On March 10, EU and US pressed to drop dispute-settlement rule from trade deal. After reading the news, I did a research on European Monetary Unification(EMU) and the euro to better understand it.
1. What is EU and EMU?
EMU is the move to a common currency for a group of countries of Europe, originally with 12 countries and now increased to 18. The purpose is to further the economic integration of Europe that began with the European Economic Community and is today called the European Union (EU). The currency is shared by all 18 countries and is not controlled by any one of them – it is controlled by the European Central Bank (ECB), based in Frankfurt, Germany. This group of countries is called the Economic and Monetary Union (EMU), or informally, the Eurozone.
2. Difficulties of Adopting Common Currency
There was need for convergence but there were also difficulties of adopting common currency. First of all, if countries have different rates of inflation, the high-inflation countries will lose markets to low-inflation countries so that the exchange rates won’t adjust to correct for differences. Secondly, if countries have different interest rates, capital will flow to high-interest rate countries seeking higher return. In addition, the uncertainty about exchange rate will not offset this. Thirdly, the unification of currency brings the temptation to run budget deficits when one country is able to borrow from other countries.
From the above three aspect, we can conclude that the success with a common currency requires countries to have similar inflation rates, interest rates, budget deficits, and government debts – achieving these is “convergence”.
3. Pros and Cons of Unification
The proponents believe that the unification will hep complete the internal market and improve competition efficiency. Countries will face a very open market that there are various players from different countries. Also, there would be arbitrage across national borders. The survival of the fittest keeps the market moving forward. The market efficiency could also bring the stability of prices of goods that would benefit the consumers across countries. Considered from the financial market, the unification will lower the interest rate and therefore bring higher investments which will ultimately lead to a stronger growth.
The opponents have negative voices that the unification will lead to the loss of sovereignty. This is controversial because some people worry that the countries may not be able to make their own decisions independently. Secondly, there are difficulties of adjustment to asymmetric shocks. As had happened before, German unification and discovery of North Sea Oil are the sources.