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One cannot begin to consider this question without explicitly defining the term “fail”. For the purpose of this essay, it shall mean that the costs of the introduction of the Euro exceed the benefits. Therefore if the Euro fails, net macroeconomic performance of all Eurozone countries is worse than it would have been without its introduction. The word ‘doomed’ refers to the future, meaning that this essay will have to look at the likelihood of failure in the future. To analyse this, we may compare the economic performance of similar countries with and without the Euro and certain ones before and after the introduction its introduction. The Eurozone or EMU (European Monetary Union) is to be defined as the collection of the 16 countries whose official currency is the Euro (Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain). Although euro coins and banknotes entered circulation on 1st January 2002, the currency entered the financial markets 3 years prior to that date. However, 1st January 2001 shall be the date that we consider as the introduction of the Euro as it would have also allowed time for any financial changes to come in to effect. It is important to outline at least one issue with a currency union that has become particularly pertinent within the EMU. For all countries to share a currency, there must also exist a common central bank (the European Central Bank (ECB)) and therefore common monetary policy. This is a necessity as if two Eurozone countries had different policy rates, investors could constantly profit from arbitrage opportunities (higher returns with no extra risk) and as there is no exchange rate mechanism to correct for this, countries could rates interest rates to benefit from more lending, and their export markets not have to suffer the usual side-effect of an exchange rate appreciation. To be clear, one common policy rate does not mean that all interest rates are the same as the spread between the policy rate and bond yields will differ depending on factors such as creditworthiness of the sovereign and future macroeconomic prospects. In any case, the problem with a common policy rate is that it cannot be changed to counter cyclical movements in specific countries. This is a problem as Eurozone countries may be in different stages of the trade cycle, or some may be prone to more depressed fluctuations in economic activity than others, thus require less radical rate changes. The ability of monetary policy to control national inflation rates diminished largely. This issue exists within almost every economic trading block, ie within the UK, inflation differs between regions – usually prices rise faster in the south than the north – but it is far more severe on an inter-, rather than intra-national scale. Furthermore, it is often the countries with smaller economies that lose out as France and Germany usually have more lobbying power to influence monetary policy according to their own needs. In the future, this is
if monetary policy is too loose. Then again. It is not possible to implement a policy rate change that increases Greece’s growth rate whilst slowing Slovakia’s. the Eurozone countries’ growth rates are similar – in the range of 1% to 2%. this point is of little importance. One must also recognise that it has another flaw. using changes in taxation and government spending to control effective demand and affect the real economy. For example. their trade cycles will become more relatively influential in the EMU and as a consequence. Member countries have largely independent control over their fiscal policy. too high for certain economies to recover from deep recessions. price competitiveness of exports monetary policy is still reflationary. As emerging markets economies (eg. This may potentially lead to more conflict over monetary policy as political tensions rise. Slovakia) grow. their lobbying power may increase. Monetary policy is not the only way to dampen fluctuations in economic activity. increasing long-term productive potential. This means that one common policy rate change is not suitable for the whole region. this could be beneficial in the long term if firms are forced to increase innovation and efficiency to survive. the more likely case is that some countries experience more fluctuating GDP and inflation than others – eg economies based on consumer good production may experience more stable growth than those focused on capital good manufacturing due to the accelerator effect. and the rate may be for instance. then tighter fiscal . The chart above shows how much real growth rates in 2009 in Europe differ between countries. for a minority of countries currently with high inflation rates. by and large. meaning that the argument is not so relevant. However. This can be more tailored to individual economies. Therefore the data supports the argument to an extent. The significance of this point depends on how well the economies of the EMU move in tandem – if their trade cycles coincide. However. Furthermore.likely to become more of an issue.
One reason why the Euro is beneficial is that it reduces exchange rate risk with other non-EMU investors. making it harder to find counterparty with which to trade and often meaning that it is far more volatile. encouraging international trade. between 2006 and 2008 the Euro was rising an extraordinarily steady rate. However. Beforehand. which brings with it ‘technical expertise’ and ‘access to foreign markets’ according to Stiglitz. but in mid2008 the financial crisis hit European exports hard and demand for the Euro fell sharply against the dollar. which encourages FDI. so the Euro was no more stable than any other currency. as an exogenous shock to one economy is unlikely to affect expectations of the Eurozone as a whole. It is relevant to point-out how Greece’s debt problems originated from her not keeping to these regulations as stated by The Stability Pact – designed specifically to avoid this style of crisis. thus ensuring stability. Foreign exchange markets in this currency would have been extremely illiquid. Until the financial crisis. trade in general with non-Eurozone nations should rise for similar reasons. QuickTimeª and a decompressor are needed to see this picture. It is easier to buy and sell Euros than koruna. investors believed that the Euro was more-or-less stable and could not experience radical fluctuations. the Euro has opened-up some developing economies’ financial markets such that investors are more willing to lend to economies such as Malta and Slovakia as they are less concerned about exchange rate risk (risk due to changes in the exchange rate potentially diminishing profits). he would have to consider how the Slovak koruna was going to change in value. Clearly this point depends on the type of shock – the financial crisis in fact affected every Eurozone economy.policy can be implemented to counter the effect. Moreover. Even so. largely helping infrastructure and business development. . Below is a graph showing the exchange rate between the Euro and the US dollar from Yahoo Finance: Indeed. along with low wages and tax rates. The EMU enforces the Maastricht fiscal criteria to avoid excessive budget deficits and manage debt to maintain confidence in the Euro and stability mean that the reverse cannot be implemented too liberally. fiscal policy does have its limitations. However. The Euro offers stability and liquidity to investors. more recently. In the case of Slovakia. and also less risky. the introduction of the Euro has helped FDI inflows to grow more than 600% from 2000. the theory has departed from reality. if an investor were to lend to a Slovakian country. leaving some lack of freedom in policy-making.
of which there is a large range in the EMU. effectively rendering the earlier point insignificant. When two firms trade with different currencies. but also of the situation that the Euro has fallen sharply at the time when the principal is paid-back. where lenders no longer demand the Euro as not only are they afraid of default. the Euro has moved far more erratically and unpredictably. The theory goes as follows: a currency union eliminates some transaction costs between countries. Consumer confidence figures still remain fair from their peak. the effect is magnified and ultimately many benefits gained from the Euro disappear. causing a further fall in demand and exchange rate. QuickTimeª and a decompressor are needed to see this picture. the volatility itself has induced a selfperpetuating cycle. but dollars instead. such as the US Dollar. Although this depreciation may be beneficial for exports.Since then. In addition. or usually the buying firm (firm A) will convert his currency to the selling firm’s (firm B) preference. . Even though the positive results of the European bank stress tests may have restored some confidence. This risk is greatest in more open economies. In extreme circumstances. they were highly criticized for being too lenient and financial markets did not react much. One of the aims of the Euro was to encourage trade between member countries so that each can profit from the benefits of international trade. meaning that the common monetary policy argument becomes more pertinent. this is only in the short term and is likely to increase inflation in some countries due to higher import prices (cost-push) and rising AD due to higher exports (demand-pull). if wealthy European individuals and firms decide that they no longer want to hold Euros due to their falling value. wiping out their profits. This induces two problems: firstly. particularly in the wake of the Greece debt crisis has been a further cause of volatility. they must either both convert their currency to a common one. the financial institutions which execute this foreign QuickTimeª and a decompressor are needed to see this picture. strengthening the case for the failure of the Euro. whilst the monetary policy problem still exists. The lack of confidence in creditworthiness European sovereigns.
both transaction and financial costs are reduced or eliminated. raising trade and output. Nowadays. trade has increased at an even faster rate than it was rising before the crisis. . Despite the large decline in 2008-09 caused by the global recession. QuickTimeª and a decompressor are needed to see this picture. essentially meaning that it costs the firms more money to trade with different currencies. Furthermore. This shows that the Euro has enormously aided trade between member countries. Perhaps then. the rate of growth of trade is not much different with the Euro. changes in the exchange rate mean that firm B cannot accurately forecast its future costs. largely due to the fact that the exchange rate fluctuations between countries that adopted the euro were already low before the formation of the EMU. With the Euro. the seller of such products charges a ‘risk premium’ for taking on the risk himself. the Euro is not necessarily a causal factor for this rise. shifting the supply curve right in most international markets. such firms are able to purchase futures or options contracts – essentially a hedge against such risk so that it can be certain of future costs. with developed financial markets. if for example firm A is buying car parts from firm B as it is an car manufacturer. allowing them to profit from Ricardo’s comparative advantage theory – each country can raise output by specialising at producing what it is best at. On the other hand. The data shows how trade between Eurozone countries almost trebled between the introduction of the Euro and mid-2008. thus generating a cost for the firm. the chart shows how it was rising rapidly. Below is a graph showing a ECB measurement for Eurozone trade over the past 20 years.currency trade often charge commission or ‘make a margin’ on the trade. potentially discouraging some trade due to uncertainty about whether or not it is cheaper to buy now or later. and then trading the surplus for foreign goods. However. as before 2001.
In comparison. particular countries may suffer excessive surpluses or deficits. the deficit is merely EUR55. thus dampening the real consequences on the economy. the above graph shows the same indicator for the UK. export industries may grow and employ more labour. this is not necessarily a disadvantage as current account deficit management is not such a high priority. only 2. less significant and more volatile ones) and current transfers distort these forces in the real world. Perhaps this partially explains Spain’s current account deficit of EUR57. this will have little effect on the Euro as a whole. the recovery of trade in the EMU has been more rapid than in the UK. However. Admittedly. AD and the price level may . It could be argued that if an EMU country faces a shock. On balance. This may mean that a currency union increases resilience of trade to external shocks and allows for stronger recovery in trade from them. such as UK domestic demand falling or lagging competitiveness of exports. rather than that of certain countries.8bn. but the logic still holds to an extent. demand for a currency is essentially demand for the countries exports and supply essentially its demand for imports. so although this mechanism may function for the whole EMU. but it also impedes the natural self-equilibrating nature of a floating exchange rate. This is because if demand for imports in one country rises.47% GDP in 2009. However. if in recession a country may choose to lower interest rates in order to devalue their currency so that exports become cheaper and so long as the Marshall-Lerner condition is satisfied. their current account position will improve. the Eurozone remained stable. Often. Not only does the Euro prevent the use of exchange rate policy. more stable currency attracts more speculative action than many. these two forces should set an exchange rate that makes imports and exports equal. the differences may be due to other factors. thus the currency will not depreciate and exports would not fall. Due to the ECB. this cannot be done and countries may suffer in the short-term from high unemployment. although for the EMU as a whole. A further problem with the Euro is that countries lose the power to alter the exchange rate to alter their Balance of Payments.2bn (~10% GDP). it is likely to be a combination of the two as all the currency union reassures importers and gives them confidence over future costs whereas UK importing firms may prefer not to take on such risk during hard times. whereas the EMU as a whole only experienced a 28% decrease. with the Euro. the value is determined by exports and imports of the whole region. Along with this. Also. Disregarding speculation and FDI. In addition. such as Spain (over 20% April 2010) whose tourism industry was particularly damaged by the strength of the Euro. where trade fell for the UK between 2001 and 2004. various other factors such as speculation (which is yet more offsetting in the case of the Euro as one large. By the free market mechanism. On the other hand. The UK has clearly experienced more erratic trade patterns and notably suffered a 33% decline in trade due to the global recession.
fall. Germany and Italy) more integrated than the rest”. and therefore real exchange rate with other countries) compromises price competitiveness of domestic goods and exports. such as Denmark. as universal monetary policy would be more appropriate with a smaller group. in reality the USA is a main trading partner of most European countries and has far more flexible labour QuickTimeª and a decompressor markets. so relatively there will be little change. They are likely to “face common shocks. As this is unlikely to cause the value of the Euro to rise due to its small relative size. However. meaning that exporting industries become more competitive and boost growth. He also argues that countries which trade a lot with each other and those with flexible labour markets who can easily accomplish changes in the real exchange rate at competitiveness by changes in the price level will benefit most from a common currency. the Euro has maintained stability in GDP in the EMU since its formation. shown below. Bayoumi’s and Eichengreen’s studies show that “Europe is quite. the more likely that greater export demand will cause the Euro to appreciate and these benefits not to be realised. but not very integrated and there is an inner-core of countries (France. This point depends on the flexibility of labour markets in trading partner countries – if they are also inflexible and wages do not adjust. Despite the previous argument. Mundell’s work on Optimal Currency Areas (OCA’s) advocates that countries with similar economic and industrial structures are likely to work better in a currency union. The significance of this depends on the nature of the shock. . argues Begg. This means that wages often take time to changes in market forces (ie fall in demand for labour not immediately causing a fall in the wage rate. making this argument are needed to see this picture. In light of this evidence. Concerning growth. if not faster growth rates. European labour markets are notoriously sluggish and inflexible due to hiring and firing regulations. as can be seen on the graph to the right. perhaps the Euro is used by too many countries for it to benefit enough. Also. there is little difference in the GDP growth rate of the EMU countries since 2001. which can be dealt with by a common monetary policy”. Furthermore. making exports more competitive. the larger and more widespread through other countries the shock is. rather compelling towards the Euro being doomed to fail. However. potentially undermining the effect of the Euro. inflation abroad may also remain high. non-EMU countries have benefitted from similar. the country benefits from low prices and a low exchange rate.
but even so it is evident that it has had little or no negative effect on GDP growth. Nevertheless. but not succeed by any extraordinary measure either. . Confidence in the EMU is on the rise and the rebound in trade will permit countries to benefit from increased market integration and reduced risk involved in internal trades. Again then. the Euro is unlikely to fail in the near future.QuickTimeª and a decompressor are needed to see this picture. it is hard to isolate the effect of the Euro. the currency union would be a greater success had it been confined to a more similar cluster of economies as this would minimise problems generated from a universal monetary policy. It has proved resilient to the global recession and debt problems in Greece. On balance.