Free Economics Essays - “What are the arguments, for and against, a country’s adopting the euro in preference to its existing currency?
Given that, over the next ten years, all the accession states will adopt the euro, how in your view, will this affect those members states who have, to date, opted out?”
Introduction
In May 2004, ten European countries (Poland, Czech Republic, Slovenia, Hungary, Slovak Republic, Lithuania, Estonia, Latvia, Malta and Cyprus) joined the European Union (EU). These new EU member countries enlarged the EU family towards the less developed Central and Eastern Europe, making the union the world’s biggest unified market (constituted of 25 states) and the third bigger in population after China and India. The governments of the accession countries have gratefully anticipated this participation in the common market due to the wide spread belief that joining the EU would stimulate regional trade and economic growth, especially under the prospect of joining the single currency area (the euro zone). However, there are still some EU member states (Sweden, UK, Denmark and Finland) that object to redeem their independent monetary policy instruments and currencies, as their governments believe that the local economies are yet unprepared, or it is not in their best interest, to join the European Monetary Union (EMU). This diversification of opinions within the EU family creates issues on expansion policies that greatly concern both the developed and the less developed member states.
European economic integration was based theoretically on the work of a number of 1960s economists that started developing optimum single currency zone theories and open economy macroeconomics. This theoretical advance inspired partially the vision for the creation of the European Commission in 1967 (with 6 member states) and the Maastricht Treaty for an integrated union in 1993 (with 12 member states) until the recent 2002 introduction of common euro banknotes and coins. Obviously, the integration and expansion of the economic (and not only) union is backed by a number of strong arguments and beliefs that convince the governments of member and candidate states to pursue integration policies and treaties.
Arguments for adopting the euro
The most popular argument among the followers of economic union is the facilitation of intra-market trade. Evidently, tariff-free transactions between member states decrease the costs of international trade, especially without regional barriers. In a single currency area, the parity of money as a necessary median for trade extends to the whole area. Thus, prices can be directly and easily compared, a fact that almost eliminates money information and transaction costs. As an immediate consequence, all investments can be allocated to each region more efficiently, reducing investors’ risks, which lay on uncertainty for the economic situation in the host country. A monetary union reduces this uncertainty, since interest rates are common and inflation is held low throughout the broad market.
Another significant argument that relates directly to the previous one is the single monetary policy of the monetary union. That means that the whole union adopts monetary reforms as a single capital market (although for some this might be a major drawback). Single monetary policy presumes rigidness of the exchange rates of the different currencies enabling the monetary system to be unified under a single currency, at least theoretically. As a consequence, member states do not have to face exchange rate crises in an intra-union level.
The lack of exchange rate volatility in a union rectifies the individual regions against potential exchange rate crises in between them. This is obvious today for all small countries in EMU (e.g. Belgium, Ireland, Greece, Portugal), the small economies of which would be more prone to macroeconomic fluctuations outside the union. Concurrently, the whole union becomes more powerful against financial fluctuations and shocks, establishing the economic significance of the currency in all capital markets. Within EMU, all member states relish a world wide accepted currency, which comes second in importance only to the US dollar.
All the above benefits from EMU, of course, end up to each citizen of the member states. In EU, like all other big economies, there are more or less developed regions. This fact, although it might affect the buying parity of the currency, yet it does not affect the significance of the currency. Anyhow, all the accession countries will have to comply with the Maastricht criteria, in order to join EMU. This pursuit for “nominal convergence” sets prerequisites for the development of basic economic fundamentals that induce growth (like low inflation, small current account deficits, low interest rates), even in the poorest states.
Arguments against the adoption of the euro
On the other hand, the currency substitution procedure proves to be a very costly decision. The gradual change of state currency to common currency imposes a one-off important cost, as banknotes, coins, cash-related machines will have to change in any country that joins EMU. This cost, according to EMU advocates, can be offset by saving from lower transactions costs, although it is not easy to estimate approximate values for this offset in each of the non-EMU member states.
Additionally, monetary union implies relinquishment of independent state monetary policy, against monetary authority from the European Central Bank (ECB). This fact has been put forward as a positive argument for accession countries. However, for developed EU countries with robust economies, like UK or Sweden, redemption of independent monetary policy can be put forward as a negative argument. These countries make substantial use of interest rates as an instrument of controlling demand and supply for money, thus EMU would take away this advantage.
Moreover, the UK economy as compared to the Polish economy for example, has a different potential in absorbing financial shocks and excessive exchange rate volatility. It follows that fixed exchange rates do not have the same implications to all EU members that have not yet joined EMU. Critics of the single market claim that fixing the Swedish corona to the euro might avert fluctuation shocks coming from the euro zone but does not help the corona much against US dollar shocks, especially since a big part of Swedish foreign trade is done in dollars. This example shows the difference in effect that fixed exchanges rates might bear when applied in a country with significant international trade, and integrated financial systems that have been designed to absorb smoothly exchange rate shocks.
A final argument that has been put forward against a single currency is the political and nationalistic issue that stems from an integrated single market. Monetary union is a milestone towards a more politically unified Europe. With the European constitution almost completed, and the Euro Army under planning, a vague threat of national identity is floating among euro zone opponents. If Europe is politically integrating, this might impose a challenge to the national sovereignty of the member states. However, this is not an issue for some member states: Greece, for example, has dropped the most ancient currency, the drachma, in favour of the euro.
The influence of the euro adoption by the accession countries to the countries that have opted out of the euro zone
The governments of the new members of the EU face the next challenge of meeting the monetary union nominal criteria, as set with the Maastricht treaty. In other words, they try to satisfy certain economic conditions that will allow them to join the single currency market. In this case, EMU will grow even bigger, with the euro being used from almost half a billion people. This perspective is expected to increase even more the euro’s strength and importance in the global financial markets. Most likely, the expansion of the single market is going to affect the common market members that have opted out from the euro zone. The first immediate effect is that the intra-union trade of countries like Sweden, Denmark or UK, will increase in euro units, making these countries even more sensitive to euro fluctuations than they already are. Consequently enlargement of the euro zone might impose adverse effects on the foreign trade of the euro opposing countries. Also the issue of monetary union might extend to political issues, as the EU is integrated to more than an economic union. The main argument of governments in UK, Sweden and Denmark is that if true convergence is not feasible, it is not worth it to join EMU, while ECB officials claim that true convergence might not ever appear; once nominal convergence is established, the state will start behaving economically like a region in a big economy and so be able to convert its currency.
Conclusion
In conclusion, although several accession countries have recently joined EU, with the prospect of adopting the euro when they accomplish nominal convergence, the debate regarding the benefits of the EMU still divides governments and scientists. The euro advocates insist on the facilitation of trade and financial markets, as combined with a single monetary policy, an argument that has been largely experienced since euro was firstly launched 4 years ago. They also argue that an intra-union fixed exchange rate regime strengthens the individual states’ ability to face and overcome external financial shocks. However, euro opponents dispute that redeeming independent monetary policy in the name of more trade can diminish local governments’ economic initiative, especially if the specific countries are financially integrated and in a position to smoothly absorb exchange rate shocks. Nonetheless, EMU has proved up to date that a single market can attribute fair effects to the member states, although anticipations of ECB regarding economic growth were not entirely fulfilled. The viability and continuous enlargement of the euro zone will definitely influence the governments of the countries that still choose, for their reasons, to stay out of it. For economic and political reasons, the issue for a complete integration of the EU will soon come to surface.
(Word Count: 1544)
References
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