Policy Debate: Will the European Monetary Union succeed?

The introduction of the euro... has clear economic advantages. It removes the uncertainty over exchange rates from a large part of Europe.... It increases the transparency of the European market, which makes it easier to benefit from economies of scale, but - or rather, in addition - it encourages competition. The European System of Central Banks will also try to bring about price stability over a large area which, if successful, will be an important condition for a sustainable, real (i.e., actual) growth in income and employment. The economic advantages of EMU [European Monetary Union] increase in proportion to the size and stability of the euro region.
~ Willem F. Duisenberg

The ultimate irony, of course, is that the attempt to bind the European countries together in an artificial currency straight-jacket without political unity and common political will is bound to result in the exact opposite of what its founders intended: It will lead to a situation where individual national leaders will blame their economic and financial problems on the monetary straight-jacket forced upon them. One can well envision a situation in which Spanish leaders will claim that unemployment is so high because the European Central Bank's monetary policy is too tight, while at the same time Germany's leaders will blame the central bank for too high an inflation rate. This is not a recipe for monetary, economic and political harmony.
~ Robert Heller, "World View: Europe to Go?"

Most of the countries in Europe are participating in a bold economic experiment in which national currencies were replaced by a common currency (called the Euro) by 2002. In May 1998, decisions were made on which countries were eligible for participation in the European Monetary Union. A European Central Bank was created in 1998 that is charged with coordinating monetary policy for the EU. Since January 1, 1999, the Euro has been used for all foreign exchange operations in the participating countries. Euro banknotes and coins began to circulate on January 1, 2002 and completely replaced national currencies by July 1, 2002 (existing national currencies ceased to be legal tender in the participating countries on or before this date).

Supporters of the European Monetary Union argue that the introduction of a common currency will reduce transaction costs and increase the volume of trade among the participating countries. This results in larger gains from trade and increases the extent of competition in most product markets. Tourists will also benefit from the lower transaction costs associated with a single currency.

The introduction of a single European currency, however, also means that the participation countries will no longer be able to pursue independent monetary and fiscal policies. Monetary policy for the EU will be under the control of the European Central Bank. One of the major concerns about the success of the monetary union is whether this central bank will be able to maintain an independent policy of maintaining a low inflation target. While each country has some control over its own fiscal policy, the ability to engage in deficit spending is limited since the monetary union shares a common interest rate. Higher levels of government borrowing in one country raise interest rates in all participating countries. Countries that maintain deficits that exceed a specified value will be subject to sanctions. This may require countries to engage in procyclical fiscal policies during a recession (i.e., increasing taxes and/or reducing government spending or transfer payments to reduce a deficit).

One of the shortcomings of the European Monetary Union is that three members of the European Union (Britain, Denmark, and Sweden) have chosen to not participate in the European Monetary Union.

One of the major issues facing the European Union is the process of "Enlargement." As of 11/28/06, 25 countries are members in the EU. Ten of these (Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia) were added on May 1, 2004 (in time for the 2004 elections for the European Parliament). Two additional members (Bulgaria and Romania) are scheduled to join on January 1, 2007. The area and population covered by the euro have expanded rather substantially in the last few years.

• European Union
  http://europa.eu/index_en.htm
  The home page of the European Union (EU) contains press releases, links to institutions and agencies of the EU, and information about current and future activities of the EU.

• European Union, "Enlargement"
  http://ec.europa.eu/enlargement/index_en.htm
  The Enlargement website provided by the EU provides detailed information of the Enlargement process. This site provides information on the status of negotiations with each candidate country on each of the requirements that must be satisfied for EU membership.

• Euro Archive
  http://europa.eu.int/euro/home5.jsp?lang=5
  The European Union's Euro Archive page contains detailed information about the process of introducing a common currency. This site contains a calendar listing critical dates in the process, a description of the currency, press releases, speeches, and other information that described the conversion process.

• The Euro: Our Currency
  http://ec.europa.eu/economy_finance/euro/our_currency_en.htm
  The European Union's Euro page contains a description of the currency, information on currency conversion, and a list of participating member states.

• European Central Bank
  http://www.ecb.int/home/html/index.en.html
  The European Central Bank's web site contains working papers, statistics, press releases, speeches, and other information dealing with the operation of the European Monetary Union.

• The Euro: Europe's New Currency
  http://pacific.commerce.ubc.ca/xr/euro/euro.html
  This page, provided by the Pacific Exchange Rate Service and maintained by Werner Antweiler, contains a large amount of information on the process of converting to a single European currency. An extensive list of links to relevant resources is also provided on this page.

• Thomas Smailus, "The EURO"
  http://www.smailus.com/thomas/euro/
  This page, provided by Thomas Smailus, contains information on the specific coins and paper currency that will be used in the EMU. He also provides summary information on the state of the participating economies at the time at which they were considered for participation.

• Nouriel Roubini, "Homepage on European Monetary Union and the Euro"
  http://www.stern.nyu.edu/~nroubini/Emu/Emu.htm
  This web site, created and maintained by Nouriel Roubini, contains an extensive collection of links to online articles and other resources dealing with the European Monetary Union and the Euro.

• Euro Conversion FAQ
  http://www.sysmod.com/eurofaq.htm
  This Euro Conversion FAQ (frequently asked questions), provided by Patrick O'Beirne, contains substantial information on the European Monetary Union. An extensive collection of links to relevant web sites is also provided at this site.

• BBC News, "Get to Know the Euro"
  http://news.bbc.co.uk/1/hi/events/the_launch_of_emu/euro_facts/224562.stm
  This site, provided by the BBC, contains links to articles and information concerning the introduction of the Euro. Of particular interest is the material on the UK and the EMU.

• Julian D. A. Wiseman, "The end of EMU: legal ramifications"
  http://www.jdawiseman.com/papers/finmkts/emu-breakup.html
  This online article by Julian D.A. Wiseman discusses the possible legal and financial ramifications of the termination of the European Monetary Union. As part of this discussion, he summarizes international law dealing with changes in national currency.

• Treaty on European Union
  http://europa.eu.int/en/record/mt/top.html
  This site contains the full text of the Maastricht Treaty forming the European Union.

• Deutsche Bank Research, "EU Monitor"
  https://www.dbresearch.com
  Deutsche Bank, Germany's central bank, provides this page containing links to numerous studies concerning the process of formation of the European Monetary Union. (The Adobe Acrobat viewer plugin is required to view these studies. You may download this viewer by clicking here.)

• Europe 2020
  http://www.europe2020.org/en/home.htm
  Europe 2020 is a think-tank devoted to a discussion of the possibilities for the European Union. This site contains articles and information on issues currently facing the EU.

• Willem F. Duisenberg, Transcript of January 7, 1999 Press Conference
  http://www.ecb.int/press/pressconf/1999/html/is990107.en.html
  Willem F. Duisenberg, the first President of the European Central Bank, discusses the introduction of the euro in this January 7, 1999 press conference. In his discussion, Duisenberg also discusses the policy plans of the European Central Bank. A question and answer session follows his presentation.

• Captain Euro
  http://www.captaineuro.com/
  Captain Euro is a comic book character created to help provide information about the euro. This site contains multimedia comic strip episodes, links to sources of information about the Euro, and an online currency convertor. To use all of the features of this site, you must have the free Shockwave plugin installed in your browser.

• Willem F. Duisenberg, "The Euro and the Process of European Integration"
  http://www.ecb.int/press/key/date/1998/html/sp980305.en.html
  Willem F. Duisenberg was the President of the European Monetary Institute and is now serving as the first President of the European Central Bank. In this March 5, 1998 speech, he discusses the monetary union's role in the process of European economic integration. Duisenberg argues that there are significant political and economic advantages resulting from this process. He also discusses the role that must be played by the European Central Bank in maintaining a low and stable inflation rate.

• Willem F. Duisenberg, "The future of banking supervision and the integration of financial markets"
  http://www.ecb.int/press/key/date/2000/html/sp000522.en.html
  In this May 22, 2000 speech, Willem F. Duisenberg addresses the problems associated with banking supervision in a situation in which this role is undertaken by banking authorities in each of the 11 countries that participate in the European Monetary Union. He suggests that there is a need for greater coordination in bank supervision policies and practices.

• Robert Solomon, "International Effects of the Euro"
  http://www.mac.doc.gov/euro/press7.htm
  In this January 1999 Brookings Institution Policy Brief, Robert Solomon discusses the likely effects of the introduction of the euro on international trade. He argues that the volume of trade among the participating countries is likely to increase with the introduction of a common currency. Solomon believes that the Euro will become an international reserve currency only gradually.

• Peter Micklem, "Economic theory behind European Monetary Union"
  http://homepage.ntlworld.com/peter.micklem/euro/euroindex.htm
  This website, designed by Peter Micklem, discusses economic arguments in support of the adoption of the euro. It contains a good discussion of the relevant economic theory and provides links to excerpts from classic articles on optimum currency areas.

• Elena Flores, Gabriele Giudice, and Alessandro Turrini, "The Framework for Fiscal Policy in EMU: What Future after Five Years of Experience?"
  http://ec.europa.eu/economy_finance/publications/economic_papers/2005/ecp223en.pdf
  In this March 2005 study, Elena Flores, Gabriele Giudice, and Alessandro Turrini examine the effectiveness of the EMU framework in maintaining fiscal policy objectives for the member states. They note that the Maastricht Treaty and Stability and Growth Pact requirements for fiscal policy coordination have often resulted in contention among the member states. It is found that during the first five years of operation, this framework has been partly effective in keeping deficits low, but member states did not use the period of high growth in 1999-200 to reduce their budget deficits. As a result, deficits exceeded the limits during the period of slow growth beginning in 2001. Changes are suggested to help encourage higher levels of fiscal discipline in the future. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.)

• Hermann Remsperger, "Has European Monetary Union Lived Up to Expectations?"
  http://www.bundesbank.de/download/presse/reden/2005/20050908_remsperger.en.php
  Hermann Remsperger argues, in this September 8, 2005 speech, that the European Monetary Union has been reasonably successful in maintaining price stability. He observes that there has been substantial variation in inflation rates by country, but note that the U.S. experiences similar regional variations across states. Remsperger notes that the role of the euro in international financial markets has been steadily expanding. He raises concerns over the extent of fiscal policy coordination and argues that several countries have been running excessive deficits. Remsperger suggests that structural changes in these economies are needed to avoid future problems of price instability.