Single Currency on German Economy - Literature review Example

? Economic Implications of the EU’s Single Currency on German Economy Introduction Back in 1951, six European s came into an economic agreement forming the European Union (EU). Today, there are 27 countries across the European continent that are members of the EU (Central Intelligence Agency, 2011). These countries are: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and UK (ibid). In response to globalization, the initiative of the European Commission back in 1969 was put in place to coordinate the economic policies as well as to set a monetary integration among the European Union. On the 1st of January 1999, the ‘Euro’ (€) was launched in the world money markets. Since then, Euro has become the unit of exchange for the EU states except for the United Kingdom, Sweden, and Denmark (Central Intelligence Agency, 2011). The decision behind the European Union is to make the inter-regional and inter-state trading much easier (European Commission. The EU Single Market, 2011). Back in 2007, the goal European Commission has proven to be very successful. Implementing the ‘Euro’ (€) currency in 1999 was part of the strategy used by the European Union to achieve their purpose of making the inter-regional and inter-state trading much easier. Located in Frankfurt in Germany, the European Central Bank was made responsible for the implementation of monetary policies and exchange rate policies throughout the European monetary union (Carbaugh, 2009, p. 280). Likewise, it is the European Central Bank that controls the supply of euros aside from setting its short-term euro interest rate or maintaining a fixed exchange rate for all members of the European Union (ibid). It is given that becoming a member of a single currency economy could trigger some economic advantages and disadvantages to countries that decided to join the use of a single currency. For this reason, it remains a question on how the introduction of a single currency Euro (€) created both positive and negative impact over the economic situation in Germany. The main purpose of this report is to examine the economic implications of using the EU’s single currency on the German economy. To give the readers a better understanding concerning the research topic, this report will first provide a brief overview concerning the economic condition of Germany before and after the country was required to use a single EU currency. As part of conducting a literature review with regards to the potential economic impact of centralizing the currency, this report will focus on discussing the advantages and disadvantages of using the Euro (€) currency in the economic performance of Germany. Finally, the economic consequences associated with using fixed exchange rate policy will be tackled based on the historical experiences of other countries. Brief Overview on German Economy Before and After the Use of EU (€) Currency Back in the 1950s, the economic situation in Germany was highly dependent on the exportation of agricultural and industrial products. In 1988, West Germany and East Germany were exporting a total of US$323 billion and US$30.7 billion worth of different agricultural, mining, and industrial products respectively (Boyes, 2007). Since there was a high demand for food and non-food products manufactured in Germany, East Germany was able to maintain zero unemployment rate for quite some time (ibid). Despite the fact that the inter-regional and inter-state trading was made easier among the European Union (European Commission – The EU Single Market, 2011), Germany started to go through a series of economic problems. After the single currency was implemented in Germany, the country started to experience economic stagnation in the 2000s combined with a constantly increasing high unemployment rate (Merkel, 2009; Boyes, 2007). Since there were a lot of private companies that went bankrupt since the issuance of a single Euro (€) currency, Boyes (2007) reported that “the German government started to spend billions of Euros on the development of new airports, railways, and motorways on top of spending billions of Euros on pension plans and unemployment benefits to hundreds and thousands of unemployed individuals in East and West Germany”. Back in 2009, the German government had to rely on the use of the “50 billion Euro Stimulus Plan” just to stimulate new job creation and to protect the private sectors from going through the economic consequences of slow economic growth and recession (Merkel, 2009). Since Germany is one of the biggest economies in European Union, this country is still heavily relying for some euro aid up to the present time (Rinke, 2011). Economic Advantages of Using a Single EU (€) Currency Several studies have revealed that the advantages of using a single EU (€) currency in the euro-zone include a significant reduction in transportation and transaction costs of cross-border trading which often results to exchange in a variety of national currencies, an increase in the size of potential markets, increase the local companies’ competitiveness in the euro-zone markets, gain better access to more closed economy, remove business uncertainties as a result of exchange rate volatility, increases price stability in the selling of goods and services, and enhanced political and fiscal unity with a chance to share internal risks (Canuse & Driga, 2010; Goodhart, 2007; Luker & Townroe, 1999). Since there is a political and fiscal unity among the members of the European Union, the trade of each member country is protected from political pressures (Carbaugh, 2009, p. 282). In general, the presence of exchange rate volatility could create business uncertainties to the members of the European Union. By implementing a single Euro (€) currency, the members of the European Union are not only protected from the need to go through the economic risks associated with the constant fluctuations in the exchange rate but the countries also avoid the actual costs associated with currency conversion (Carbaugh, 2009, p. 282). To enable exporters to have the benefit of projecting a more accurate future markets, the use of a single currency will also put an end to the instability of internal and external currency (BBC News, 1997). For this reason, the members of the European Union need not worry about the presence of monetary disturbances or any forms of speculation in its monetary policy. Due to the presence of price stability of goods and services, Luker & Townroe (1999) explained that the use of a single currency has been successful in removing trade barriers among the members of the European Union. Since the use of the Euro (€) has removed business uncertainties caused by exchange rate volatility, and therefore the transaction costs of cross-border trading has decreased. Given that Germany could easily trade goods and services in each member of the European Union, the prospective market of German-based companies also increases. Rather than exporting German-made products and services to other non-members of the European Union, the local companies in Germany are more likely to exploit the European markets (Luker & Townroe, 1999). Economic Disadvantages of Using a Single EU (€) Currency One of the economic risk of using a single Euro (€) currency is the presence of symmetrical shocks (Frankel & Rose, 2002). Given that the monetary policy of the European Union is being managed by the European Central Bank, each member of the European Union does not have the privilege to make use of monetary policy to counter-act the presence of macroeconomic shocks (Carbaugh, 2009, p. 282). This makes the member of European Union unable to use inflation to reduce its incurred public debt in real terms. As a result, of continuous price stability, increase in market demand, and shared internal risks could somehow lead to the increase in inflation rate. Since high inflation rate could make the market prices of goods and services to increase, the presence of high inflation rate could harm the economic stability of a country that relies heavily on exportation of goods. As explained by Bernard (2007, p. 532), it is important to maintain the internal equilibrium of each economy in order to prevent the economic consequences of a distorted economy. Given that a huge capital outflow could increase the interest rate at times when the country needs to implement a low interest rate, Germany loses its opportunity to make use of monetary policy in order to control the movements in interest rates because the European Central Bank need to consider the economic situations in other European Union before the European Central Bank increasing or decreasing the interest rate. Canuse & Driga (2010) stated that “the current experience with the inflation and devaluation of the national currency shows that reducing inflation without improving other indicators is counterproductive”. To make the euro monetary integration successful, there has to be a good coordination in its macroeconomic policies. Since it is difficult to determine economic problems that are caused by the economic integration and those that are not, members of the european union are encouraged to cooperate with one another to avoid facing the economic consequences of having ineffective monetary policy. Economic Consequences Associated with the Use of Fixed Exchange Rate Under the Bretton Woods System, monetary policy was focused on fixing the exchange rates in order to protect the balance of payments stability (Hagele 2006, p. 8). After the World War II, making exchange rates stable by pegging the currencies against the US dollar was considered as one of the best ways to promote growth on international trading and in making the employment rate high (Hagele 2006, p. 9). Even though pegged exchange rates are adjustable when necessary, historical events have revealed that implementing a fixed exchange rate system could create disequilibrium in the balance of payment and international trading system (Bordo and Eichengreen 1993, p. 5). In an economy where the exchange rate is fixed, Basyal (2006) revealed the government tends to rely heavily on the use of its fiscal policy in order to control the economic situation in each country. By increasing income and employment through the use of fiscal policy, Dadkhah (2009, p. 113) explained the government can make use of its reserves or to borrow money from local or international sources in order to create more demand for products and services. However, several studies explained that excessive use of fiscal authority could result to more economic consequences since misuse or excessive use of fiscal policies could result to the exhaustion of the government reserves (Basyal 2006; Tornell and Velasco 2000). This explains why the public debt in Germany has significantly increased from 72.5% of GDP in 2009 up to 78.8% of GDP in 2010 (Central Intelligence Agency 2011). Given that the value of exchange rate should be dictated by the supply and demand, it is clear that implementing a fixed exchange rate combined with an unsound fiscal policy can lead to the increase in the balance of trade deficits which could trigger the presence of global economic crisis caused by such disequilibrium (Basyal 2006; Hagele 2006, p. 18). Since a fixed exchange rate at an artificially high level could result in either a balance of payments deficit or a balance of payments surplus (Baumol and Blinder, 2010, p. 369), Issing (2009) revealed that the price of money should be controlled to maintain monetary stability. Stated by Baumol and Blinder (2010, p. 370), “the balance of payments can be affected by the value of imports and exports of goods and services, the cross-border payments of interest and dividends, and the presence of cross-border gifts”. Germany is unlikely to experience balance of payments deficit since its total annual export ($1.337 trillion – 2010 est.) is slightly higher than the value of its total import ($1.12 trillion – 2010 est.) (Central Intelligence Agency 2011). For this reason, German economy is less likely to suffer the long-term economic consequences of having balance of payment deficit. Conclusion Even though the use of a single Euro (€) currency could make Germany benefit from a more stable price and a bigger market opportunity in cross-border trading, there are still a long list of economic disadvantages associated with the use of a single Euro (€) currency. Using a fixed exchange rate system could create disequilibrium in the balance of payment and international trading system (Bordo and Eichengreen 1993, p. 5). Since the government is heavily relying on the use of its fiscal policy, Germany is currently facing high amount of public debts. In line with this, the proposed dissertation seeks to ask the following research questions: (1) What are the economic consequences of continuously increasing public and external debts?; and (2) What are the options Germany have in controlling its increasing public and external debts? Word Count: 2,089 References Basyal, T. (2006). Monetary and Fiscal Management: Framework and Evidences. Economic Journal of Nepal , 29(2), pp. 63-76. Baumol, W., & Blinder, A. (2010). Macroeconomics: Principles and Policy. South-Western Cengage Learning. BBC News. (1997, November 21). Retrieved March 27, 2011, from Special Report. 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