Term Paper on "Forming an Economic Union"

Term Paper 11 pages (3452 words) Sources: 1+

[EXCERPT] . . . .

Forming an Economic Union

There have been conflicting beliefs concerning the requirement for an economic union at a regional level along with the competence and capability of the structure (both fiscal and monetary) that will be developed under an economic union. This paper discusses the advantages, and disadvantages, of forming an economic union, and possibly a monetary union to which members could, subject to conditions, apply to join. Factors such as, possible membership, timetable, trade and investment effects, convergence of economies, economic and social consequences and administrative structure have been covered briefly, yet concisely. The experiences of the European Union/Monetary Union has been be used as support for the arguments which have been presented in this paper.

Background of the study vital question for the triumph of an economic union is whether the economic union placed by an autonomous, supranational central bank in addition to fiscal (and other) procedures managed by a national government is helpful not only to price-steadiness but also towards economic development. This concern, amongst the scholars, of an economic union stems mainly from the commencement of the euro during 1999. Since the Euro inception, there has been a constant flow of disapproval concerning the EU'S system for economic union and harmonization. The Stability and Growth Pact (SGP) - perhaps, the most well-known aspects of union -- has been constantly criticized by economists as an unimagined, dull and eventually counter-productive procedure that encourages pro-cyclic fiscal procedures, slows down economic revival and harms the durable growth prospective of the EU financial system. In addition, accusation has also been cited, quite frequently, against the incapability of the policy structure to provide a logical policy blend, as well as, laments the deficient of suppleness in policy management (Fitoussi and Creel, 2002).

Therefore, it is important to note that macroeconomic policy and procedures in the context of Keynesian practice, as expressed by theorists such as James Meade along with Jan Tinbergen, imagined the policy blend as a way of transferring the accessible policy tools to a variety of macroeconomic variables, which had been aimed at. In the simplified-structure of concurrent equations utilized to replicate this blend, the figure of tools had to be as enormous as the aims. However, in an economic union (for instance, in the context of the European Union), the fiscal system is completely different and perhaps a lot more complicated. In an economic union a monetary policy has been given to a central bank, which has potent sovereignty, and is intended to center its attention mainly on the price steadiness all together. Fiscal procedures, by comparison, continue to be managed by the member countries and are intended to be the ways through which domestic economies regulate the demand-side of their financial systems to reproduce national deviations. The fundamental difficulty at the regional-level has been how to guarantee that there is compatibility amid the solo monetary procedure and the possibly different domestic fiscal procedures and policies (and, certainly, other aspects of an economic policy as well) (Buiter et al., 1993; Eichengreen and Wyplosz, 1998).

Economic Union can be classified in this background as supranational policies or standards, which have been decided by all member countries, and which leave prime tasks of the policy-making sphere with national establishment, however, set restrictions on their judgment. Action to implement the policy or, at least, to guarantee conventionality with the character of joint policy goals will be activated if there has been a failure to remain inside the limitations and restrictions stipulated by the legislation. For case in point, in the case of the European Union there has been Agreements-pledges to avert extreme shortfalls, which refer to all member countries (together with those countries, which are not the members of the euro), with restrictions and strong fiscal measures if they are unsuccessful in doing so: this can be characterized as 'hard law' economic union. A dissimilar method relies exclusively on soft law procedures (for example identifying and disgracing governments) devoid of the support of specific official rules.

There has been an extreme discussion in relation to whether wide-ranging economic and monetary unions are practical. Some leading figures and theorists have been unambiguous. For example, Alesina et al. (2001) and Issing (2002) have been inflexible that it is not at all essential, quarrelling that even though arguments can very nearly be made on hypothetical basis for an economic union, wherein fiscal, as well as, monetary policies have been placed in cooperation, any likely paybacks are heavily overshadowed by political economy contemplations. This argument reverberate the caution put forward by Rogoff (1985) that regional and/or global economic union will jeopardize the trustworthiness of monetary policy aimed towards domestic stability and steadiness. The spirit of Alesina et al. (2001) argument has been that if the national authorities maintain fiscal and monetary discipline, everything will end up well. In the context of who does what, it descends to the monetary policy (and therefore the central bank) to manage symmetric upsets or changes; at the same time as financial policy (domestic ministries) has the duty to manage asymmetric upsets (Buti and Giudice, 2002).

The aim of an economic union

It will be helpful to elucidate what the end goal of economic policy coordination (predominantly as projected and planned in the Euro region) is. In the context of political economy, it can be considered as a mode of resolving and reacting to two different but equally significant problems. The first problem can be explained as a dilemma of social expenditure and related to the problems of carrying out several financial procedures inside a sole monetary unification. The second problem is fundamentally a difficulty of joint action and relates to the 'stipulation' of central bank trustworthiness in a decentralized financial organization. Harmonization objectives to attain an agreeable macroeconomic-strategy-blend including financial and other plans that are both jointly congruent and compatible with the aims of the union's monetary policy. The value of the economic union's guidelines-design ought to, as a result, be measured on its aptitude to maintain both goals.

The disadvantages of an economic union

Economic union and the dilemma of social expenditure

In an economic union social expenditure might increase when associate countries take action in an inept style and generate domestic financial stances that are critically damaging to economic strength of other associate countries. If the economic union's financial strategies can be synchronized in order to manage the general apprehensions of all associated countries, the consequences of financial wastefulness will be re-internalized (Commission Working Group 4a on Governance, 2001). From a Mundell-Fleming open macro-economy point-of-view, if the exchange rates have been capable of floating without stinting, insufficient expenditure by a national government would have "packed out" exclusive financiers in the national economy due to a superior national interest rate. Collective demand would slow down still more by the rise of the national exchange rate notwithstanding monetary tapering. In the context of this state of affairs, a government has little enticement to follow a loose fiscal policy because this would source only tighter monetary circumstances and a damage of global competitiveness. Inside a supranational financial union, on the other hand, domestic exchange rates are permanent and there is a solo interest rate for all associates. An associate country enduring a shortfall will no longer confront a superior real exchange rate in relation to the remainder of the exchange zone, at the same time as the burden of "packing-out" will be moved onto the exchange zone all together in the manner of an elevated united interest rate. Therefore, associate countries can externalize the expenses of unnecessary shortfalls and the requirement to exercise financial restraint is, by connotation, reduced (Aizenman, 1994; Allsopp and Vines, 1996; Beetsma and Bovenberg, 1999). If all associate states have the liberty to take action on this spur -- and this is evidently the situation in a decentralized economic government -- then a corrective and dissonant blend of financial policies will initiate a decline in the collective financial position (Agell et al., 1996; Collignon, 2001). Presuming that the solo currency has a supple exchange rate in relation to the rest of the world, the outcome will be a superior interest rate, as well as, damage to global competitiveness. This consequence is suboptimal to the social system for the currency zone. One can pose a similar argument when referring to the policies of supply-side economics.

Economic Union and the dilemma of collective action

Freedom from unnecessary political pressure and apparent and explicit policy likings are the foundation of realistic and reliable monetary policy (Cukierman, 1992). Still, with such procedures in position, on the other hand, financial policy - as Sargent and Wallace (1981) notably observed -- has got to be in harmony with the aims of monetary policy if integrity of the central-bank is to be sustained. On the other hand, regardless of how traditional or sovereign the central bank might be a fiscal influence that produces undue budget shortfalls over a protracted era will position the bank under increasing demands to monetize the public… READ MORE

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