Unit 4: The Euro,Monetary Union and the Eurozone Crisis

In order to become an economic union the EU itself needed to create a common currency. Therefore there also had to be a monetary union which number of elements included:

  • A single currency used by all participants, the euro and operates in the FOREX market as a managed float.
  • An independent central bank which regulates the rate of interest and monetary policy
  • A stability and growth pact that limits the public sector borrowing of the participating countries to 3% if GDP so stop frustrating the monetary policy used by the ECB.

So what are the potential benefits of a single currency:

  • Reduced Transaction Costs- the cost of changing from one currency was gone meaning countries could potentially gain more GDP- it was said average 0.4% more
  • Reduced exchange rate uncertainty- this allows for businesses to trade more and also more investment within these countries.
  • Increase competition
  • Increased foreign direct investment
  • Lower interest rates

Potential Costs of a single currency 

  • LOSS OF AUTONOMY OF FINANCIAL SERVICES: Loss of an independent monetary policy– one size fits all policy as the interest rates would be the same for the whole eurozone area and it isn’t very suitable as not every country is at the same stages. Some may need lower interest rates to stimulate growth some may need higher to restrict growth.
  • Not Optimal Currency area whereas it is said people can move easily however there are barriers in terms of language unlike USA where someone from New York could move to New England
  • Limits Fiscal Policy– the growth and the stability pact had restricted countries spending otherwise they would be in debt.
  • Lack of Incentives– it was said that once a country was part of this single currency they would be protected from currency crisis however this was not the case- e.g. Greece.
  • Lack of devaluation to make goods more competitive

The Eurozone Crisis had started since 2008/2009 where there was a fatal flaw that was part of the eurozone. This had included that in order for a monetary policy and the single currency to work there had to be centralised political control and a fiscal policy are required. This is as a policy is needed in order for countries like Greece not to be spending too much running up huge budget deficits and borrowing far too much.

Additionally there had been said to be a division between countries of the Eurozone where not all the money had been distributed fairly and that is why a common fiscal policy is needed in order to redistribute some of the wealth of the richer members of the monetary union. However the Eurozone itself had not met any of these requirements leading to the breakdown of the eurozone.

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