Euro

The Euro and its Impact on its Participants

Marvin Powell
Bradley University
ude.yeldarb|llewopm#ude.yeldarb|llewopm

Scott Sowers
Bradley University
ude.yeldarb|srewoss#ude.yeldarb|srewoss

Abstract


The euro was introduced electronically almost a decade ago, and has been in circulation for over six years; what impact has the euro had on its participants and the European Union (EU)? Overall, the euro has helped its participants and the EU as a whole. Within the EU, the euro has created increased price stability, helped mature financial markets, and eliminate exchange rate risks in the eurozone. With the elimination of exchange rate risk, the borders of EU countries no longer pose major trade issue, allowing trade to more freely occur within the eurozone. Monetary policy is stable and consistent in the zone, and GDP growth seems stable and relatively consistent among participants. The future of the euro also appears strong as several countries hope to implement the euro in the near future. With the growing eurozone and the amount of transactions taking place in euros, the euro is becominging an increasingly important unit when it comes to trade in the EU and for multinational corporations around the world.

History of the Euro

graph.gif

As shown above, it’s apparent that the Euro has a much storied history. “The euro was launched on January 1, 1999 as an electronic currency and became legal tender on January 1 2002, but attempts to create a single currency go back 20 years. This chart shows the value of the euro (before 1999 as a basket of the 11 legacy currencies) against the US dollar [1].”

The start of monetary integration in Europe started in 1962 with the Marjolin Memorandum, which discussed monetary cooperation among the European Economic Community (EEC) Member States. The end result was to be irrevocably fixed exchange rates between Member States’ currencies by the end of the 1960’s. However, the Bretton Woods system was currently in place and providing widespread stability and the Member States decided that there was no further need to stabilize between the EEC states. By the end of the 1960’s, the Bretton Woods system was becoming strained; and the European Commission submitted the Barre Plan to develop a monetary identity within the EEC. Under this plan, the Heads of State or Government had meetings to discuss economic and monetary union. The Werner Report came out of these meetings in 1970 and called for the economic and monetary union to be staged in by 1980. In April of 1972 a “snake” system was put into place to narrow the margins of fluctuation of between Member State currencies. The European Monetary Cooperation Fund (EMCF) was created in 1973 to be a central point of the organization of central banks. By the late 1970’s, however, the monetary unity process lost steam and only a few countries were only using the “snake” system [2].

In March of 1979 the European Monetary System (EMS) was launched to restart the monetary union process. The EMS introduced the European Currency Unit (ECU), which was a basket of Member State currencies. The ECU was supposed to be focus of the EMS, but only played a minor role in the system. The ECU did gain some momentum in the financial markets as a means of portfolio diversification. This caused an increase in ECU-denominated debt by some parts of member states, but without a solid unit behind the ECU, it remained limited in its ability to function as a single currency [2].

As shown, in 1986 The Single European Act is signed, containing the basic provisions for what would be the European Union's objectives, organization, and some of its economic law. In January 1999, the exchange rates of the participating currencies are irrevocably set. All of the ECB transactions with commercial banks and foreign exchange activities begin to be in euros. In January of 2002, the euro banknotes and coins are introduced in twelve member states of the European Union. Finally, in March of 2002 the euro becomes the sole legal tender in the euro zone [3]. The euro is managed by the European Central Bank, which has the sole authority to set monetary policy, and the Eurosystem based in Frankfurt.

Today, the euro is the sole currency in Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia and Spain. These 15 countries are collectively known as the Eurozone. There are three countries in the European Union that do not currently participate, which include: Denmark, Sweden, and the United Kingdom. Several former colonies of European Union states have currencies pegged to the euro. These are French Polynesia, New Caledonia, Wallis and Futuna (the Cape Verde; the Comoros; and fourteen nations of Central and West Africa (the CFA franc) [4]. There are five countries with a formal agreement to use the euro, including: Mayotte, Monaco, Saint Pierre and Miquelon, San Marino, and Vatican City. Furthermore, there are four countries using the euro without a formal agreement, including: Akrotiri and Dhekelia, Andorra, Kosovo, and Montenegro.

Performance and Results

61908994lz8.jpg

Shown above is the performance of the Euro relative to the U.S. Dollar, Japanese Yen, and British Pound. As depicted, it’s apparent that the euro suffered significantly during its inception. But, however, after its first couple years the euro began to rebound and gain significant value, especially against the U.S. Dollar and the British Pound.

Clearly the Euro has benefited the European Union as a whole, but has each individual country benefited equally as well? As a whole, every country has experienced increased price stability as well as more mature financial markets. “Since the introduction of the euro, there have been a lot of changes in the financial markets in Europe. The elimination of exchange rate risk has increased the depth and breadth of financial markets and boosted financial innovation. Government bond yields in the euro area have become nearly perfectly correlated. There is also evidence of close integration of stock markets. The euro had a particularly significant impact on the European market for corporate bonds, with a considerable increase in the number of medium-sized firms placing issues outside their home country [5].” These financial markets will continue to become more efficient as well as more liquid. This further integration is an enormous benefit of the adoption of the euro. Also, trade amongst European Union participants have surged since the inception of the euro. Moreover, countries that are expected to adopt the euro in the future have benefited from this increase in trade.

76853034ie3.jpg

The chart above “shows the real GDP, in terms of cumulative deviations from zero, of Hungary, Poland, and the Czech Republic, which joined the European Union in 2004. Although they had been outperforming EU economic growth before accession, after accession their performance reached much higher levels [6].” However, increased trade also means that countries are more exposed to increased levels of competition. “Italy, for example, has suffered greatly from losses of market shares in the intra-euro area market. This poor performance may be related to increased competition from low production-cost countries that have a pattern of specialization similar to Italy [5].” Individual governments of participating countries have benefited immensely as well. “Government debt markets, because of their size, safety, and benchmark status, are central to a vibrant fixed-income market, and they have been particularly strengthened by the adoption of the euro. Notably, since the run-up to monetary union began, sovereign debt yields have converged to a remarkable extent. For example, between 1990 and 1996, spreads on Italian and Spanish government bonds, relative to German bonds of comparable maturity, averaged about 430 and 350 basis points, respectively. Today the spreads paid by these governments are quite small, in the vicinity of 15 basis points over the German equivalent for Italy and essentially zero for Spain [7].” This government stability should continue to be passed on to its respective residents through lowered inflation risk, lowered exchange rate risk, and increased economic stability.

Thus, although every individual participant has benefited by varying degrees, each participant has also had to make sacrifices as well. Because there is a common interest rate, this may hinder countries that are growing faster or slower than the Eurozone average. Furthermore, because of language barriers, labor is not nearly as mobile as in other parts of the world, such as the U.S. The adoption of the euro also “limits fiscal policy. With a common monetary policy it is important to have similar levels of national debt, otherwise countries may struggle to attract enough buyers of national debt. This is a growing problem for many Mediterranean countries like Italy, Greece and Spain who have large national debts. For example Italy's national debt is over 100% of GDP [8].” Before the inception of the euro, devaluation would have been a feasible option; an option that is no longer viable with the euro. “Without the option of devaluation to restore their competitiveness, Italy, Portugal and Spain are losing out to Germany, where companies have used the threat of whisking production off to Poland to impose wage cuts in real terms and win market share from their European rivals [9].

56421357hd8.jpg

Now having the same currency, the Eurozone countries tend to have similar rates of GDP growth. However, some countries are growing at a bit slower rate due to differences in fiscal policies; a good example is the previously mentioned national debt level of Italy causing it to have a slightly lower growth rate than their other Eurozone counterparts. The GDP growth rates and debt level of the Eurozone countries are shown in the chart above [10]. As you can see above, there seems to be a bit of a correlation between the amount of debt, and the GDP growth. For example Italy exhibits a debt level of 104% of GDP and they have a relatively low growth rate, whereas Luxembourg has only a 6.8% level of debt to GDP and exhibits a relatively larger GDP growth rate [10].

It is important to note that although participating countries have in fact benefited from the adoption of the euro, there have been sacrifices as well as increased competition in various forms that countries must adequately manage. As long as the benefits continue to far outweigh the sacrifices, the inception of the euro should prove to continue to reap benefits.

81390781et9.jpg

It’s also worth mentioning the affects that not adopting the euro have had on the United Kingdom, Sweden, and Denmark. By looking at the same factors as above, GDP Growth and debt level, it appears that the three countries have not been negatively affected as shown in the chart above [10]. In 2005 and 2006 the UK was right on track with the European Union in terms of GDP growth, and out-paced the EU by 0.7% in 2007. Part of this upside could be due do the fact that they carry a lower percent of debt to GDP. Sweden has consistently outpaced the European Union in GDP growth over the past three years and also exhibits a lower debt to GDP ratio than the EU as a whole. Denmark showed similar successes of using their own currencies in 2005 & 2006, but had a downturn in 2007 [10].

Future Outlook

65805090hg5.jpg

As shown above, ten currencies are expected to convert to the euro in the foreseeable future. The entry of Lithuania and Estonia was planned for January 2007 but was postponed due to unacceptably high inflation rates in those countries. The Czech Republic had originally aimed for entry into the European Exchange Rate Mechanism II in either 2008 or 2009, but the current government has officially dropped the 2010 target date, saying it will clearly not be able to meet the economic criteria. The new stated goal is 2012. Latvia had aimed to join the euro in 2008 but inflation rates of over 11% have resulted in a delay as the country does not meet the current criteria under council rules. The government's official target is now January 2012 although the head of the Bank of Latvia has suggested that 2013 may be a more realistic date [4][11].
43731723ty8.jpg

The GDP growth rates of the future euro adopters can be seen in the chart above [10]. The future adoption of the euro by these aforementioned states appears to be helping their economies in terms of GDP. The future adoption of the euro by these countries has helped stabilize monetary policy in these countries. These Eastern European nations’ GDP is out-pacing their Western European counterparts that use the euro partially due to the recent stabilization of their monetary policy [10]. Over time, we would expect these countries’ GDP to grow at a slower rate, similar to rates of the current euro users.

The UK could play a large part in the advancement of the euro. On June 9, 2003 it was announced by UK Chancellor Gordon Brown that the UK had not met four of five tests it has for the adoption of the euro. The UK met the test for impact on financial services, but failed to meet convergence with the eurozone, enough flexibility to adapt, impact on jobs, and impact on foreign investment. He mentioned progress was being made on the convergence and flexibility tests and that those would lead to meeting the other two tests as well. Brown pointed our several potential benefits to the UK joining the euro: UK trade within eurozone could increase by 50% in 30 years, lower interest rates, less exchange rate volatility, and thus lower overall transaction costs [12]. With the UK being a large world player in the economic and financial sectors, and London being one of the financial capitals of world, the adoption of the euro in the UK could have great impacts everywhere. UK adoption could further talks to expand the eurozone even further, and possibly lead to discussion about a world currency unit, or at least more stability among all major world currencies.

Bibliography
2. Scheller, Hanspeter K. The European Central Bank History - Role and Functions. Frankfurt, Germany: European Central Bank, 2004. http://www.ecb.int/pub/pdf/other/ecbhistoryrolefunctions2004en.pdf. 20 Apr. 2008.
3. Barber, Lionel, and Sarah Naimark. "The Birth of the Euro." (2002). Business Source Elite. 6 Apr. 2008.
4. "Euro." Wikipedia. 4 Apr. 2008 <http://en.wikipedia.org/wiki/Euro>.
5. "ECB: the European Central Bank." 31 Mar. 2006. European Central Bank. 6 Apr. 2008 <http://64.233.167.104/search?q=cache:C02sW2ZB7U4J:www.ecb.eu/press/key/date/2006/html/sp060331_1.en.html>.
6. Cohen, Ariel. "Ukraine's Economic Benefits." 7 June 2007. 7 Apr. 2008 <http://64.233.167.104/search?q=cache:RYg6tDop2qcJ:www.heritage.org/research/europe/hl1045.cfm>.
7. Bernanke, Ben. "What Have We Learned From the Euro At Five." 26 Feb. 2004. 6 Apr. 2008 <http://www.iie.com/publications/papers/paper.cfm?ResearchID=507>.
8. Pettinger, T. "Problems with the Euro." Economic Essays. 24 Apr. 2008. 25 Apr. 2008 <http://64.233.167.104/search?q=cache:DZXOwOajJTYJ:www.economicshelp.org/econ.html>.
9. Stewart, Heather. "Euro Still Shining in the East." Guardian. 17 Dec. 2006. 2 Apr. 2008 <http://64.233.167.104/search?q=cache:zxKf6BAXgvoJ:www.guardian.co.uk/business/2006/dec/17/theeuro.europeanunion>.
10. "Economy of the European Union." Wikipedia. 18 Apr. 2008 <http://en.wikipedia.org/wiki/Economy_of_the_European_Union>.
11. "Enlargement of the Eurozone." Wikipedia. 16 Apr. 2008 <http://en.wikipedia.org/wiki/Enlargement_of_the_eurozone>.
12. "BBC News Politics UK 'Not Yet Ready for the Euro'" BBC News. 9 June 2003. 9 May 2008 <http://news.bbc.co.uk/1/hi/uk_politics/2975560.stm>.
Unless otherwise stated, the content of this page is licensed under Creative Commons Attribution-ShareAlike 3.0 License