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European Monetary Union can be defined as the coming together of European member states into one organized economic system with the Euro as the national currency of these member states. This process occurred through a three phase process. The first phase included complete freedom for capital transactions, increased cooperation between central banks, free use of the European currency unit, and improvement of economic convergence. The second phase saw the establishment of the European monetary institute, ban on the granting of central bank credit, increased coordination of monetary policies and the strengthening of economic convergence. In addition, there was the process leading to the independence of the national central banks. The third phase included the adoption of the euro, conduct of single monetary policy by the European system of the central banks and the entry of the stability and growth pact (Union, 12).. The monetary union is largely driven by the expectations member states have towards the union. This includes the lower transaction costs, reduced exchange risk, high competition, the deepening of the financial markets and political integration. This paper will argue this in detail, purposing why a country would rather be a member of a monetary union and further providing counter arguments why it is not advisable to join a monetary union.
The Euro Crisis
The great Euro crisis began in the year 2007 barely five years after speculations by a bank in the US had caused international money markets to freeze. Three countries in the Euro zone at the time were in receipt of bailout programs and Greece was on the brink of exiting the monetary union. The mechanisms of the euro faced breaking pressure. The collapse of Lehman Brothers particularly, in the year 2008 led to a major financial crisis that ushered a global recession (Carolina, 17). This led to the rising of deficits for several leading economies of the world. The then deeply indebted countries of the euro zone, which accrued these great debts after years of weakening competitiveness led to restricted access to international bond markets. Several states were threatened with bankruptcy, thus putting a huge risk to the European banks the major lenders of the periphery. In order to rescue the banks, the euro zone had to bail out peripheral states. These bailouts were particularly accompanied by severity that induced deep recessions and rendered it hard to remain in the monetary union particularly for countries like Greece (Costas & Eustache, 56).
The banking crisis took hold of states. The crisis had transformed to sovereign debts. Strong economies like Germany proved resilient but weak ones like Greece were overpowered. Every meeting the International Monetary Fund held; the negotiation was between debtors and creditors and it ended in a long series of bailouts accompanied by endless austerity packages and shock therapies (Schadler, 33). There was blame especially to the south that was as a result of the polarized reality created by the European integration. The public sector particularly in Greece had been at the epicenter of the crisis. This is because of the weakness of the sector in the peripheral countries. The Euro needed stability in order to be able to compete with the dollar in the world markets. The crisis led to rising in public debts and deficits. Public finances are a reflection of the historical, social and institutional development of each country. The declining revenue and rising expenditure caused by the crisis led to the rapid increase in public deficits. This contributed to several peripheral states coming to seek financial aid in the monetary markets. The borrowing was particularly strong in Greece, Spain, Ireland and less in Portugal. Additionally, the national debt began to rise relative to the GDP. This was particularly so in Germany and Portugal. The finance sector was a great contributor to the crisis also
The banking sector in Euro zone constituted financial and productive capital. The European Central Bank and the national banks make up the European system of central banks (ESCB). The ESCB has price stability as its primary objective. The ECB has the sole power of decision-making on monetary and financial policy. The ECB also makes recommendations relating to supervision of credit institutions and stability of the financial system. It authorizes issuance of bank notes in the EU and holds and manages official foreign reserves for member states (Cooper & Tomic, 68). However, ECB is not allowed to purchase public debt instruments. The European central bank is an independent institution and does not require authorization. Concerning this, the Euro has been served by an appreciation bias that has served the interests of financial capital. It has induced global wealth holders to favor the Euro. Hence, the euro has provided liquidity supporting banking expansion across the world. However, after the outbreak of the crisis the lack of coordination between monetary and financial spheres was a weakness to the monetary union.
The crisis resulted in exposure of core banks. Many of these banks had overestimated their assets, hence had huge debts that had accumulated as a result of borrowing due to competition with United States banks. So the crisis resulted in financial pressure since many banks were struggling to find liquidity. The money markets too were affected by the crisis. There was the drastic widening of the LIBOR-OIS spreads resulting in a freeze in money market rates. The LIBOR is a rate of interest closely linked to the interbank money markets for maturity between one month and one year. The collapse of the Lebham brothers worsened the situation further (James, 25). To confront the situation, the ECB increased its long-term refinancing operations. This was supposed to reestablish confidence in money markets as well as induce free lending by the banks. The drop in output resulted in a reduction in revenue and expenditure rose greatly to rescue the financial system. It is on this basis that some critiques argue that the European monetary fund should be abolished. However, I tend to differ for the obvious reasons, the benefits of the monetary union to the member states (Jean, 96).
Major Advantages of European Union
First was the reduction in transaction costs. With the monetary union in place, the transaction costs reduced and were visible through savings (Roeselare, 17). Both household and company savings reduced as a result of the reduction of the transaction costs that were associated with the exchange of currency by firms dealing with imports and exports. Invisible savings too were obtained in the accountancy because of financial evaluation done in one currency. The elimination of exchange rates contributed to an objective and fair financial report. The elimination of transaction costs in the Euro zone sector allowed the citizens of different euro states the privileges of low costs of travel because there was no exchange of currency involved and no paying of currency rate. There was no need to exchange currency in order to buy and sell. This contributed greatly to the boom in the tourism sector. Companies across the euro zone enjoy the privilege of making financial deals without worrying about the value added tax on purchasing power. The single currency again ensures elimination of fluctuations experienced with currency exchange leaving the euro in competition with only the dollar, yen and any other currency outside the Euro members (Beetsma & Giuliodori, 48).
Secondly was the increase in price transparency. The monetary union introduced a great level of transparency in trade among the member states. The transparency in prices contributed to the harmonization of prices resulting in the overall reduction in price levels. This reduction stimulated trade among the member states integrating the commodities and services hence promoting economic efficiency. The price transparency led to intensive competition both among the European countries and globally. The single currency contributed to similar prices of commodities across the nations of the Euro zone. The price transparency enables members of the union compare prices of commodities hence can decide about the supply in regards to quality and price. The transparency also enables price harmonization and healthy competition leading to massive internal trade. Therefore, the Euro makes the market more efficient and increased competition. The companies benefit from the price transparency because of the economic boom associated with it and hence they create job opportunities (Economic, 26).
Additionally was the prevention of competitive devaluation and speculation. Competitive devaluation occurs when a country devalues its currency so as to export more commodities. Competitive devaluation results in inflation in terms of currency value. With the introduction of the single currency by the European market union, inflation rates were kept low since there was no speculation among member states. The single currency resulted in the development because there are no high commission rates that would occur as a result of speculation among countries. Credibility of the monetary policy was secured (Lama & Pau, 7).
The monetary fund ensured strengthening of Europe in the global economy. The stability of the national economy and companies was a remarkable achievement of the monetary fund. Today the euro is an international currency. The euro being the most used currency in the euro zone gradually replaces the dollar in international trade. The importance of the euro cannot be underestimated as portrayed in its role in international investment reserve and trading currency in countries which are not members of the Euro zone. The euro has great importance when it comes to integration. It accrues huge benefits from the flexibility associated with it in regard to the mobility of the members across different states in the euro zone. Additionally the euro is used as reserve currency in foreign countries. It also serves the purpose of a referential currency for approximately forty countries (Sadeh, 46).. This illustrates how the currency strengthens Europe’s position in the global economy. The strength of a country reflects its currency appreciation and the effect it has globally. A stable currency contributes greatly to stable commission rates and great investments. Additionally there are guaranteed prices during currency exchange that contributes to larger trade size. There is increased trading between members of the Euro zone and across the world (Cormick, 156).
The political aspect of the European Union was seen by many as the main force towards the formation of the European Union. The political aspect and the monetary aspect of the union are conjoined. The union shares important political decisions. The great political integration is a way of Europe establishing its political and cultural leadership in the world (Kose & Arricia, 28).
A critique would argue that joining the monetary union would result in the loss of a countries identity and culture; for example, the inability to put a picture of countries heroes on the currency. However, this is discredited by the fact that the benefits accrued from joining the union are way greater than such a disadvantage. The single currency gives country great abilities in terms of trade, such which a picture of a countries hero cannot give. The generalization of the country grants country greats ability to trade since the currency is not limited. Another argument raised is that a monetary policy is not suited to a country’s needs. With time, this argument is disregarded as a country adapts to the single currency in use. The benefits that result from the adaptation are huge compared to when a country is using their currency. First is easy movement as there is no currency exchange involved. The benefits accrued to trade are also huge. The prices are harmonized hence huge economic benefits. Monetary union also could result in economic fluctuations. This occurs mainly when there is an economic crisis, which results into deep recessions. However, a crisis is easily resolved with adaptation of simple policies such as reduction in borrowing from the banks.
In conclusion, the European monetary union is a perfect representation of European integration. The union has contributed greatly to the formation of a single and democratic Europe where differences are easily solved and within which there is free movement of people, commodities, and investments. As a member of the EU, one enjoys great and intense benefits. One can enjoy a reduction in the cost of a transaction, a reduction of exchange rate fluctuation, bigger price transparency, prevention of competitive devaluation and speculation and political integration. With such benefits, there is a profitable trade within the member states, integration of the markets, stimulation of trade among the countries of the Euro zone and the rest of the world. Additionally there is stimulation of international trade and investments. The common currency prevents further competitive devaluations and speculations. Therefore, as a member of the European Union one enjoys huge benefits and stands on a global competitive level.
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