Benefits And Costs Of Using Common Currency In Greece, Germany And Eurozone - Research Paper Example

? Benefits and costs of using Common Currency in Greece, Germany and Eurozone The mutual acceptance of Euro as a common currency between the Eurozone nations does away with exchange of currencies between the Eurozone nations. This resulted in savings due to reduced transaction cost because of the import and export between the many Eurozone nations which required exchanging currencies (Eudey, pp. 14). As a result of reduced transaction costs, Eurozone nations expected a thirty billion dollar annual savings (The Euro, the European Central Bank, p. 154). Directly as result of eliminating exchange of currencies, the exchange rate volatility was also removed. These exchange rate fluctuations make the trade between countries more risky; because if one currency devalues in relation to other, the marketer of the depreciated currency will be affected by getting less than what his product is worth. Or conversely the buyer of depreciated currency may require paying more than what he originally contracted for (Eudey, pp. 14-15). Exchange rate rish is thus another form of transaction cost which was avoided. Another major benefit of Euro as the common currency was the avoidance of speculation. Before the introduction of Euro, speculation used to greatly occur throughout the Europe. Whenever a currency was thought to be devalued in near future, people used to sell all their holdings in that currency. The only solution to the problem of speculation was keeping the interest rates as high as possible to keep the people interest in the currency. These high interest rates were bad for the economy and hindered economic progress in Europe during 90s (Eudey, pp. 15, 16). Adoption of Euro as a common currency thus removed speculation and economies of the member countries could develop and flourish easily without the disadvantages of higher interest rates. Euro also does away with the problem of competitive devaluation of currency among the member nations. Before the era of Euro, European nations used to devalue their currency to increase the exports. Inflation was a direct result of this devalution (Eudey, p. 15). The adoption of common currency did in fact come with many costs as well. The first and the foremost disadvantage of adopting common currency by the Eurozone countries was that by accepting Euro as national currency they surrendered their right to adopt and change their monetary and economic policies to suit their domestic conditions (The Euro: Expect, pp. 123). There was another big cost of not being able to adjust the exchange rates between trading countries to eliminate the economic falloffs of individual countries. Even after the adoption of common currency and a unit monetary policy throughout the Eurozone and its many benefits, there is no surety that some member country may not go in recession; and this was the main concern for all the countries. If at any time one country goes into recession, it cannot alter the individual monetary policy and as a result the only option left is to wait, because a change in the monetary policy of all the nations would adversely affect more countries than benefit the country in recession (The Euro, the European Central Bank, pp. 157). Despite of this, the idea of creating a common currency was that by tying many European nations through a common currency, the business cycle of all countries will soon be closely linked to each other and very soon would there be no possibility of recession in one country while stability in other (The Euro: Expectations and Performance, p. 123). However, changes in individual Fiscal policies was allowed. Benefits and Costs of common currency in Greece Recently there has been a debt crisis in Greece and other Eurozone countries which has jeopardized the likelihood of continuing with the Euro. Especially Greece is highly considering to quit the Euro and reverting back to its national currency Drachma. The debt crisis is raising a lot of questions and discussions about the potential advantages and disadvantages of using Euro as the common currency in Greece and other countries with high national debts. If Greece chooses to continue to be a member of Eurozone, it'll have to face serious threats and challenges of paying back the national debt and restoring its economy to an optimum level. In reality, countries in severe debt crisis need the ability to devalue their currency in relation to other countries for rebalancing the export/import ratios without any difficulties. But since having the common currency, Greece cannot devalue the Euro, it's very difficult to restore the economic conditions without deteriorating it for other Eurozone countries. The differences in economic performance between different Eurozone countries have always worried the supporters of Euro. These differences make it impossible to implement the one unique Fiscal policy for all the Eurozone countries. As a result the inflation rate set by the European National Bank is not feasible and workable for all the European countries, which means that the weaker economies like Greece may bring down the economic progress of the stronger economies like that of Germany and France. This that made the departure of Greece from the Eurozone from nearly impossible to arguable and finally nearly inevitable. Nouriel Roubini, a renowned economist believes that Greece's only chances of redemption and to progress towards a better economy is now to return to their old nationa currency Drachma, and devalue in order to remain competitive. The average burden of debt for the Eurozone countries is set to a required rate of 60% by the European Commission. However the average debt burden for the Eurozone countries ion aggregate is expected 90.4% in 2012, which is far above the required rate. And Greece's debt is expected to raise up to 151% of GDP which is way more than the average and required rate. The budget deficit in Greece is also expected to be 10% in Greece which is greater than the average of 4.1% is all of Eurozone. Greece is now highly dependent on the foreign aid to reduce their national debt and debate continues regarding the possible pros and cons of Greece continuing or exiting the Eurozone. Benefits and Costs of common currency in Germany As stated in the above section, Greece's exit would provide a good momentum for the integration of Eurozone, but it would also make it difficult to progress. This is because the Eurozone countries, including the most powerful and economically sound Germany, would not be willing to assume the liabilities of failed Greek banks. It will even adversely affect the national debt of the state. At the time of formation of Eurozone, the primary benefits to the other countries were definitely in the form of stable economy and credibility of a strong common currency, whilst for Germany the greatest advantage was the trade integrity and advantages that Euro would bring to it. Some Germans believe that this benefit was perhaps not as big as the risk of being a part of club with potentially risky countries. However the current debt crisis has proved that Germany has benefited from the Euro far more than the rest of countries. Germany has nevertheless performed well during the period of Euro. It has managed to bring a reduction in the labor costs that resulted in increasing exports, and consequently Germany has developed a surplus in this Balance of Payments current account and eventually quicker GDP growth. Paul Krugman, an economist has argued that the Germany's strategy needed the Euro to work. They have tried to keep controlled labor cost but always failed. As exchange rate was fixed with the launch of Euro and capital started to flow in developing countries, which produced inflation in those countries.SO even with a slight inflation, Germany didn't had to worry about it as there was an inflation gap with other competing countries which made Germany more competitive than its fellow members. The following passage from the Paul Krugman's article summarizes the situation. “Or to put it differently: Germany believes that its successful adjustment was the result of its own virtue, but in reality it was successful in large part because of an inflationary boom in the rest of Europe. And here’s the thing: the Germans are now demanding that the European periphery replicate its achievement (and actually surpass it, because the required adjustment is much bigger) without providing a comparably favorable environment — they’re demanding that Spain and others do what they never did, which is deflate their way to competitiveness.” The inference that we could draw from this controversial issue is that Germany benefited from the common currency of Euro in a way that was not expected at the time of launching the common currency by increasing the relative competitiveness it had over other Eurozone countries. And this is the reason Germany still wants Greece to be a part of Eurozone as long as it abides by the reform program. Works Cited Eudey, Gwen. (1998). Why Is Europe Forming A Monetary Union. Federal Reserve Bank of Philadelphia Business Review(Vol. 0, Iss. 0, pp. 13-21) Salvatore, Dominick. (2002). The Euro: Expectations and Performance. Eastern Economic Journal(Vol. 28, No. 1, pp. 121-136) Salvatore, Dominick. (2002). The Euro, the European Central Bank, and the International Monetary System. Annals of the American Academy of Political and Social Science(Vol. 579, pp. 153-167) Krugman, Paul. "German Adjustment." The New York Times- The Opinion Pages. The New York Times, 6 2012. Web. 30 Oct 2012. . Read More