Benefits of a Monetary Union in the European Union
1. Discuss the main benefits one might expect to accrue from monetary union in Europe.
Monetary union commenced in 1999 with the circulation of the euro as the common currency of eleven of the fifteen European Union states with the other states joining the monetary union in the succeeding years. The basis of the monetary union is the Maastricht Treaty in 1993 that created the European Union and paved the way for the development of the euro. The monetary union means the use of a single currency by the 300 million citizens of the participating economies. (Salvatore 2002a; Leblond 2004) This constitutes a radical change in economic and political infrastructures within the participating economies. The radical change required as well as the long-term onset of results mean the emergence of risks and apprehensions over potential outcomes. However, the decision to engage in the monetary union by eleven countries also forming the European Union means that the expected benefits outweigh the drawbacks. Various adjustments are required of the participating economies including the transfer of a certain degree of sovereignty and change in economic and political infrastructures. The introduction of the monetary union in Europe should give rise to a number of main benefits characterized into economic and political benefits.
The economic benefits revolve around market integration, foreign exchange stability, and trade competitiveness.
First benefit is the creation of a single market that pools the economic strengths of the different economies into a single large market relative to other markets. This means the necessary pooling and even sharing of resources and infrastructures to integrate these in forming a single market for the member countries. This involves mutual benefit for the member countries not only for the weaker and poorer economies but also for the stronger and richer economies. The weaker economies benefit from infrastructure and resource support from the richer countries. (Eudey 1998; Leblond 2004; Vujic 2004) An example is the strengthening of the banking system under the regulation of the European Central Bank. This means that the banking system in the different economies have to conform to a single standard that not only facilitates inter-linkages but also efficiency in operations. This leads to the strengthening of the overall banking system within the European Union to make the banking and finance industry more competitive against the banking systems in East Asia and North America. (Salvatore 2002b) Another example is the pooling of the labor market across the different European Union economies that ushers the redistribution of the labor force from one economy to another as needed.
Second benefit is the sharing and minimization of economic risks. With a single currency, the different member countries do not have to contend with the economic risks arising from foreign exchange or money market and trade relations involving different competing currencies. A single currency removes foreign exchange competition that results to some currencies at a loss and other currencies at the top. By implementing a monetary union through the euro, the only concern of the economies is the performance of the euro relative to other currencies such as the US dollar. Exchange rate volatility is addressed. As such, instead of each economy addressing foreign exchange volatility, the entire monetary union having euro as the single currency only have to deal with other strong performing currencies such as the US dollar and Yen. In effect, volatility in exchange rate is minimized. The effect on the different economies becomes uniform because of the common effect of the performance of the euro to these economies. (Eudey 1998)
As such, the monetary union shares or spreads risk among the different European Union countries instead of just segregating the stronger economies from the weaker economies. The effect on businesses engaging in trade is also positive since minimal risks supports greater engagement in import and exports across the economies participating in the European Union. The only risk concern of importers and exporters in European countries participating in the monetary union is the volatility of the euro relative to other strong currencies. Although the economies have to contend with international business risk, the minimal risk involved in trading within the monetary union benefits the EU economies.
Third benefit relates to the benefit for minimized currency risk is the minimization of speculation and competitive devaluation. Speculation is a common occurrence in Europe prior to monetary union. Speculation involves the vigilance of the different economies in monitoring changes in the value of various currencies in the region as a signal in making decisions in the money market. When the value of a currency is expected to drop because of factors such as political unrest or economic problems, the other economic would sell that currency to prevent incurring losses. This act creates a wave effect by constituting a signal for other countries resulting to the widespread selling of the foreign currency that further affects the value of that currency. The response to speculation is the raising of interest rates to prevent the massive selling of currency based on the signals and movements of other economies. However, interest rates constitute a hindrance to economic growth in Europe because of its restrictive effect on the financing of business or industry expansion. In eliminating speculation, growth is easier to achieve in economies participating in the monetary union. With the introduction of a single currency, speculation across the different economies is no longer needed resulting to an environment more conducive for economic trade because of the minimal risks as well as informed business operations since it is easier to read market trends across the European Union with the operation of a single currency. (Eudey 1998; Vujic 2004)
Competitive devaluation pertains to the control of the value of its currency by economies to support trade goals. Some economies deliberately and artificially lower the value of their currencies to boost imports. The response could be the decrease in the value of other currencies. When this happens, a barrage of currency devaluation occurs and inflation happens. By introducing a single currency, inflation rates are kept at low levels resulting to the lack of need to devalue the currency. Moreover, the single currency means there will be no different currencies to devalue. In case of the need to devalue the euro, this would be relative to other currencies in compliance with the monetary policy of the country. (Eudey 1998; Vujic 2004)
Fourth benefit is ensuring price stability across the country members of the European Union. Price stability means the implementation of a uniform inflation rate less than two percent for the entire European Union area. To have a uniform annual inflation rate, the euro as the single currency for the member countries of the European Union emerged. (Eudey 1998) Price stability develops since the European Union economies use the same currency and price adjustments depend on changes in supply and demand functions across the entire European Union instead of considering signals from the relative supply and demand of each European country. When price adjusts to changes in a large single market, the effects of the movements in the supply and demand function is less when absorbed by the wide economic security net across the European Union economies.
Fifth benefit is the cost savings from the elimination of the need for switching currencies with other European countries. Prior to the monetary union, each European country needs to deal with foreign exchange reserves and implement monetary policy based on the relative performance of its currency. The rule of foreign exchange provides the need to exchange currencies needed in stabilizing the value of one currency over another and in trading. Savings from eliminating the need to exchange currencies adds up to thirty billion dollars every year on the part of business firms engaging in exports and imports with other European Union and non-European Union countries. The savings is due to the lesser transaction costs needed in implementing a single currency for the different European economies. With a decline in transaction costs resulting to savings, the economies participating in the monetary union have resources for allocation to the expansion of business activities. (Salvatore 2002a)
Sixth benefit is greater bargaining power of the monetary union in international trade and relations. Economies engage in free trade agreements with other economies to facilitate efficient trade relations. The success of finalizing a trade agreement that is beneficial to the participating countries in the monetary union depends on their bargaining power, which is turn based on their traded commodities and monetary strength. With a monetary union that operates through the euro by all the member countries, the supranational body governing the monetary union has greater bargaining power to engage in beneficial free trade agreements with economies in the different regions. As an example, the monetary union established free trade agreements with four countries in Latin America to support closer trade relations. The monetary union achieved greater bargaining power because of its positively performing and stable currency that means lesser risk for its trading partners because of the lower volatility level of the euro. Concurrently, the monetary union also offers larger capital investments through the aggregate trading capabilities of the participating countries. In addition, the monetary union also achieves better terms in the free trade agreement by being able to engage in different agreements with key countries that represent a potential market as well as source of raw materials and resources. Beneficial trade agreements spur further growth in the participating economies by providing opportunities for investment and market expansion. (Eudey 1998)
Political benefits revolve around improvements in political infrastructure that support economic growth. The overall benefit is political stability across the different countries participating in the monetary union. The implementation of a monetary union means the necessity of relinquishing a certain degree of sovereignty by the participating countries and transferring these to the supranational institution. By transferring a certain level of sovereignty to a governing institution covering the member countries, this represents the integration of political aspirations as well as the demonstration of harmony in terms of policies and preferences. The monetary union contributes to political stability by providing a common policy framework for all the participating countries representing their common aspirations and goals. (Eudey 1998)
Political stability in turn benefits the participating countries in terms of effective political institutions supporting business expansion and economic growth. The monetary union implies the development of fiscal and monetary policies that reflect the common aspirations of the participating countries of enhancing the competitiveness of industries to compete internationally.
The benefits from the establishment of the monetary union have economic and political dimensions. Political benefits revolve around political stability and enhancement of political infrastructures across the participating countries reflecting the common aspiration of these countries. Uniformity based on standards set by the monetary union means improvement in the political infrastructures of the weaker economies to spur collective political development. Economic benefits revolve around the minimization of risks and uncertainty in foreign exchange and trade and fostering of economic growth.
References
Eudey, G., 1998. Why is Europe forming a monetary union. Federal Reserve
Bank of Philadelphia Business Review, 1998, pp. 13-21.
Leblond, P., 2004. Completing the Maastricht contract: Institutional handicraft and the transition to European Monetary Union. Journal of Common Market Studies, 42(3), pp. 553-572.
Salvatore, D., 2002a. The Euro: Expectations and performance. Eastern
Economic Journal, 28(1), pp. 121-136.
Salvatore, D., 2002b. The Euro, the European Central Bank, and the
International Monetary System. Annals of the American Academy of Political and Social Science, 579(1), pp. 153-167.
Vujic, B., 2004. Euro adoption: Views from the third row. Comparative Economic Studies, 46(1), pp. 159-176.
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