Pros and Cons for and against the Euro In the table below a number of arguments for and against a single European currency have been compiled. For the success or failure of the single European currency much depends on the size of the effects described below. Do the gains from reduced transaction costs, the disappearance of exchange rate instability, and greater price transparency outweight the losses from the cost of introducing the new currency and possible macroeconomic adjustment costs?Judge for yourself: Arguments for a single European currency| Arguments against a single European currency| Transaction CostsHaving to deal with only one currency will reduce the cost of converting one currency into another. This will benefit businesses as well as tourists. No Exchange Rate UncertaintyEliminating exchange rates between European countries eliminates the risks of unforeseen exchange rate revaluations or devaluations.Transparency & CompetitionThe direct comparability of prices and wages will increase competition across Europe, leading to lower prices for consumers and improved investment opportunities for businesses.
StrengthThe new Euro will be the among the strongest currencies in the world, along with the US Dollar and the Japanese Yen. It will soon become the 2nd-most important reserve currency after the US Dollar. Capital MarketThe large Euro zone will integrate the national financial markets, leading to higher efficiency in the allocation of capital in Europe.
No Competitive DevaluationsOne country can no longer devalue its currency against another member country in a bid to increase the competitiveness of its exporters. Fiscal DisciplineWith a single currency, other governments have an interest in bringing countries with a lack of fiscal discipline into line. European IdentityA European currency will strengthen European identity. | Cost of IntroductionConsumers and businesses will have to convert their bills and coins into new ones, and convert all prices and wages into the new currency.This will involve some costs as banks and businesses need to update computer software for accounting purposes, update price lists, and so on. Non-Synchronicity of Business CyclesEurope may not constitute an “optimum currency area” because the business cycles across the various countries do not move in synchronicity. Fiscal Policy SpilloversSince there will only be a Europe-wide interest rate, individual countries that increase their debt will raise interest rates in all other countries. EU countries may have to increase their intra-EU transfer payments to help regions in need.
No Competitive DevaluationsIn a recession, a country can no longer stimulate its economy by devaluing its currency and increasing exports. Central Bank IndependencePreviously, the anchor of the European Monetary System has been the independence of the German Bundesbank and its strong focus on price stability. Even though the new European Central Bank (ECB) will be nominally independent, it will have to prove its independence. This will at the very least incur temporary costs as it will have to be extra-tough on inflation.Excessive Fiscal DisciplineWhen other governments excert pressure on a government to reduce borrowing, or even pay fines if the budget deficit exceeds a reference value, this may have the perverse effect of increasing an existing economic imbalance or deepening a recession. | An important aspect in the debate about the pros and cons is what part of Europe would constitute an “optimum currency area” (OCA).
There are several criteria which determine this; the two most important are synchronicity of the business cycles and high bilateral trade intensities. The concept of OCAs was originally proposed by R. A.
Mundell in an 1961 paper in the American Economic Review. According to Mundell, an OCA is an economic unit composed of regions affected symmetrically by disturbances and between which labour and other factors of production flow freely. In an OCA, policymakers balance the savings in transaction costs from the creation of a single money against the consequences of diminished policy autonomy from the loss of the exchange rate and monetary policy as instruments of responding to economic shocks. That loss will be more costly when economic shocks are more region-specific (ie, more “asynchronous” or more “asymmetric”).Countries qualify for membership in an OCA if its benefits outweigh its costs. A very rough way to assess the synchronicity of the business cycle is to look at the correlation coefficients for the (seasonally-adjusted) quarterly changes in Gross Domestic Product (GDP) for pairs of countries. Using data from the IMF’s International Financial Statistics for the period 1980-I through 1996-IV for Austria, France, Germany, Great Britain, the Netherlands, Spain, and Sweden, I find that an optimal currency area would include France, Spain, Italy, and Germany with correlations ranging between 0.
59 (France/Spain) to 0. 31 (Germany/Spain).The Dutch business cycle is closest to Germany (0. 38) and France (0. 33), but more distant to Italy and Spain (both 0.
23). Great Britain is not far behind by being close to Spain (0. 40), France(0. 34), Italy (0. 29) and Germany (0. 16).
Both the Netherlands and Britain would be suitable extensions of the optimum currency area. In the case of Britain, this result somewhat contradicts the claim that Britain is not well integrated into the continental-European business cycle. In this sample, the countries which are indeed not well integrated into a common European business cycle are Sweden and Austria which became members of the E.U. only during the last round of expansion.
Incomplete data for Finland suggests that this country is very close to Sweden (0. 62) as well as Austria. Pros and cons The United Kingdom will not join the single European currency with the first wave of countries on 1 January 1999. The Chancellor of the Exchequer, Gordon Brown, said in October that, although the government supported the principle of the single currency, Britain would not be ready to join at least until the second wave of countries join in 2002. He added that the UK should, however, begin to prepare for monetary union.There are many possible advantages and disadvantages that the government had to consider: Advantages: 1.
A single currency should end currency instability in the participating countries (by irrevocably fixing exchange rates) and reduce it outside them. Because the Euro would have the enhanced credibility of being used in a large currency zone, it would be more stable against speculation than individual currencies are now. An end to internal currency instability and a reduction of external currency instability would enable exporters to project future markets with greater certainty.This will unleash a greater potential for growth. 2. Consumers would not have to change money when travelling and would encounter less red tape when transferring large sums of money across borders. It was estimated that a traveller visiting all twelve member states of the (then) EC would lose 40% of the value of his money in transaction charges alone. Once in a lifetime a family might make one large purchase or transaction across a European border such as buying a holiday home or a piece of furniture.
A single currency would help that transaction pass smoothly. . Likewise, businesses would no longer have to pay hedging costs which they do today in order to insure themselves against the threat of currency fluctuations.
Businesses, involved in commercial transactions in different member states, would no longer have to face administrative costs of accounting for the changes of currencies, plus the time involved. It is estimated that the currency cost of exports to small companies is 10 times the cost to the multi-nationals, who offset sales against purchases and can command the best rates. 4.A single currency should result in lower interest rates as all European countries would be locking into German monetary credibility. The stability pact (the main points of which were agreed at the Dublin summit of European heads of state or government in December 1996) will force EU countries into a system of fiscal responsibility which will enhance the Euro’s international credibility. This should lead to more investment, more jobs and lower mortgages.
Disadvantages: 1. Fifteen separate countries with widely differing economic performances and different languages have never before attempted to form a monetary union.It works in the United States because the labour market is mobile, helped by the common language and portability of pensions etc. across a large geographical area. Language in Europe is a huge barrier to labour force mobility. This may lead to pockets of deeply depressed areas in which people cannot find work and areas where the economy flourishes and wages increase. While the cohesion funds attempt to address this, there are still great differences across the EU in economic performance. 2.
If governments were obliged through a stability pact to keep to the Maastricht criteria for perpetuity, no matter what their individual economic circumstances dictate, some countries may find that they are unable to combat recession by loosening their fiscal stance. They would be unable to devalue to boost exports, to borrow more to boost job creation or cut taxes when they see fit because of the public deficit criterion. In the United States, Texas could not avoid a recession in the wake of the 1986 oil price fall, whereas demand for Sterling changed in the light of the new oil price, adjusting the exchange rate downwards. . All the EU countries have different cycles or are at different stages in their cycles. The UK is growing reasonably well, Germany is having problems. This is the reverse of the position in 1990.
Since the war the UK economy has tended to have an economic cycle closer to the US than the EU. It has changed because interest rates are set in each country at the appropriate level for it. One central bank cannot set inflation at the appropriate level for each member state. 4. Loss of national sovereignty is the most often mentioned disadvantage of monetary union.The transfer of money and fiscal competencies from national to community level, would mean economically strong and stable countries would have to co-operate in the field of economic policy with other, weaker, countries, which are more tolerant to higher inflation. 5.
The one off cost of introducing the single currency will be significant. The British Retailing Consortium estimates that British retailers will have to pay between ? 1. 7 billion and ? 3. 5 billion to make the changes necessary. Such changes include educating customers, changing labels, training staff, changing computer software and adjusting tills.