Theoretical Foundations For The European Monetary Union example essay topic

The movement towards the European Monetary Union and the creation of the euro lasted many years, complete with key personalities and major governmental treaties. When finally organized and implemented, it lead to a historical event that will forever change international economics. Of course with a change this tremendous comes the good and the bad, but if the economic welfare of the people is improved, everything was worth all the hassle. HISTORY OF THE MOVEMENT The beginnings of the movement for European monetary unification go back at least to the founding of the Organization for European Economic Cooperation (which then became the Organization for Economic Cooperation and Development, or OECD) in 1948. One of the OECC's first accomplishments was the European Payments Union, established in 1950 and accomplished by the end of 1958, where the nations of Western Europe put their international reserves together and coordinated their policies with the intent of reestablishing current account convertibility. In 1962 the Commission of the European Communities produced its first plan for a monetary union, which included a deadline for completion of nine years.

Obviously, this deadline was a little overambitious for a group of countries whose only collective achievements had been the European Coal and Steel Community, an atomic energy community (Euratom), a customs union (the European Economic Community), and the Common Agricultural Policy of farm-product subsidization. The only accomplishment of the 1962 effort was a Committee of Central Bank Governors which was set up in 1964 but did not actually operate until the 1970's. At the Hague Summit in 1969, European governments delegated a committee headed by Pierre Werner, then Prime Minister of Luxembourg, to devise a new plan. The Werner Report, finished in 1970, called for monetary unification within ten years. The plan scheduled a transition to happen in stages.

In the first stage, exchange rate fluctuations would be limited, and governments would start to integrate their monetary and fiscal policies. In the second stage, exchange rate variability and price discrepancies would be further reduced. In the third stage, exchange rates would be fixed permanently, capital controls removed, and an European Community (EC) system of central banks (somewhat modeled on the U.S. Federal Reserve System) would take control of the monetary policies of the member nations. The size of the EC budget would be greatly increased and the EC would coordinate national tax and spending programs.

The makers of the Werner Report were not attached to a single currency. Parts of the Werner Report were put into use in 1972 when EC countries made an agreement dubbed "the Snake" limiting bilateral exchange rate movements to 2 1/4 percent bands. Policy union and coordination was a bit slow. When the first OPEC oil shock caused different levels of unemployment in different European countries, national governments were under various levels of pressure to respond in ways that risked inflation. Some of the nations' currencies were devalued and some revalued. The arrangement proved to be incapable of accomplishing the exchange rate stability that the makers originally hoped for.

This realization lead to another round of exchange rate stabilization negotiations at the Bremen Summit of 1978, leading to the creation of the European Monetary System (EMS) in 1979. Its goal was to stabilize exchange rates without simultaneously requiring the elimination of international policy divergences either through the use of fiscal and monetary rules or by empowering the EC to coordinate national policies. Its central element, the Exchange Rate Mechanism (ERM), was designed to accommodate the different policies pursued in different countries. The EMS had been functioning for seven years when the EC installed the Single European Act in 1986. It basically laid out the basic provisions for what would be the European Union's goals, organization, and some of its economic law. This committed the EC members to the creation of an integrated market without obstacles to the movement of goods, capital, and labor by the end of 1992.

With the process of European economic integration gaining momentum, in 1988 the European Council appointed Jacques Delors, President of the European Commission, to study the feasibility of supplementing the single market with a monetary union. There were significant differences between the Werner Report and the Delors Report. Where the Werner Report recommended removing capital controls at the end of the process, Delors endorsed the beginning. Also, Delors did not propose transferring control of national budgetary policies to the European Community. Another difference is that the Delors Report included a new entity, the European Central Bank (ECB), to make and execute the Community's single monetary policy.

National central banks were to become operations arms of the ECB. The clearest image of the contrast is Delors' insistence on the early introduction of a single currency to insure "the irreversibility of the move to monetary union". The Delors Report provided the framework for intergovernmental talks in 1991, with many of its conclusions finding their way into the Maastricht Treaty. CREATION AND INTRODUCTION OF THE EURO Speaking of the Maastricht Treaty (formally known as the Treaty on European Union), it was this bravely launched 1992 agreement among European Community members that implemented the Economic and Monetary Union (EMU) in Europe, called for fixed exchange rates, a move toward political union and military cooperation, and spawned the creation of the euro. The main objectives of the economy of the EU were to increase efficiency through competition and deregulation, encourage employees to own shares in the firms where they work, spread ownership in the general economy, reduce government expenditures to eliminate deficits, create more foreign trade, and build up the capital market and the economy as a whole.

Robert Mundell, the Canadian economist, is sometimes called the "Father of the euro". He laid many of the theoretical foundations for the European Monetary Union, and obviously, was an ardent supporter of the euro. His theory of optimum currency areas (OC As), noted in the Nobel Committee's citation as one of his most important scientific contributions, has served since the 1960's as an analytical framework for many debates on the validity of the creation of a European currency. Beginning with Mundell in 1961, economists have long agreed that there are four main criteria for a region to be an optimum currency area. The first is that the countries should be exposed to parallel sources of shocks or disturbances. The second is that the relative importance of these common shocks or disturbances should be similar.

The third is that the countries should have similar responses to common shocks, called "symmetric" responses. The fourth criterion is that if the countries are affected by country-specific sources of disturbance, they need to be able to correct themselves quickly. The central idea is that countries satisfying these criteria would have similar business cycles, so a common monetary policy reaction would be optimal. The creation of the euro was a monumental historic event because for the first time since the Roman Empire, a good part of Europe was to use the same currency.

The euro also has the extraordinary quality of not being issued by a sovereign government. In order for a country to use the euro as their currency, they had to meet stringent criteria like a budget deficit of less than three percent of GDP, a debt ratio of less than 60 percent of GDP, as well as low inflation and interest rates similar to the EU average. Denmark, Sweden, and the United Kingdom opted out of becoming charter members. Many Europeans, particularly the British, disagreed with the introduction of a single currency used by all EU members, feeling that it would be a big step toward a complete disobedience of national sovereignty to the bureaucracy of Brussels. Greece did not initially meet the economic criteria although it did so later in 2001. The euro currency was introduced in the forms of traveler's checks and electronic transfers in 1999, when the national currencies of member nations ceased to exist independently in that their exchange rates were fixed subdivisions of the euro.

Therefore, the euro became the successor to the European Currency Unit (ECU). The bills and coins that were previously used for the old currencies continued to be accepted as legal tender until new bills and coins were produced on January 1, 2002. The span of time when the euro was not in tangible form was a time of skepticism, with critics saying the euro was doomed to fail, but as soon as it was produced in "real" form, the confidence in the euro rose dramatically. The changeover period where former currencies' notes and coins were exchanged for those of the euro lasted about two months, until February 28, 2002. WHY MONETARY UNION? There are various benefits to a monetary union.

Having only one currency is expected to boost the interdependency of the EU members that have adopted the euro. This, if all continues to go well, should be beneficial for citizens of the euro area because increases in trade are historically one of the principal driving forces of economic growth. According to the European Commission, the gains from conducting transactions in a single currency could be as high as 0.5% of EU GDP every year. Additionally, this would fit with the long-term goal of a unified market with the European Union. Another benefit is the removal of the bank currency transaction charges that previously were a large cost to businesses as well as individuals when exchanging currencies. On the down side of this said benefit, banks will suffer a significant blow to profits with the loss of this income.

Some economists have said that another advantage of implementing the euro is that it will add great liquidity to the financial markets in Europe. Since governments can now borrow money in euros instead of their own local currency, it allows access to many more sources of money. Other scholars consider that the potential strength of the Eurozone (the area encompassing all the coun tries officially using the euro) is in the coherent efforts of a virtual greater super-economy, in which it is now possibly easier to generate stronger financial associations, instead of in the mere sum of single. Four major outcomes were expected after the implementation of the European Union. The first being a significant reduction in costs because of improved utility by companies of economies of scale in production and business organization. The second is an improved efficiency within firms, widespread industrial reorganization, and a scenario where prices decrease toward production costs under the pressure of more competitive markets.

The third outcome is new patterns of competition between entire industries and, like our old friend Ricardo analyzed, a reallocation of resources as, in home conditions, real comparative advantages determine the role in market success. The fourth effect is increased innovation and new business methods and products generated by the dynamics of the internal market. Although these effects can not occur at the same time, their overall impact is very important. They increase the urge to compete of businesses and the general economic welfare of consumers. Consumers would no longer be confronted with huge price differences depending on their own domestic currency.

Also, this causes greater consumer choice, as market integration and increased competition lead to differentiated products and economies of scale. There are also other effects of monetary unification. Most economists would say that monetary unification coincides and also leads to more extensive international financial activity. The two main reasons for this argument are because integration reduces "currency risk", which is the risk that the value of debts would change because of currency fluctuations; and being a member of a monetary union might make a nation that borrows more reluctant to evading its own debts because of a strong fear of other member countries "throwing the book at them". These same two reasons also lead to different assumptions about whether a new monetary union member's increased borrowing and lending would be partial towards other union members. CRITICISMS OF EUROPEAN MONETARY UNION Of course, along with the benefits of a monetary union, come the disadvantages.

Many economists are cynical about the long-run practicality of the EMU. Eurozone members have given up their right to set their own interest rates and the choice of moving their exchange rates against each other. There is a widespread view that this loss of flexibility might involve significant costs in the form of unrelenting high unemployment rates and low GDP if their economies do not act as one or cannot easily adjust in other ways. The main concern of these economists is that for some countries, these macroeconomic costs will eventually overshadow the benefits and cause them to eventually abandon the EMU.

Another concern is relating to the possible dangers of adopting a single currency for a large and varied area. Because the Eurozone has a single monetary policy set by the ECB, it cannot be fine-tuned for the economic circumstance in each individual country. Public investment and fiscal policy in each country is the only way that economic changes can be introduced specific to each region or country. Eurozone members are currently experiencing large variations in inflation and unemployment, but not yet enough to cause substantial economic damage. Yet another apprehension about EMU is that there are perceived flaws in the Maastricht Treaty. The enforcement methods are vague or nonexistent, which heightens uncertainty about how they system is to work.

Most of this uncertainty comes from the different economic objectives that principal countries sought to achieve with monetary union. The Germans wanted to expand German regulations for fiscal and monetary policy to the rest of Europe. They expected that, if their rules were adopted, currencies would be more stable and they would not be required to finance their neighbors' budget deficits. The French ("frogs") wanted to increase their influence over monetary policy, and were "bothered" by rules made by the Bundesbank. The second flaw in Maastricht is that Germany and France have decided on an economic arrangement mostly to solve a perceived political problem. Lenders on both sides see value in establishing common organizations that will unite the two countries and replace unequal ends with common purposes.

They could not get agreement on a federal structure, so they hoped to move by steps toward monetary union. As Dr. Omar Is sing, director of the Bundesbank, has noted, the two countries have reversed the usual process. Normally, political union comes before monetary union, and for good reason. Control of government expenditures and budget finance is necessary for effective monetary control in the long run. The current vague criteria for admission and weak enforcement rules for budgets cannot take the place of a political mechanism. The absence of a political arrangement to control deficits is significant because monetary union will increase pressures for regional transfers within Europe.

The worry is that in some future fiscal crisis, a country will bargain for an opt-out by the central bank in exchange for an increase in domestic taxation or a cut in government expenditures. The last source of conflict comes from the opportunity for exchange-rate adjustment by non-member European countries. Those countries retain an adjustment mechanism that countries within the union give up. When economic developments produce exchange-rate adjustments, member countries will grumble and groan that nonmembers are using their exchange rates to "export unemployment". This has already happened many times with French and German producers against British producers. Opportunities for friction will greatly increase if part of Europe is in monetary union and the rest continues to opt out or is excluded.

A partial monetary union tests not only the foundation of monetary union but also the regulations for open trade and other relations among countries in the current EU. Some economists suggest that a more desirable option for Europe would be a largely voluntary, non bureaucratic, dispersed arrangement covering more of the world's trade where countries would be allowed to join or remain outside the union. However, this option does not look at all likely any time soon. THE FUTURE OF THE EUROPEAN UNION Currently, there are many possibilities for change in the EU. In September of this year, European finance ministers agreed to study making common rules for calculating corporate tax in the EU. Some say this move would open the window to a future with a single European tax.

Starting in October, governments were to start discussing how a single set of corporate-tax rules across Europe would reduce red tape and assist investors in comparing different tax regimes. Taxation has become a controversial issue since Europe expanded eastward in May. It puts poor eastern countries yearning for growth against powerful western ones that want to keep everything they already have. The discussions may lead to a ground-breaking group of countries testing out the common tax rules.

Another pressing issue in the EU is the decision to extend membership to Turkey. EU officials are worried about a poor Muslim country of 70 million people becoming one of the union's largest members. However, the EU's enlargement commissioner visited Turkey and praised the country for recent progress including a curb on military power, economic liberalization, and abolishing the death penalty. An EU extension of membership to lesser-developed countries does not necessarily lead to a fragile and chaotic Europe, specifically when there is a growing acceptance of new members with certain adjustment periods. Other European countries might join the union, which could one day reach even fifty member-nations, equaling the number of American states. However, such a scary thought does not need to enter into the minds of Americans and bash our hopes of remaining a world power forever!

CONCLUSION It was a long and tedious journey to European Monetary Union, but one that was well worth the wait. Yes, there have been ups and downs, and advantages and disadvantages, but the future of the European Union remains bright. Who knows how this powerful union will affect the rest of the world for the years to come? Barry Eichengreen, "European Monetary Unification", Journal of Economic Literature, Vol. I, September 1993, p. 1321-1357. Nicholas V. Gianaris, The North American Free Trade Agreement and the European Union", (London: Praeger Press, 1998).

Alexandre Sloboda, "Robert Mundell and the Theoretical Foundation for the EMU", International Monetary Fund, December 13, 1999. Michael A. Kouparitsas, "Is the EMU a viable common currency area?" Economic Perspectives, Vol. 23, 1999. Robert Solomon, "International Effects of the Euro", The Brookings Institution, January 1999". The Euro", Wikipedia Online Encyclopedia, web 11/22/2004.

John Robinson, The European Challenge: 1992 and the Benefits of a Single Market (Vermont: Wildwood House, 1988), p. 73. Mark Spiegel, "Monetary and Financial Integration: Evidence from the EMU", FR BSF Economic Letter, Number 2004-20, August 6, 2004. Allan H. Meltzer, "The Problems of Monetary Union- and a Better Alternative", AEI Online, January 1, 2000. John W. Miller, "EU to Study Common Tax Rules for Companies", The Wall Street Journal, Vol.

CCXLIV, No. 51, September 13, 2004. Dan Bilefsky and Hugh Pope, "As EU Weighs Invitation to Turkey, Dissent is Aired at the Top", The Wall Street Journal, Vol.