Term Paper on "Cost and Benefit of a Single Currency"

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Single market - reaping the full benefits of the EU single market single currency is a natural complement to the European Union's single market, allowing it to function more efficiently and making it more conducive to growth, through:

Elimination of exchange rate fluctuations

This provides a more stable environment for trade within the euro area by reducing risks and uncertainties for both importers and exporters, who previously had to factor currency movements into their costs.

Businesses are better able to plan their investment decisions because of reduced uncertainties.

Elimination of the various transaction costs related to the exchange and/or the management of different currencies due to elimination of exchange rate fluctuations. For example, the costs resulting from: i) foreign exchange operations; ii) hedging operations intended to protect companies from adverse exchange rate movements; iii) cross-border payments in foreign currencies, which are typically more expensive and slower than domestic operations; iv) management of several currency accounts, which complicates currency management and internal accounting systems.

Price transparency

Consumers and businesses can compare prices of goods and services more easily when always expressed in the same currency.

Enhanced competition

Easier price comparisons foster competition and hence lead to lower prices in the short to medium run. Consumers, wholesalers and traders can buy from the cheapest source, thus putting pressure on companies trying to charge a higher price. Companies can no longer charge the highest price each national market will bear.

More opportunities for consumers

The single currency makes it simpler for consumers to travel and to buy goods and services abroad, particularly when coupled with the progress of e-commerce.

More attractive opportunities for foreign investors large single market with a single currency means investors can do business throughout the euro area with minimal disruption and can also take advantage of a more stable economic environment.

Single financial market - benefits for savers and borrowers single currency zone opens up huge opportunities for both capital suppliers (savers and investors), and capital users (private or corporate borrowers and issuers of equity capital). The euro helps provide a single market for financial operators. At the same time, small and fragmented national capital markets evolve into a larger, deeper and more liquid financial market. This is beneficial to both savers and borrowers: 1) Savers benefit from a wider and more diversified offer of investment and saving opportunities. Investors can spread their risks more easily, and have an appetite for riskier ventures; 2) Private and corporate borrowers as well as equity issuer's benefit from better funding opportunities because money is easier to rise on capital markets.

Macroeconomic framework - benefits of the single currency to the economy as a whole

Economic and Monetary Union (EMU) is based on the establishment of a sound and healthy macroeconomic framework (stable conditions for the economy as a whole), which is notably characterized by:

Price stability

This is the primary objective pursued by the European System of Central Banks (ESCB), which operates in full independence.

Sound public finances

The Treaty sets out a number of requirements in order to avoid that Member States run excessive levels of government deficits or excessive levels of government debt relative to GDP. The Stability and Growth Pact moreover prescribes that Member States should have budget balances close to balance or in surplus over the medium term.

Low interest rates

The level of interest rates benefits from low inflation expectations, improved control of government debt (which allows for improved borrowing possibilities for private companies) and the increased size of euro securities markets, which improves liquidity. In addition, the elimination of exchange rate fluctuations has a positive impact on intra-European trade and a further downward impact on the level of interest rates.

Incentives for growth, investment and employment

Price stability, sound public finances and low interest rates constitute ideal conditions to foster economic growth, investment and employment creation within the euro area.

Shelter from external shocks

Because of the important size of the euro area economy and the fact that the majority of its trade takes place inside this area (between 50 and 75% depending on the country concerned), the euro area is far better equipped than the previous national currencies to withstand external economic shocks or fluctuations in the external exchange rate vis-a-vis the U.S. dollar and other major currencies. The euro is also becoming a major transaction currency, enabling a significant proportion of European exports and imports to be invoiced in euros.

Europe's role in the world - advantages for Europe's international role

Having a single currency and an economic and monetary union strengthens Europe's role in international and organizations like the International Monetary Fund, World Bank, and Organization for Economic Cooperation and Development.

As a world currency, the euro is taking on an important role as an international investment and reserve currency. The euro has already become a major currency in which to borrow money, issues of international securities denominated in euro now rival dollar issues.

Use of the euro in international trade is also expanding, reflecting Europe's weight in the world economy. A single currency makes Europe a strong partner to trade with and facilitates access to a genuine single market for foreign companies, who will benefit from lower costs of doing business in Europe.

The option of pricing goods and commodities in euro (such as oil and metals for example) will become more attractive over time.

Political integration - benefits related to the wider process of integration

The euro is a symbol of common identity, shared values and the success of European integration in bringing the peoples and nations of Europe together.

It acts as a stimulus to further integration by showing that common action by Member States can bring widespread benefits to all those who take part.

Although there are many benefits from a single currency, there are also costs.

Lost of autonomous monetary policy

With the formation of Euro, the ECB and not national central banks that set the interest rate for the Euro area. ECB also controls the money supply within the Euro area. Thus, nation states within the Euro area loss the ability to employ monetary policy to fine-tune their respective national economies. The commitment to the stability pact of 1996 also put pressure on these nation states to pursue discretionary fiscal policy because budget deficit has to be kept within certain acceptable limit.

Risk of uneven development within the single currency area

Harmonization of national regulations and the introduction of a single currency like Euro in principle create a single market from the different national economies that join this currency union. In the word of ECB, the creations of Euro enhance the mobility of capital and financial services within the Euro area. Due to external economies of scales, businesses have the tendency to concentrate in certain areas. This means, some peripheral areas within the Euro area would lose out on employment and growth.

Higher unemployment rate and lack of growth increase deflationary costs in these peripheral areas. These areas may experience more social problems (e.g. crimes, suicide, broken homes, etc.), loss of skills and loss of irretrievable economic potential.

Although capital can move with ease within the Euro area, labor force does not enjoy the same mobility. There are still great cultural and language barriers to labor mobility within the Euro area.

Some economists argue that the Euro area is by no means a single economy. National economies maintain their distinct… READ MORE