The EMU and the Euro Essay

This essay has a total of 3293 words and 14 pages.

The EMU and the Euro

The movement towards the European Monetary Union and the creation of the euro lasted many
years, complete with key personalities and major governmental treaties. When finally
organized and implemented, it lead to a historical event that will forever change
international economics. Of course with a change this tremendous comes the good and the
bad, but if the economic welfare of the people is improved, everything was worth all the
hassle.

HISTORY OF THE MOVEMENT
The beginnings of the movement for European monetary unification go back at least to the
founding of the Organization for European Economic Cooperation (which then became the
Organization for Economic Cooperation and Development, or OECD) in 1948. One of the OECC's
first accomplishments was the European Payments Union, established in 1950 and
accomplished by the end of 1958, where the nations of Western Europe put their
international reserves together and coordinated their policies with the intent of
reestablishing current account convertibility.

In 1962 the Commission of the European Communities produced its first plan for a monetary
union, which included a deadline for completion of nine years. Obviously, this deadline
was a little overambitious for a group of countries whose only collective achievements had
been the European Coal and Steel Community, an atomic energy community (Euratom), a
customs union (the European Economic Community), and the Common Agricultural Policy of
farm-product subsidization. The only accomplishment of the 1962 effort was a Committee of
Central Bank Governors which was set up in 1964 but did not actually operate until the
1970s.

At the Hague Summit in 1969, European governments delegated a committee headed by Pierre
Werner, then Prime Minister of Luxembourg, to devise a new plan. The Werner Report,
finished in 1970, called for monetary unification within ten years. The plan scheduled a
transition to happen in stages. In the first stage, exchange rate fluctuations would be
limited, and governments would start to integrate their monetary and fiscal policies. In
the second stage, exchange rate variability and price discrepancies would be further
reduced. In the third stage, exchange rates would be fixed permanently, capital controls
removed, and an European Community(EC) system of central banks (somewhat modeled on the
U.S. Federal Reserve System) would take control of the monetary policies of the member
nations. The size of the EC budget would be greatly increased and the EC would coordinate
national tax and spending programs. The makers of the Werner Report were not attached to a
single currency. Parts of the Werner Report were put into use in 1972 when EC countries
made an agreement dubbed "the Snake" limiting bilateral exchange rate movements to 2 ΒΌ
percent bands. Policy union and coordination was a bit slow. When the first OPEC oil shock
caused different levels of unemployment in different European countries, national
governments were under various levels of pressure to respond in ways that risked
inflation. Some of the nations' currencies were devalued and some revalued. The
arrangement proved to be incapable of accomplishing the exchange rate stability that the
makers originally hoped for.

This realization lead to another round of exchange rate stabilization negotiations at the
Bremen Summit of 1978, leading to the creation of the European Monetary System(EMS) in
1979. Its goal was to stabilize exchange rates without simultaneously requiring the
elimination of international policy divergences either through the use of fiscal and
monetary rules or by empowering the EC to coordinate national policies. Its central
element, the Exchange Rate Mechanism (ERM), was designed to accommodate the different
policies pursued in different countries.

The EMS had been functioning for seven years when the EC installed the Single European Act
in 1986. It basically laid out the basic provisions for what would be the European Union's
goals, organization, and some of its economic law. This committed the EC members to the
creation of an integrated market without obstacles to the movement of goods, capital, and
labor by the end of 1992. With the process of European economic integration gaining
momentum, in 1988 the European Council appointed Jacques Delors, President of the

European Commission, to study the feasibility of supplementing the single market with a monetary union.
There were significant differences between the Werner Report and the Delors Report. Where
the Werner Report recommended removing capital controls at the end of the process, Delors
endorsed the beginning. Also, Delors did not propose transferring control of national
budgetary policies to the European Community. Another difference is that the Delors Report
included a new entity, the European Central Bank (ECB), to make and execute the
Community's single monetary policy. National central banks were to become operations arms
of the ECB. The clearest image of the contrast is Delors' insistence on the early
introduction of a single currency to insure "the irreversibility of the move to monetary
union." The Delors Report provided the framework for intergovernmental talks in 1991, with
many of its conclusions finding their way into the Maastricht Treaty.

CREATION AND INTRODUCTION OF THE EURO
Speaking of the Maastricht Treaty (formally known as the Treaty on European Union), it was
this bravely launched 1992 agreement among European Community members that implemented the
Economic and Monetary Union (EMU) in Europe, called for fixed exchange rates, a move
toward political union and military cooperation, and spawned the creation of the euro. The
main objectives of the economy of the EU were to increase efficiency through competition
and deregulation, encourage employees to own shares in the firms where they work, spread
ownership in the general economy, reduce government expenditures to eliminate deficits,
create more foreign trade, and build up the capital market and the economy as a whole.

Robert Mundell, the Canadian economist, is sometimes called the "Father of the euro". He
laid many of the theoretical foundations for the European Monetary Union, and obviously,
was an ardent supporter of the euro. His theory of optimum currency areas (OCAs), noted in
the Nobel Committee's citation as one of his most important scientific contributions, has
served since the 1960s as an analytical framework for many debates on the validity of the
creation of a European currency. Beginning with Mundell in 1961, economists have long
agreed that there are four main criteria for a region to be an optimum currency area. The
first is that the countries should be exposed to parallel sources of shocks or
disturbances. The second is that the relative importance of these common shocks or
disturbances should be similar. The third is that the countries should have similar
responses to common shocks, called "symmetric" responses. The fourth criterion is that if
the countries are affected by country-specific sources of disturbance, they need to be
able to correct themselves quickly. The central idea is that countries satisfying these
criteria would have similar business cycles, so a common monetary policy reaction would be
optimal.

The creation of the euro was a monumental historic event because for the first time since
the Roman Empire, a good part of Europe was to use the same currency. The euro also has
the extraordinary quality of not being issued by a sovereign government. In order for a
country to use the euro as their currency, they had to meet stringent criteria like a
budget deficit of less than three percent of GDP, a debt ratio of less than 60 percent of
GDP, as well as low inflation and interest rates similar to the EU average. Denmark,
Sweden, and the United Kingdom opted out of becoming charter members. Many Europeans,
particularly the British, disagreed with the introduction of a single currency used by all
EU members, feeling that it would be a big step toward a complete disobedience of national
sovereignty to the bureaucracy of Brussels. Greece did not initially meet the economic
criteria although it did so later in 2001.

The euro currency was introduced in the forms of traveler's checks and electronic
transfers in 1999, when the national currencies of member nations ceased to exist
independently in that their exchange rates were fixed subdivisions of the euro. Therefore,
the euro became the successor to the European Currency Unit (ECU). The bills and coins
that were previously used for the old currencies continued to be accepted as legal tender
until new bills and coins were produced on January 1, 2002. The span of time when the euro
was not in tangible form was a time of skepticism, with critics saying the euro was doomed
to fail, but as soon as it was produced in "real" form, the confidence in the euro rose
dramatically. The changeover period where former currencies' notes and coins were
exchanged for those of the euro lasted about two months, until February 28, 2002.

WHY MONETARY UNION?
There are various benefits to a monetary union. Having only one currency is expected to
boost the interdependency of the EU members that have adopted the euro. This, if all
continues to go well, should be beneficial for citizens of the euro area because increases
in trade are historically one of the principal driving forces of economic growth.
According to the European Commission, the gains from conducting transactions in a single
currency could be as high as 0.5% of EU GDP every year. Additionally, this would fit with
the long-term goal of a unified market with the European Union.

Another benefit is the removal of the bank currency transaction charges that previously
were a large cost to businesses as well as individuals when exchanging currencies. On the
down side of this said benefit, banks will suffer a significant blow to profits with the
loss of this income.

Some economists have said that another advantage of implementing the euro is that it will
add great liquidity to the financial markets in Europe. Since governments can now borrow
money in euros instead of their own local currency, it allows access to many more sources
of money. Other scholars consider that the potential strength of the Eurozone (the area
encompassing all the countries officially using the euro) is in the coherent efforts of a
virtual greater super-economy, in which it is now possibly easier to generate stronger
financial associations, instead of in the mere sum of single liquidities.

Four major outcomes were expected after the implementation of the European Union. The
first being a significant reduction in costs because of improved utility by companies of
economies of scale in production and business organization. The second is an improved
efficiency within firms, widespread industrial reorganization, and a scenario where prices
decrease toward production costs under the pressure of more competitive markets. The third
outcome is new patterns of competition between entire industries and, like our old friend
Ricardo analyzed, a reallocation of resources as, in home conditions, real comparative
advantages determine the role in market success. The fourth effect is increased innovation
and new business methods and products generated by the dynamics of the internal market.
Although these effects can not occur at the same time, their overall impact is very
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