The Euro Term Paper

This essay has a total of 1931 words and 13 pages.

The Euro

The Euro is the single currency of the European Union. It was first introduced in cashless
form on Jauary 1st1999, following years of negotiation and preparation. Euro notes and
coins will officially come into circulation on 1st January 2002 in the twelve
participating countries.

These countries are Germany, Belgium, the Netherlands, Luxembourg, Italy, France, Ireland,
Spain, Portugal, Austria and Finland; Greece became the twelfth member when it joined the
Euro on January 1st 2001.

Any country that is a member of the European Union can join the Euro providing that they
are able to pass economic tests set out by the Maastricht treaty. The treaty requires
economies to have achieved certain levels of performance on areas such as inflation,
public deficits and debts, exchange rates and interest rates. These targets ensure not
only stable economic conditions but also a degree of convergence between the participating
member states which allows the European monetary Union to function smoothly.

The convergence criteria set out in the terms of the Treaty are that:

• Annual government deficit must not exceed 3 per cent of the GDP (Gross domestic product)
• Total outstanding government debt must not exceed 60 per cent of the GDP
• The rate of inflation should be within 1.5 percentage points of the three best performing EU countries
• The average long term interest rate must be within 2 percentage points of the
average rate of the three countries with the lowest inflation rates

• Exchange rate stability, which means that for at least two years the currency has
kept within the normal fluctuation margins of European Exchange Rate (ERM)

The final decision on whether a member state fulfils the requirements to enable adoption
of the Euro rests ultimately with the European council.

There is at this time no provision for a country that has joined the Euro to withdraw.

The Economic and Monetary Union is the single currency area within the European Union
single market where ideally people, goods, services and capital will be able to move
freely between countries with minimal restrictions. The intention is that the European
Monetary Union will create a framework for economic growth and stability.

Economic and monetary union is based on two concepts; theses are the co-ordination of all
economic policies along with an independent monetary institution in the form of the ECB,
European Central Bank.

The ECB is independent of all political and private institutions of the European Union and
member states and has its own budget, independent of that of the European community.

The main objective of the ECB is to maintain price stability, it sets a medium term target
inflation rate at between 0 and 2 per cent, and this has already been criticised for being
too strict.

Gordon Brown the UK Chancellor has indicated that he prefers our own British system under
which the UK government asks the bank of England to meet an inflation target of 2.5 per
cent, with a leeway of 1 percentage point on either side.

Many companies currently operating within the eurozone have already experienced a
reduction in many of their costs, particularly those in treasury management and foreign
exchange transactions, as there has now been an elimination of foreign exchange risk.

With the conversion of the Euro currency increased price transparency should now prompt
strong competition within many business sectors.

The general expectation is that consumers will now be able to shop around for bargains, as
it becomes increasingly easier to seek out price comparisons between countries, as all
goods will be valued in Euro.

This should result in a reduction of some costs within those markets that will inevitably
be passed on and so benefit the consumer.

Smaller companies may have in the past experienced anxieties about the complexities of
pricing calculations, foreign exchange risk and cross border transactions. The
introduction of the Euro will lead to the elimination of these barriers and should
increase the potential supplier base.

There are some fears that amid the confusion of the conversion of currencies to the new
Euro some businesses might seize the opportunity to raise prices but this should only be
able to occur on a short-term basis as the conversion period settles.

Tony Blair’s labour government has declared that there are no political barriers of
entry that should prevent Britain from adopting the Euro and the only tests to be applied
are those of economic advantage.

Gordon Brown, Chancellor of the Exchequer stated (financial Times Oct 2001), “The
government is pro-Euro because we believe that in principle membership of the Euro can
bring benefits to Britain.”

In October1997 the chancellor laid out a set of five tests to apply, which will assist in
the process of deciding whether or not Britain will benefit, these conditions will be
assessed in June 2003.

If the government decides that the conditions have been met it has promised that it will
put British entry to a referendum soon afterwards.

The five tests that will be applied are:

• Is there suitable convergence between the UK and the eurozone economies?
• Is there sufficient flexibility to cope with economic change?
• Will it encourage or discourage companies from investing in the UK?
• What will the impact be on the financial services industry?
• Will it be good for employment?

The test of convergence suitability is to determine whether Britain in similar enough to
the rest of Europe to be able to live with the same interest rate. To judge this test the
government will compare inflation rates, the speed at which economies have been growing
and whether Britain responds in the same way to unexpected economic shocks such as sudden
rises in oil prices.

The second test is related to the first because if the ECB sets the interest rates either
too low or too high for the UK economy Britain would have to adapt to survive. Rates that
were set too high could endanger growth, UK workers might have to accepts a cut in wages
as we could no longer rely on a falling currency making UK exports cheaper.

The third test is to determine whether joining the EMU would create better conditions for
outside firms making the decision on whether or not to invest in Britain.

Britain already has an excellent position as a choice destination for foreign firms
investing in Europe and also wants to encourage domestic firms to invest. Fixing the rate
to the rest of the eurozone may help and indeed several car- makers have warned that
sterling current high rate is proving difficult for them.

The impact on the financial services industry is the fourth test, the government must
consider that the city is a major employer and wealth generator yet may stand to lose some
of its most lucrative deals if it remains permanently outside the eurozone.
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