‘A single currency for Europe is a good thing and the sooner the UK joins the Euro, the better.’ Do you agree?

Document Summary

1. Introduction

2. Advantages of the EMU

2.1. Advantages of fixed exchange rates

2.2. Additional advantages of a single currency

3. Disadvantages of the EMU

4. Conclusion: Should Britain join the Euro?

5. Referencing List

6. Bibliography

1. Introduction

On 1.January 1999 the European single currency, the Euro, was officially introduced. At that point eleven member states wanted to be a part of this significant leap and fulfilled the necessary criteria determined by the Growth & Stability-Pact (GSP) in 1997. Greece as the twelfth member joined in 2001.

On 1.January 2002 the Euro was distributed and became the single currency for the partaking countries.

This date marked only the final step in a long history of desire for a fixed exchange rate system and a monetary union within Europe – with a single currency as the summit of this ambition.

In this essay I want to analyse if a single currency is a good thing for the EU and what the drawbacks are respectively.

Later I will deal with the question if the UK should join the Euro soon – if at all.

2. Advantages of the European Monetary Union

To give a survey of the numerous advantages of the Euro, first I want to show the general benefits of a fixed exchange rate system, as it existed till 1972 in the ‘Bretton Woods System’ or from 1979 on in the ‘Exchange Rate Mechanism’ in Europe. Thereafter some further advantages are pointed out which are specific for a single currency as the “ultimate fixed exchange rate” system. (Sanders 2005)

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2.1. Advantages of fixed exchange rates

Fixed exchange rates rely on institutional interference (Cook&Piggott 1993) to assure that they are constantly tied to another currency, to gold or to a basket of currencies. (Tayeb 2000). Without such a system it has always been a problem for firms to deal with the risk of loosing money due to unfavourably changing exchange rates. However, with fixed exchange rates there is no need for hedging this risk expensively. (Dearden 1997; Artis&Nixon 2001) This reduction of transaction costs (TAC) and the resulting gain of certainty can induce economic growth, encourage trade between the member states and provide assurance to location decisions. Without exchange rate uncertainty investments are placed with regard to efficiency and economies of scale within Europe and long-term planning is made easier. Deleting the risk of floating exchange rates leads to a lower risk premium in interest rates. This tends to result in an increase of investments because of lower financing costs. (Artis&Lee 1997) Furthermore, the member countries benefit of low interest- and inflation rates caused by Germany’s low-inflation-policy in the last decades. (Cook&Piggott 1993)

2.2. Additional advantages of a single currency

Introducing a common currency means introducing a perfect fixed exchange rate without any fluctuation or devaluation (as it happened for example in the ERM crisis 1992 to British sterling).

The most obvious benefit is that no longer TAC arise for tourists and firms by changing one currency into another. (Dearden 1997; Artis&Lee 1997; El-Kahal 1994). Examples for these costs include bank commissions and the costs of exchange rate uncertainty for firms. Besides, a unified currency entails perfect price transparency and comparability for all member states, which strongly enhances intra-EU competition and an efficient distribution of investments.

One of the most important advantages in comparison to a fixed exchange rate system is that it’s not threatened by speculative attacks (as the ERM 1992).

Private funds, George Soros’ Quantum fund first to be mentioned, were able to force a currency into devaluation by selling it until the national bank has no reserves left to defend the fixed rate. With this “one-way-bet” speculators were able to make enormous profits. (Artis&Lee 1997)

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In a common currency there is no possibility to devalue within the system and thus no point of attack for speculators.

For this reason there is no need for individual countries in such a system to hold large reserves of foreign exchange and to manage their exchange rates. As Sanders (2005) said “without a war there’s no need for the weapons”.

Another major point is that the Euro as a primarily political project encourages political unity and cooperation within Europe. A strong Euro is able to compete with the dollar as a world currency and Europe gains political as well as economic influence. (El-Agraa 1994)

In the end, the mentioned advantages are supposed to lead to more stability and certainty within Europe and it seems probable, that economy and trade benefit from proceeding integration and a single currency.

However, we have to take a look at the drawbacks before we can make a final conclusion.

3. Disadvantages of the European Monetary Union

Artis&Lewis (1991) as well as Cook&Piggot (1993) point out that one serious disadvantage of joining a monetary union is the loss of national sovereignty. On the one hand this means a decrease of political power being “one voice in the crowd”. On the other hand, by centralising the monetary policy in the ECB and by loosing the exchange rate policy, the chance of boosting the economy gets lost: Interest rates are set by the ECB and there’s no national currency anymore that can be devalued to attract investments and to create a competitive advantage for the national economy.

Furthermore, without exchange rates it is hard to counter asymmetric shocks but for that we have to take a closer look at the ‘Optimal Currency Area’-theory (OCA).

In an OCA there’s no loss of welfare by a common currency and economic imbalances will be removed by the free play of market forces without the need for exchange rates. (Cook&Piggott 1993) Examples of working OCAs include Canada and the USA. In presence of asymmetric shocks some countries suffer while others suffer less or even profit. Policy like adjusting the interest rate will help some countries and hurt another.

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