulation. It's proved hard to have a one-size-fits-all monetary policy for a dozen countries. The ECB is expected to cut interest rates later this year, which would be good for Germany's malaise but could overheat Ireland's bustling economy" (http://www.usatoday.com/money/world/2005-06-05-euro-usat_x.htm?csp=34).

Currently 1.00 EUR equals 1.22578 USD. (http://www.xe.com/ucc/convert.cgi). This value is expected to increase. "Eurostat's flash estimate for quarter-on-quarter growth of euro area real GDP in the fourth quarter of 20043 confirms a slowdown in activity in the second half of the year. However, there are reasons to assume that this slowdown will be temporary. Against this background, it is projected that average annual real GDP growth will be between 1.2% and 2.0% in 2005 and between 1.6% and 2.6% in 2006. Export growth, as implied by the assumption of continued strength in foreign demand, is, over the horizon, expected to continue to support economic activity. Domestic demand and employment should gradually strengthen. At the same time, labor supply is expected to increase as a result of improved job prospects and structural labor market reforms in various euro area countries. Overall, according to the projections, the unemployment rate should start to decline this year" (http://www.ecb.int/pub/pdf/other/ecbstaffprojections200503en.pdf)

It is interesting how the value of the Euro and the US dollar has changed over the years. Part of the changes is primarily due to the fact that other countries have or are contemplating using euros rather than the US dollar