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Do the Advantages of Economic and Monetary Union Outweigh the Disadvantages Essay Sample

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Do the Advantages of Economic and Monetary Union Outweigh the Disadvantages Essay Sample

The European Economic and Monetary Union (EMU) is the most ambitious economic project undertaken in modern history. However, nearly every EU country has seen some kind of protest against monetary union, and three countries – Denmark, Sweden and the United Kingdom – have refused to participate (a fourth, Greece, did not qualify for economic reasons). Even Euro enthusiasts admit that there are a number of things that can go wrong.

First the context of the EMU’s development will be presented, followed by the presentation of arguments in favour of EMU and against EMU. This essay is presented with a critical view towards EMU.

Moves to EMU took place in the context of the collapse of the Bretton Woods international monetary system. The first serious attempt to tie together the value of national currencies came in the early 1970s, but collapsed in the face of turbulence in the global monetary system.

The successful establishment of the European Monetary System (EMS) in the late 1970s, and the stability that it induced, encouraged proposals for another attempt to move to monetary union with the establishment of a single currency. Following commitment in the Treaty on European Union (TEU)2 to this policy, the French and German Governments put forward two very different proposals on how it should be managed. The Germans predominated on nearly every significant issue, and in January 1999 eleven member states of the EU joined the single currency. Franco-German tensions culminated in a dispute over who should head the ECB, but this altercation only slightly spoiled the launch of the ‘Euro’.

The ‘Euro’ coins and notes entered into use as a currency on January 1st 2002, with what was generally regarded as a smooth launch3.

A key advantage to EMU is that the ECB will be completely independent. Free from political interference, The ECB can set interest rates that are suitable, without pressure to change for political reasons – politicians in control of setting their own rates often manipulate inflation, particularly before elections, in order to heighten their popularity, without concern for real economic issues. An independent ECB means that economic experts that are not concerned with political popularity deal with interest rates and inflation. The interest rate policy of a European central bank is likely to be both less austere and also less volatile than that of an independent, but dominant, Bundesbank. The credibility that attaches to the monetary policy of a European-wide central bank will render the Euro a strong currency and thus permit lower interest – investment and growth are obvious beneficial consequences.

Price transparency is also another benefit for the member states of EMU. When prices are transparent, competition is fiercer, thus driving down prices for the consumer. This is because once all prices are quoted in the single currency, consumers are able to shop around, thus bringing downward pressure on prices. In addition the ECB is committed to ensuring an environment of price stability. Therefore, a common currency removes a significant barrier to free competition across national borders.

The crucial advantage to be derived from EMU is the contribution that it would make to monetary stability and economic growth. A single market combined with freedom of capital, works less well without a single currency which eliminates internal exchange rate risks. Interest rates should be significantly lower because the risk premium attached to the currencies of smaller and weaker economies will no longer be necessary.

Lower interest rates and a more stable economic environment should encourage more investment and trade, and stimulate growth and employment, thus firms will be able to plan ahead more effectively in the knowledge that there will be less uncertainty. Greater stability should encourage longer term, higher trust relationships within the firms and the economy, and lead to increases in productivity and innovation. Thus, the introduction of a single currency will act as a stimulant to economic restructuring and change across the single market. For individuals, greater stability could result in lower mortgage rates, higher living standards and more job opportunities

However, the relatively smooth transition of the ‘Euro’ distorts the many flaws in its fundamental principles.

Firstly, monetary union will spell the end to a nation’s ability to conduct its own economic policy. National economies are invariably cyclical; experiencing booms as well as busts. The traditional short-term way for a nation to control this and create stability is to lower or raise interest rates. However, interest rates are specific to a currency and membership of EMU incurs a single rate of interest. EMU membership would therefore be too inflexible. This can be seen in Britain’s economic crisis of 1991.

Following withdrawal from the Exchange Rate Mechanism, Britain required 15% interest rates in order to control the economy and prevent total collapse. This interest rate may have been applicable to Britain, but it would be suitable to apply it to the other members of the EMU. If one EMU country suffered a boom or bust, the ECB would be caught in the dilemma of whether to let an economy collapse or hyper-inflate, or to introduce unsuitable interest rates to the other countries that would be unpayable or would in turn stimulate hyperinflation by overspending. A single rate of interest is therefore too inflexible for such a widely varied set of economies.

The eleven-country Euroland makes such problems even more pronounced. The ECB initially set interest rates at 3%, and has since lowered them to 2.5%. Some politicians have complained that this is still too high. They should spare a thought for Europe’s smaller economies. In Ireland, Spain and Portugal business is booming, and interest rates were high to prevent the economy from overheating. But already before the launch of EMU interest rates had to come down to the eurozone level and this has triggered higher rates of inflation4. It is the old question of microeconomics versus macroeconomics. What is good for the economy as a whole may not be good for every sector and region.

The structure of the ECB is also problematic. A Seventeen-member council rules the new central bank: Six of them represent the ECB leadership, eleven are the governors and presidents of the national central banks of the countries participating in monetary union. This semi-centralised banking system means that the national central banks are keeping too much power – the council will not be able to react quickly to an economic crisis and clear guidelines are missing on who is in charge of crisis management. Banking supervision, which is fully in the domain of national central banks, is perhaps the most intense example of this. Furthermore, the in-built majority of eleven to six means that national banks could work concurrently against the Frankfurt-based leadership.

The lack of transparency, though, is probably the Euro-bank’s biggest fault. The bank has decided to keep its proceedings secret. The council argues that this will reduce the threat of political pressure. If nobody knows how council members have voted, they cannot be taken to task for it. This secrecy will make the bank accountable to no one but itself, enabling politicians to use the bank as an easy scapegoat. Financial markets, meanwhile, may be unduly nervous, as they cannot gauge the governing council’s true thinking.

A key question to monetary union is: Who is in control? The ECB is officially independent, but politicians have and will continue to try and influence the bank’s decisions. For example, Oskar Lafontaine, Germany’s Finance Minister, told the ECB leadership to lower the eurozone’s interest rate. Government politicians from France and Italy ascertained Lafontaine’s position, and central bankers from around the world supported the ECB’s independence5.

Under its treaty obligations the ECB’s main task is to keep inflation under control, and changing the level of interest rates is its main instrument to do so. For this monetary policy to work, it has to be complemented by a strict fiscal policy, because high budget deficits increase the inflationary pressure.

With regard to spending and stability, the ECB’s problem is that is has to deal not with one but eleven governments, who all have differing budget policies. If one or two governments decide to run up huge deficits, the ECB could be forced to raise interest rates to a level harmful to other EMU countries. To prevent such a free-rider mentality by deficit-prone governments, the EMU members have signed a ‘stability pact’, pledging that they will adhere to strict spending limits or face financial fines. Extraordinary economic circumstances though, may win a country permission to exceed narrow spending targets, and there are worries that an economic crisis could trigger huge budget deficits and a collapse of the Euro.

The suggestion that the European countries need to converge in order to benefit their manufacturing sectors is a total myth. In most developed countries, about 90 per cent of production is still carried out for the domestic market and about 90 per cent of consumption is locally produced6. The manufacturing industry is therefore not as troubled by fluctuating currency conversions as many would suggest. Convergence with different countries’ manufacturers would therefore not be beneficial to the manufacturing sectors; it would merely be a reshaping of the market, targeting different customers.

However, each of the manufacturers are economic competitors and instead of being beneficial to the whole of the manufacturing sector, economic and monetary union would benefit the larger successful companies at the expense of farmers, smaller exporting companies and non-exporting companies who only target the domestic market. This is an inevitable feature of the capitalist system, which is only exaggerated by engaging more and more in globally cohesive trading (think globalisation – the rich few benefit more and more at the expense of the poor many – the third world is getting poorer and poorer. This would just be replicated within the EMU). EMU would only benefit the elite of the 10 per cent who export their goods.

Conclusion

The current main arguments supporting economic and monetary union centre around the benefits for the manufacturing sector, which would be shared out evenly and, coupled with the monetary stability that is generated, would enable stable economic growth for everyone.

In this essay I have argued that this is in fact inaccurate because it overexaggerates the benefits, which would only be felt by the bigger businesses that are in a position to export their goods and reap the rewards of cheaper exportation costs. A single rate of inflation is too inflexible for the very divergent economies and the structure of the ECB is far too problematic. This ‘one-size-fits-all’ approach to economics is too idealist and does not take into account that each of the member states would solely be pursuing their own interests.

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