The Euro Is a Good Thing?

"European Economic and Monetary Union is a good thing for those involved because the advantages are guaranteed while the dangers might never become a reality." Explain and discuss this statement.

In order to explain and discuss the above statement, firstly it is essential to define and briefly explain what European Economic and Monetary Union (EMU) is. Secondly it is also essential to examine the advantages of membership alongside the disadvantages, finally there is a need to examine the dangers of being involved and discuss how likely it would be for these dangers to become a reality.

The new European single currency was introduced as a physical currency on Jan 1st 2002 across 12 European Union members. For all those involved the "Euro" was born and previous legal tender within these countries were withdrawn. What EMU actually involved was a uniformed monetary policy with common interest rates throughout the zone. "The long process of monetary integration was capped by the successful creation of EMU and European central bank 1999, and the remarkably smooth introduction of the Euro on 1st January 2002." (Wallace et al 2005, page 142).

The main aspects of EMU consisted of the setting of interest rates through the newly created central bank for all those in the zone. For all members this meant a move from previous intergovernmental power to supranational power with regards to decisions made in all areas relating to EMU. "Today, policy capacity in the monetary realm is truly supranational, with political authority firmly located at European level." (Wallace et al 2005, page 142). In order for integration of these policies to be viable there needed to be certain constraints on fiscal policy, involving the growth and stability pact, which was agreed at Maastricht. This meant that member countries were not allowed to have a budget deficit greater than 3% of GNP. "Budget deficits must be less than 3% of GNP unless higher deficits are temporary or exceptional." (Mercado 2001, page 126). If member countries exceeded this then they would be breaking the rules and this in turn may potentionally affect the interest rates within the zone.

However, according to McDonald and Deardon 2005, page 95, "the early years of EMU have demonstrated the limitations of a mechanistic budget deficit ceiling", and "potential dangers of forcing member states in recession to offset the operation of automatic stabilisers with deflationary spending cuts and tax increases."

For those in favour of the Euro, its introduction is seen as a further step towards capital market integration a goal since "the first proposals for EMU at the 1969 summit in the Hague". (Wallace et al 2005, page 141). EMU sees the removal of barriers in the finance and investment markets for those in the Euro zone. Supporters of EMU could see the introduction of the single currency as a natural progression into further integration, using the neo-functualist theory of a process of functional spill-over, simply meaning once steps have been taken to integrate in one area, such as coal and steel, it is predictable that further integration into other sectors, such as finance will follow. "Neo-functialists argue that, as functional areas of government are integrated, the political and bureaucratic elite that handle these policies will increasingly switch their loyalties, expectations and goals from the national government arena to the overall aims of the integration agencies." (McDonald and Deardon 2005, page 4).

For all those involved in EMU, the benefits promised were an end to exchange rate uncertainty and thus predicting further price stability. By having a single currency it should promote price transparency as consumers and buyers have been able to compare prices in the same currency. Previously the national currencies had fluctuating interest rates which changed fairly regularly and made it difficult to see who the most competitive producer was. Therefore any unfair price hikes can be seen by those members of EMU and enable them to switch to cheaper suppliers, with more consumers and suppliers using the ever popular internet it encourages trade between different countries, partly due to the fact that trading in a single currency is easier to use.

The problem with the fluctuating exchange rate is that it costs to trade with other countries. Having a single currency it is expected to give savings on transaction costs as there is no need for an exchange rate and therefore it costs nothing to convert your currency. By adopting the Euro members had to have had "domestic currency values within the narrow bands of the ERM for two years." (Mercado 2001, page 126). This was in preparation for EMU as member countries had to stabilise their exchange rates. Many non-members in order to trade with other countries would not have this stability and would have to have insurance against exchange rate fluctuations; this may discourage trade because of the extra cost.

Therefore in theory the ease of trade between EU members who have adopted the Euro should increase and be beneficial to the citizens of the Euro zone. This should increase economic growth as it encourages integration and trade, uncertainty is reduced as the Euro has the same value and this should encourage investment. "It can be argued that common European monetary authority and a single currency will make a contribution to a healthier economic environment that inspires greater confidence, growth and wealth creation." (Mercado 2001, page 134).

All of these benefits should lead to a more integrated market, as removing uncertainty is effectively removing a barrier to trade, increasing investment, leading to more competition and therefore better internal economies of scale, as potentially an investors output could rise. "New business start-ups may also be encouraged." (Mercado 2001, page 135). This in turn could improve external economies of scale as it encourages clustering, meaning a particular industry, such as the car industry in America, could all cluster together and trade in one particular area.

A further benefit of adopting the Euro, could in theory, lead to lower inflation, because if more countries join EMU, this could make it a strong, stable currency, big finance company's may decide to hold reserves and this would further increase its strength. However, this all depends on the governments in the Euro zone not breaching the rules of the convergence criteria, such as the growth and stability pact, as this could then push inflation up.

All of the benefits and advantages associated with being a member of EMU are only guaranteed