Question

Describe COSTS of the Euro as a single currency for the members of the Eurozone. Also, describe pros of the euro as a single currency for the members of the Eurozone.

Answer 1

1. The Costs are as follows:

Loss of independent monetary policy. In the Euro, interest rates are set by ECB but may be inappropriate for UK economy. For example, the 2008 recession hit the UK harder than other European countries because of our exposure to the financial sector. The ECB increased interest rates earlier than in the UK. This could have pushed the UK into a double-dip recession.

Loss of ability to depreciate currency in recession. In the Euro, there is no possibility to devalue. If you have higher inflation than other European countries (e.g. higher wage growth, lower productivity growth) you will soon become uncompetitive. This has been a major problem for European countries such as Greece, Spain and Portugal. There decline in competitiveness has led to lower exports and lower economic growth, contributing to their decline in tax revenues.

Growth and stability pact limits expansionary fiscal policy in the recession. In theory, the growth and stability pact limits the amount of government borrowing, therefore making it harder to escape recession. The EU’s response to the fiscal crisis is to make stronger treaty legislation to penalise countries who have deficits which are too big. But, spending cuts can push economies into recession.

No Lender of Last Resort. In the Euro, the ECB is unwilling to act as lender of last resort. This causes greater pressure on government bond yields and puts pressure on countries to pursue austerity (spending cuts) which create lower economic growth. Lender of last resort.

Can’t leave. Greece experienced great financial hardship in Euro, with a drastic recession. However, the costs of leaving the Euro were too high, and they had to accept stringent spending cuts and conditions from Europe to receive a partial bailout. This also damaged feelings of national pride and democracy as the government had little influence over economic policy.

2. Pros of the Euro as a single currency for the members of the Eurozone are

Lower transaction costs for firms and consumers

Evaluation – only a small % of firm’s turnover

Greater certainty for firms investing in capacity to export to Europe. May also encourage inward investment.

Evaluation – firms already reduce risk by hedging against exchange rate movements

Greater Price Transparency – easier to check different prices in same currency

Incentives. Greater pressure to increase productivity and keep inflation low, otherwise become uncompetitive.

Encourage inward investment. Foreign firms keen to invest in Eurozone area.