Essay
In economics, a monetary union is a situation where several countries have agreed to share a single currency among them. In the strictest sense of the term, monetary union means complete abandonment of separate national currencies and full centralization of monetary authority in a single joint institution. In political terms, monetary unions divide into two categories, depending on whether national monetary sovereignty is shared or surrendered. Unions based on a joint currency or an exchange-rate union in effect pool monetary authority to some degree. They are a form of partnership or alliance of nominal equals.
European Economic and Monetary Union is one of the well-known examples of this, in which 12 member states of the European Union have replaced their individual currencies with a common currency, the euro. The 12 members were Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Nethlerlands, Portugal, and Spain.
European Monetary System (EMS) was the arrangement established in 1979 where most nations of the European Economic Community (EEC) linked their currencies to prevent large fluctuations relative to one another. This originated in an attempt to stabilize inflation and stop large exchange-rate fluctuations between European countries. It is an agreement by participating European Union member countries that includes protocols for the pooling of currency reserves and the introduction of a common currency.
U.K. is not a member of European Monetary Union. Would it be better for UK to join the monetary union of the European countries or not?
Membership of EMU would mean that UK should adopt the euro as its currency and UK interest rates would be set by the European Central Bank on the basis of economic condition as a whole.
What are the advantages and disadvantages that should be considered by U.K. in joining the European Monetary Union?
The greatest advantage of a monetary union is that it reduces transactions costs as compared with a collection of separate national currencies. With a single money or equivalent, there is no need to incur the expense of currency conversion or hedging against exchange risk in transactions among the partners or to insure themselves against the threat of currency fluctuations. Businesses would no longer have to face the cost of accounting in different currencies. With single currency, there is no need for UK to change money into foreign currencies. This would save time and money. Tourists and businesses would be benefited. With this, volume of trade among participating countries would increase. Lower transaction cost would also induce in the increase of specialization. This would increase efficiency in production because of increased specialization and economies of scale. Small firms would stand the most to gain because currently the currency cost of exports is ten times higher for small companies than for multi-nationals.
Another advantage is that there would be cheaper mortgages and lower interest rates. A single currency should also result in lower interest rates as European Central Bank takes on the monetary credibility of Germany’s Bundesbank. This should lead to more investment, more jobs, lower interest rates and for home owners to lower mortgages.
Furthermore, tourism would be promoted because tourists will no longer be forced to change money and pay back the commission charges. Tourists would not have to change money when traveling within the euro zone and would encounter less red tape when transferring large sums of money across borders. For instance a customer would have wished to make a large purchase across European border such as buying a car or a house, a single currency would make the transaction easy.
Another advantage of a single currency is stability of currency of the participating countries because the euro would have the enhanced credibility of being used in large currency zone. It would be more stable against speculation than individual currencies right now. This would end internal currency instability and reduction of external instability would enable exporters to project future markets with greater certainty. This would unleash great potential growth.
Single currency also would reduce exchange rate uncertainty. International trade becomes easier because exchange rates can’t affect prices. More foreign businesses and more investment may choose to set up in UK and would reduce the cost of national debt service, ultimately increasing national income
It would also mean fiscal sustainability and more flexible labor markets. The single currency will be a catalyst for enormous structural change and should make a much more competitive trading area. It increases the transparency of market which makes it easier to benefit from economies of scale. In addition, it encourages competition in most product markets. The subsequent enhancement of competition will increase economic efficiency and should cause price convergence, thus ending any market discrimination. With market transparency, this would also mean price transparency in an integrated market and end of market segregation. It would be easier to compare prices in different countries because all figures are quoted in Euro’s.
Further advantages as regards to single currency is that free trade would emerge. Monetary union will give the UK increased bargaining power in such negotiations because a common position could be put forward. A single currency leads agents to modify their wage and price setting in a more disciplined way. This would increase business confidence, investment and the rate of economic growth in the community.
Monetary union also could provide stability for internal and international trade, it disallows predatory speculation on a national currency, and it disallows one nation from artificially manipulating its currency for unfair trade advantage. This would bring about price stability over a large area which will be an important condition for sustainable, real growth in income and employment.
But in contrast, there are also serious problems that would emerge with this single currency policy because to bind countries together with single monetary currency in a straight-jacket without political unity might lead to a situation where individual national leaders will blame their economic and financial problems on the monetary straight-jacket upon them. For instance, Spanish leaders will claim that unemployment is so high because European Central Bank’s monetary policy is too tight or Germany’s leaders will blame the central bank for too high inflation rate. This might lead to monetary, economic, and political chaos.
In addition, this monetary policy also might not be suited with the economy of all countries. Some European Union (EU) countries may find that they are unable to combat recession by loosening their fiscal stand. Members would be unable to devalue in order to boost exports, to borrow more to boost job creation or to cut taxes when they see fit because of the public deficit criterion.
Another disadvantage is the differing of economic cycles because all EU countries have different economic cycles or of different stages between boom and recession. Single currency may abolish the policy option to set interest rates separately at the level appropriate for each country.
Problems would also emerge when economies with different fundamental economic structures, levels of efficiency, productivity and inflation are integrated under a single currency.
Furthermore, language in Europe is a huge barrier to labor force mobility and monetary union is only possible if the whole area covered by the single currency has the same legal framework such as taxation, labor laws, etc.
Another disadvantage is that introducing single currency is costly because there are some changes which include educating customers, changing labels, training staff, changing computer software and adjusting tills which should be implemented.
Moreover, the most often mentioned disadvantage of monetary union is the loss of national sovereignty. The participating countries would no longer be able to pursue independent monetary and fiscal policies. Monetary policy will be under the control of European Central Bank and government would lose the option of devaluation. In the event of asymmetric shock that puts the economy in recession, the government would be very limited in its policy response options in EMU. It could not devalue to restore competitiveness or decrease interest rates, and fiscal policy is also likely to be severely restricted. Basically the government would only be left with microeconomic options to boost the economy which may help to increase employment and output in the long run but would do little in the short run during a recession. The transfer of money and fiscal competencies from national to community level would mean economically strong and stable countries would have to cooperate in the field of economic policy with other, weaker, countries, which are more tolerant to higher inflation. The introduction of a single currency could eventually lead to the end of nation state. Individual partners lose control of both the money supply and exchange rate as policy instruments to cope with domestic or external disturbances. Against a monetary union’s efficiency gains at the microeconomic level, governments must compare the cost of sacrificing autonomy of monetary policy at the macroeconomic level. Individual countries lose the capacity derived from an exclusive national currency to augment public spending at will via money creation. Technically defined as the excess of the nominal value of a currency over its cost of production or an alternative source of revenue for the state beyond what can be raised by taxes or by borrowing from financial markets.
But the seriousness of these disadvantages will depend on the type of monetary union adopted. In an alliance-type union, where authority is not surrendered but pooled, monetary control is delegated to the union’s joint institution, to be shared and in some manner collectively managed by all the countries involved. Hence each partner’s loss is simultaneously also each other’s gain. Although individual states may no longer have much latitude to act unilaterally and may lose control of the money supply and exchange rate, each government retains a voice in decision-making for the group as a whole.
Monetary Union has its advantages and disadvantages. So, should UK join the European Monetary Union or not?
As mentioned, monetary union reduces transaction cost because there is no need to money currencies in transactions made outside country, reduces exchange rate uncertainty, would result to stability of currency, fiscal sustainability and cheaper mortgages and lower interest rates.
But in contrast, there are also disadvantages because monetary union would only be successful if all participating countries are of the same political, monetary, and economic status. There would also a loss of sovereignty. It is also costly due to some changes which should be implemented and the language barrier among the participating countries.
For the UK to join the European Monetary Union, they should consider these advantages and disadvantages.
Credit:ivythesis.typepad.com
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