The pros, the cons and a little background on the creation of
the euro MONETARY INTEGRATION
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Monetary Integration defined The adoption of a single currency
by a group of nations. The European Monetary Union (or Eurozone) is
the worlds largest monetary union. 23 countries currently use the
euro, which began circulating in January 2002.
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Joining the Euro-club Founding members were required to agree
to convergence requirements in order to join the European Monetary
Union. Heres what they had to do before becoming members: Limit
their inflation rate Limit their budget deficits to 3% of GDP Limit
their government debt to 60% of GDP Give up some of their economic
independence to the ECB, which conducts monetary policy for all
members Give up control of their money supply
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Fixed or floating? The euro floats against foreign currencies
like the US dollar and other foreign currencies. The euro may be
thought of as a system of fixed exchange rates among the
participating countries, but without the option of revaluation or
devaluation for any country. The role of the ECB cannot be
understated.
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Arguments for a single currency
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A single currency for a group of countries eliminates exchange
rate risk and uncertainty. Importers, exporters, and investors
benefit from the certainty of the currencys value, leading to a
more efficient allocation of resources
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Arguments for a single currency A single currency eliminates
the transaction costs that come from exchanging one currency for
another. No longer do Italian lira have to be exchanged for French
francs as both countries use the euro. This encourages trade and
investment and can lead to savings of as much as 1% of the combined
GDPs of countries in the union
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Arguments for a single currency A single currency encourages
price transparency. This allows consumers to compare prices among
countries within the union without making exchange rate
calculations. Competition and efficiency result from this
clarity.
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Arguments for a single currency With the European Central Bank
directing monetary policy for the entire union, its commitment to
keeping inflation rates low should lead to low interest rates,
higher levels of investment and output. Previously, high inflation
rates were common in some of the less stable economies of
Europe.
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Arguments for a single currency A single currency promotes a
higher level of inward investment. Countries who are not members of
the union will be attracted to the stability of the unions
currency, and therefore be willing to invest in the economies of
the union members, with economic growth resulting
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Arguments for a single currency A single currency (allegedly)
can promote fiscal discipline. The EU convergence requirements were
supposed to ensure fiscal responsibility among all union members,
but recent history seems to indicate that this did not actually
happen.
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Arguments for a single currency Theres strength in numbers!
Members of a currency union should have a greater influence on the
world stage than they would if they remained isolated with their
own currency.
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Arguments for a single currency A single currency may lead to a
single market which can lead to a coordinated fiscal policy. The
idea here is that a currency union is the first step towards even
greater economic cooperation among members, which could lead to
greater economic gains
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Arguments against a single currency
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A single currency involves loss of exchange rates as a
mechanism for adjustment. If countries have their own currencies
that float freely, trade imbalances can be corrected. In addition,
devaluation is a possibility for a country experiencing inflation
if it has its own currency. Members of a currency union lose these
opportunities
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Arguments against a single currency A single currency involves
loss of monetary policy as an instrument of economic policy.
Countries who are members of a monetary union lose the power to
direct their own monetary policy. If your country is experiencing a
unique economic problem, you cant assume the European Central Bank
will come to the rescue.
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Arguments against a single currency The convergence
requirements may restrict fiscal policy. As we mentioned, union
members must agree to certain fiscal constraints which are designed
to create economic stability. In case of emergency, extreme fiscal
measures may be appropriate, but unavailable to union members.
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Arguments against a single currency Currency Union members must
accept the monetary policy decision of the European Central bank
even if their economic situation is unique. So if your country is
suffering from high unemployment, but the other members are not,
your countrys monetary policy needs are unlikely to be met
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Arguments against a single currency The power that belongs to
the European Central Bank is enormous. The power of elected
officials and banks of member countries lose much of their ability
to shape economic policy to this single institution. This can lead
to disagreement among members and loss of sovereignty.
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Room for compromise? Regional problems may be addressed in a
monetary union nonetheless. The following allow some degree of
regional autonomy: Freedom to conduct some level of fiscal policy
Mobility of factors of production may correct imbalances among
union members If a particular region is lagging behind other
members, wealthier members may take steps to improve economic
conditions in the poorer region, which would benefit the currency
union as a whole.
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So do the advantages outweigh the disadvantages? The crisis in
Europe is still unfolding. It should be fascinating to see how it
plays out..