Pros and Cons of the Euro

Topics: Monetary policy, Euro, Currency Pages: 5 (1729 words) Published: June 12, 2011
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,...
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