Has Monetary Union within the EU Been Successful - Case Study Example

Critically Assess Whether Monetary Union Within The EU Has Been Successful And Discuss Suggested Changes Which Could Be Made To It. In Particular, Evaluate The Performance Of The European Central Bank, The Operation Of The Stability And Growth Pact Table of Contents Table of Contents 2 Introduction 3 The Success of Monetary Union within the European Union 3 Discussion of the Problems and the Suggested Changes 4 Assessing the Performance of the European Central Bank 9 The Operation of the Stability & the Growth Pact 12 Problems of Sovereign Debt 12 Critical Assessment of the Impact of EMU Within EU 13 14 Conclusion 15 References 16 Bibliography 18 Introduction The essay will focus on the formation procedure of the European Union, with special attention to the monetary union formation and if the European states have benefitted from it. In particular, it will try to assess the changes and impacts on state sovereignty, given its current relevancy around the discussions to save the Euro, and try to establish if being part of the EU has reshaped that relation. It will also lay out some of the discussion regarding the debt crisis and the importance of the European Central Bank in the current situation. The Success of Monetary Union within the European Union The Economic and Monetary Union (EMU) has been extraordinary in the contemporary history of the European economy and was successful in altering the international economic landscape. Following a decade of its release, the Euro was successful in offering steadiness with regard to businesses along with the national economies. The Euro protects against tentative sprints in relation to the national currencies. A sole monetary policy that was adopted for the Member States, which was united with synchronized global fiscal policies, was capable of promoting macroeconomic steadiness. The EMU successfully encouraged Europe of economic integration and also amplified investments, financial incorporation and cross-border business. EMU within the EU also facilitated in enhancing the budgetary discipline and even took care and stabilised the repositioning of the exchange rate which were known to upset the European economy at regular intervals in the past (European Union, 2009). The EMU had even augmented the EU’s flexibility to unfavourable jolts and facilitated in promoting management of the international economy by the EU. Besides these the tangible advantages that were generated by the EMU gave rise to or created strong public finances and strengthened the worldwide position of Euro (European Union, 2009). Discussion of the Problems and the Suggested Changes By entering the Euro zone, European countries lost their monetary independence and also their central banks, which in cases like that of the current crisis would back the countries’ sovereign bonds. This is a drawback of the European monetary system and the European Central Bank (ECB) should be allowed to “stand behind solvent and sovereigns with unconditional and unlimited liquidity” (The Economist, 2011, p. 65). Whether Germany can accept this situation is still to be seen, but it should admit the implications and get ready for a breakdown of monetary union or try to act in symphony with other various member states. A parallel, although not obvious, could be traced with Argentina’s debt issues a decade ago. Argentina had its peso fixed to the dollar, maintaining something close to a monetary union with the US. In 2001 to early 2002 it suffered a debt and currency crisis leading that country to default. Source: (Hugh, 2011). However, this has not been an option for Greece. German finance minister holds the keys to the money printing machines. The German Chancellor needs to be approached to receive consent for the reason of printing money. Therefore, this trims down the prudence enjoyed by the Portuguese government, but the ways by which the Eurozone gets affected owing to this still need to be explored. In order to further comprehend the aspect, help of an assumption can be taken. For instance, a Chinese official in Beijing who has trillions of Euros worth of reserves starts speculating about the fact that whether there will be certain kind of quantitative easing (or certain other similar sophisticatedly named ways of devaluation) followed in Europe. This official will subsequently begin getting disturbed about the worth of the reserves in their possession. A response to it would be towards selling Euros as well as purchasing US Dollars. This would lower the worth of the Euro (Gilbert, 2011) and allow investors be anxious about the same problem and follow the identical strategy. European CEOs amid dual-listings would discover a fall in the worth of their American Depositary Receipts (ADRs) and those with the US denominated debt would uncover their liabilities (within local currency terms) rise suddenly. As a consequence, in the course of the period related to a single trading day, the European Central Bank pooled with concurrent liberalised markets related to currency are sending out the unfavourable news from Portugal towards the financial institutions, the corporate and the governments with the assistance of the Eurozone. Furthermore, it is important to state that the Greek situation differ from the Argentinean in the sense that if Greece defaults, it would cause an even bigger panic around markets given its European integration. As instinctively striking as the descriptions above (accompanied with numerous others possibly), factual causality cannot be recognised with the help of qualitative analysis similar to easy linear regression. Ceteris paribus, the above mentioned causes provides a comprehension of the issues in Portugal or Ireland and the reason for which they would have some impact on France and Spain. If the other half of Europe had been experiencing fiscal surpluses for a number of decades, it would be convenient to offer a solution to the sovereign worries suffered by Greece and Portugal by facilitating reassigment of wealth from more affluent European states. But the overall Eurozone is still in place (The Economist, 2011). Source: The Economist, 8.10.2011 (Note: the chart provided above depicts the extent of Greece’s fiscal deficit, the continued recession that Greek is presently facing and the continued important differences between the Greek Troika’s budget as well as actual fiscal performance). The one positive aspect depicted in the chart is that the degree of deficit is anticipated to come down over the following two years. However, in practice this would be almost determined more by a default, biased or otherwise, amount outstanding of the country than by the indisputably stern austerity methods which would also be requisite. It is therefore implied that an absolute debt crisis in Portugal, Greece or Ireland should have an adverse effect on the balance sheets of private as well as public sector financial institutions in another place in Europe. For various kinds of geographical, trade, historical and cultural reasons, a high contact to Greek debt was indulged in by the French financial institutions (both public along with private). On the other hand, the Spanish institutions are affected unduly by the disaster in Portugal. It is pertinent to take into consideration in this regard that association of a fundamental security does not create a boundary for the syndication (i.e. "spreading") of the degree of risk involved with the security. The creation of derivative instruments, like credit default swaps, has offered the financial institutions with the competence to widen the risk on the assets even, which are actually occupying the organisations individual balance sheets. Consequently, it can be appropriately identified that the startling current situation was considered to be a consequence of weak decisions which were adopted by the economic agents at an individual level throughout the monetary union. A solution to it could only be provided over time with the help of an alteration in the behaviour of such agents. It could be moreover recommended that the EU and the EMU needs to develop increased level of political integration. In addition, the task of the monetary union would be to undertake endeavours which would be in harmony with the general interest and reaching overall advantageous and profitable agreements. Assessing the Performance of the European Central Bank It is not easy to judge whether European monetary integration has been a success or failure. The question has no simple answer. Firstly, just because a system is in crisis does not mean that it is a failure. Secondly, looking back on the history of the EU, one will see that during that time period it overcame many challenges and created and sustained a system that many believed were born to fail (Geraats, 2008). The European Central Bank (ECB) is responsible for the monetary policy in the Euro zone since its creation on 1 January 1999, and during the past 10 years the ECB was successful in forming a monetary union, having a single currency and keeping the control on inflation which was at an average of 2.0% while DGP kept at 2.2% (Geraats, 2008, p. 4). The ECB is considered to be the most independent central bank in the world (The Economist, 2011, p. 38). The president of the ECB claimed in a few interviews how successful the bank’s monetary policy were that despite the ‘crisis,’ the Euro kept in line with its definitions of price and also kept inflation under control – around 2%. This performance, therefore, gave confidence to the currency. However, the ECB failed even in its own stringent inflation mandate and, moreover, “the ECB’s performance has featured a series of policy blunders that have left the economic giant Eurozone [sic] stranded in stagnation and at the mercy of the rest of the world [i.e. export demand]” (Bibow, 2005, p. 26). When problems arise, who is accountable for ECB policy blunders and to whom? In general, the ECB’s position was to articulate a return to its mandate of below but near 2% inflation (to calm down the post-financial crisis credit support), but did not state anything related a ‘last resort lender’ should Greece’s woes worsen, being upbeat on the fragile European and global economic revival, opposing a possible IMF ‘involvement’ in Greece, except for ‘technical assistance,’ and supporting the Euro’s largest economy (Germany) to take a fiscal ‘Euro-Police’ role. In short, it was safeguarding its ‘independence’ and defending a ‘rules-based’ order. In this case accepting the perceived fiscal ‘failure’ first identified by the financial sector (Geraats, 2008). The ECB 2% inflation policy, leaves the ‘option’ to the member states to finance their deficits with exports or raise the money in the market through the sales of government bonds. These rules are applicable to all, it does not separate the states in order of economy or any other differences or neither on how might a financial crises impact each state separately. For instance, Greece’s fiscal ‘irresponsibility’ was made easier by years of ECB-set structure of policies lessening interest rates, which reflected German growth. Consequently, the Greek government could borrow cheaply on the international debt markets (Hodges, 2010). Greece suffered its first downgraded in December 2009 mainly due to the fact that the country was because it had been operating at a higher level that what was permitted, spreading worry that it could go burst on its public debt (Oakey and Hoppe, 2009). Market conditions deteriorated by January of the following year and Greece was blamed for make use of unreliable data (or manipulated), which lead to an increased debt interest rates and investors had to pay a special premium on the Greek bonds. Many economists support the fact that additional stimulus packages represented a risk to asset wealth as well as an increased political hampering of the market mechanism, involving an uncertain future of political social ordering. This was linked to uncertainty in government spending, and on whether the policymakers would be forced, perhaps due to public anger, to prioritise the built-in automatic stabilisers, dampening fluctuations in GDP but increasing government expenditure, in a longer period of economic recession. In this context, automatic stabilisers, especially the public transfer methods became to be supposed as a failure of fiscal policy. The fiscal ‘failure’ was thus identified according to the interests of the financial sector, the exploratory hedge funds, the big institutional investors and the powerful creditors, the banking sector (Grauwe, 2006). Recently, Germany’s finance minister, Wolfgang Schauble, wrote on the Financial Times that “excessive state spending has led to unsustainable levels of debt and deficits that now threaten our economic welfare” (The Economist, 2011, p. 64). Furthermore, he is imposing a reactionary policy which affects all Eurozone countries, and such measures will be imposed by EU institutions. The policies are based in a doctrine of “expansionary fiscal contractions” (The Telegraph, 2011, p. 1), which has so far not succeeded unless offsetting monetary and exchange stimulus (The Telegraph, 2011). These extreme budget cut demands do not seem to be the solution, as they put stress on governments like Spain and Italy to reorganise their economy faster and tight, which in a moment of recent crisis, only helps to create more anxiety and cause delay in the process of rebuilding investors confidence. The Operation of the Stability & the Growth Pact The Stability and Growth Pact was referred to as a ‘political agreement’ which was made for the reason of developing restrictions with regard to the public debt and the fiscal deficits related to the European Monetary Union (EMU) Member States. These policies were developed so as to ensure a strong administration of the public finances among the countries entailed in EMU. The guidelines were aimed at checking an individual Member State’s negligent budgetary guidelines from leaking out and damaging the economic steadiness of the complete Euro area. The laid down rules as well as regulations mentioned in the Pact were targeted with the purpose of attaining constant, long-run union in relation to the economies of the countries falling under the area of Euro (Larosere, 2004). The quantified boundaries related to the Stability and Growth Pact was drawn from the ones that were developed by the ‘Maastricht Treaty (1992)’. It was stated there that the fiscal deficits of a particular member state should not go beyond 3 percent of the entire GDP and the public debt to remain within 60 percent of the entire GDP. These boundaries or restrictions were planned to keep a check on and control an extreme budgetary deficit (Larosere, 2004). Problems of Sovereign Debt In legal-based definitions, sovereignty is discussed in terms of authority, while in political definitions it is about de facto control (Nagan & Hammer, 2004). However, in the case of the EU this was a bit more complicated. The current recession not only had an adverse effect on the household budgets but even upon the financial positions of the governments. For an instance, when the expenditures of the government surpasses the tax receipts for a particular fiscal year then it suffers a condition of deficit and calls for the requirement of borrowing money for the purpose of taking care of the difference. Sovereign debt is referred to as the collection of these borrowings made from foreign as well as domestic creditors. If creditors become uncertain of the fact that whether a government is capable and eager to return the debts then in that instance the government might have to shell out an increased rate of interest on the issued bonds. When the government is not capable of releasing bonds to meet its debts then in such a situation it needs to opt for other means like increasing taxes, reducing expenditures or avail loans from international groups. This has been stated to be the present condition of Greece along with other few European countries (Noeth, 2010). Critical Assessment of the Impact of EMU Within EU The European Monetary Union (EMU) was believed to strengthen the demands for the reason of trimming down the active surplus competence. This was expected to be done with the intention to demand profitability and to direct towards increased degree of geographical expansion as well as nationalisation outside the EMU and also to amplify mergers as well as acquisitions along with conglomeration. It was believed by the European Central Bank (ECB) that a steady monetary situation would support the banking segment. The aspect of liberalisation was not prevalent in EU as the single or sole banking market was still to turn up and there existed chief distinctions in the accounting systems pursued by the corporate and the government. In spite of the different evaluations performed based on the sole market plan and the demands of ‘globalisation’, the financial markets of Europe have been stated to be still fragmented, particularly in the retail field of financial services. The constant distinctions in the corporate governance, tax regimes and the accounting regulations were identified to be the vital reason behind the existing fragmentation. It has been forecasted that alterations on the mentioned subjects have been expected to take place slowly in spite of the spur initiated by the EMU towards fast integration. Integration has been stated to likely progress in a fast pace for the markets with fixed revenue in comparison to equities whereas, the households were predicted to the most to be slow one in terms of amending. The Monetary Union would make a marked distinction but the perseverance of the non-regulatory hindrances like the corporate law and the taxation system would imply that the arrival of ‘euro’ would not be able to form a single financial market in Europe (Petrick, 2002). Conclusion From the above discussion, it is quite evident that the Monetary Union within the EU has been successful in stabilising the economic condition of the European countries. It could be also inferred that the European Union so far achieved its main purpose which was to avoid war in the continent, but the monetary union, although not flawed, is yet to overcome important challenges in few individual countries. The monetary union debate shows that the underlying causes of the crisis are deepened in the way agents made decisions about it and that the crisis is as much political as they are economical and that to ‘fix the Euro’ would only be possible with better integration and common accord among member countries. References Bibow, J., (2005), ‘Refocusing the ECB on Output Stabilization and Growth through Inflation Targeting?,’ Levy Economics Institute of Bard College, Working Paper 424. European Union, (2009), ‘EU Economic and Monetary Union and the Euro: A Decade Of Achievements’. The Delegation of the European Commission to the USA. Evans-Pritchard, A., ‘Spain – the fifth victim to fall in Europe’s arc of depression’. The telegraph (2011). Accessed on 01.12.2011. Geraats, P., (2008). ‘ECB Credibility and Transparency,’ European Economy - Economic Papers 330, Directorate General Economic and Monetary Affairs, European Commission. Gilbert, Katie. “Sovereign Debt Overshadows All”. Institutional Investor, Feb 2011, Vol. 45 Issue 1, p 81-83. Grauwe, P., (2006), ‘What have we Learnt about the Monetary integration since the Maastricht Treaty?’ JCMS 2006 Volume 44. Number 4. pp. 711–30. University of Leuven. Hodges, W., (2010) ‘The Greek Debt Crisis’ The Gateway Hugh, E., (2011). ‘Greece: Last Exit To Nowhere?’ EconoMonitor. Larosiere, J. D., (2004), ‘The Critical Mission of the European Stability and Growth Pact’. Consultative Group on International Economic and Monetary Affairs, Inc, pp. 1-51. Nagan, W. & C. Hammer, (2004), ‘The Changing Character of Sovereignty in International Relations and International Law’. Columbia Journal of Transnational Law 43, 141. Noeth, B. J., (2010), ‘Sovereign Debt Crises: It’s All Greek to Me’. Economic Information Newsletter. Oakey, D., and Hope, K., ‘Greece downgraded over high debt,’ The Financial Times (2009). Accessed on 01.12.2011. Petrick, K., (2002). 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