Weaknesses Of The Eurozone Economics Essay

Weaknesses Of The Eurozone Economics EssayRobert Mundell described the Bretton Woods System as Hamlet without the Prince collect to the lack of a unified coin in the form of a pecuniary compact expressed as Bancor or Unitas. Given the experience of emu, does this analysis still hold theoretic wholey and/or by empirical observation? Discuss.Introduction of EMUIn 1999, the European Central Bank (ECB) launched the single currency (euro) together with the foundation of the Economic and Monetary Union (EMU). The EMU is found on the existence of the euro as a honey oil currency. The ECB supervises the implementation of a common monetary policy. At the beginning of 2002, euro replaced the national currencies of 12 sh are countries for all transactions. Sweden, Denmark, and the United Kingdom joined European Union (EU) but did non join the euro. In 2004, there were ten new atom countries joined the EU, v of them joined the euro.The prior monetary unions are unsuccessful as they rested on the value of metals (i.e. gold or silver). The money printed should be determined by the silver of gold stored, therefore the Metallism monetary system is a stable system since silver and gold are scarce resources.The EMU rests on the euro or chartalism, as fiat money which is issued by a central national bank. The credit level of the issuing body is important to determine the value and stability of the fiat money. The stability of the country in terms of sparingal and semipolitical will in turn determine the credit level. However, when the treasury is unable to pay the deficit, fiat monies can become unstable due to the temptation of the inflationary tax or seigniorage. In order to achieve and sustain the stability, the EMU require an economical union and a monetary union. Economic union is achieved by complying with the Stability and Growth Pact (SGP). The goal of SGP is to maintain fiscal stability through implementation of specific fiscal requirements among app endage states of EMU.The strength of the Eurozone rests completely on the credibility of the requirements set when the EMU was being implemented and the ECB was established. However, if member states are not respect or follow the set requirements, the credibility level of Eurozone will be affected and as a result negatively affect the euro.Mundells TheoriesThe captain idea of a common currency in Europe was derived from the theory of Robert Mundell on the areas of optimal currency. In his paper A plan for a European Currency in 1973, Mundell clarified the gains of European countries if they adopt a common currency. The works of Mundell have been classified into two categories by Ronald McKinnon (2004).Mundell IIn 1961, Mundell promulgated his paper entitled A Theory of Optimal Currency Areas which is rooted in Keynesian ideas. The theory of Optimum Currency Areas (OCAs) studies how countries with a monetary union and common currency adjust, if these countries are affected by asymme tric economic shocks. Mundell point out that adjustments are based on whether wages are rigid, apprehend mobility is limited, income transfers are difficult, and differences exist in the labour market and growth tempos. Mundell claimed that when countries are in a monetary union and use a common currency, they cannot delineate asymmetric shocks properly unless, among other(a) circumstances, labour mobility is unlimited.Mundell IIIn Mundells article Uncommon arguments for common currencies which published in 1973, an alternative theory is illustrated. Mundell emphasised the common currency assures an automatic and equal sharing of the risk of the fluctuation, a common currency has advantages in overcoming economic shocks. Mundell II argues that it is easier for member countries to stay inside a monetary union than outside it since the private insurance would assist against asymmetric shocks. More specifically, it will be easier for member countries to borrow in the capital market s of the monetary union when hitting by a negative shock, as a result it will be easier for member countries to smooth consumption. In addition, the exchange rate would be a source in arising asymmetric disturbances especially capital mobility of financial market is very high.The criticism of Mundell II becomes more obvious in terms of political context. If financial markets in a monetary union provide insurance to reduce asymmetric shocks, the need to integrate national budgets for political means becomes weaker. Hence the motive to form a political union is even weaker. However, the Mundell II point out that if there is no budgetary union, it would be optimistic to say that private financial markets would provide insurance against asymmetric shocks. The financial markets will merely provide insurance to those who possess high assets root in the financial markets. Since wealth is not equally distributed, the private provision of insurance will overwhelmingly support the wealthy a nd keep the poor comparatively uninsured. In addition, the Mundell II theory ignored the possibility that countries may involve in a position of a bad equilibrium. If there are not adequate instruments to lead the economy out of the bad equilibrium, countries would get caught in the bad equilibrium after a negative shock. It is a major task for the future of EMU if there is no adequate instrument in a monetary union. This is reinforced by the fact that different member countries of EMU continue to work in different directions due to the absence seizure of a political union.Weaknesses of the EurozoneIn the last ten years, the euro has demonstrated that there are some efficiency gains by adopting a common currency (i.e. reduced transaction costs of exchanging currencies, eliminated exchange rate uncertainty, and increased transparency in prices), percenticularly if the currency becomes not only an international currency but besides a global currency. However, maintaining various s tandards requires difficult adjustments and constant surveillance of every single member state in Eurozone.As the economic crisis has hit the world, certain Eurozone Member States Greece, Portugal and Spain are being seriously affected. The Greek tragedy is making the EU consider that highly indebted countries can put the EMU at risk and that measures must be taken without delay.Institutional WeaknessArticle 102.a of the Maastricht Treaty establishes that member states and the community should conduct their economic policies with a view to contributing to the achievement of the objectives of the Community. In order to guide Article 102.a, Article 103 highlights that the correct implementation of economic policies is a matter of common, stating that Member States are to coordinate them within the Council, in accordance with the provisions of Article 102a. Article 103 also highlights that it is important to avoid excessive deficits of for each(prenominal) one authorities. There i s an obvious institutional weakness in terms of monetary policies. The Maastricht Treaty had defined the objectives of the ECB which is price stability. ECB has defined an inflation rate below 2% as the objective of price stability. In addition, in terms of unemployment, the rest of society is not convinced and will not easily accept the begin of the ECB to release itself from any responsibility for unemployment. However, the delegation of the responsibility of unemployment to the governments of each member country creates a political bother.The purposes of SGP contain that member countries should avoid excessive debt and deficits and each member country should maintain fiscal stability. There are two important two Council Regulations in SGP (i.e. Regulations 1466/97 and 1467/97). These two regulations require member countries of the EU must comply with to help contribute to the overall climate of stability and financial prudence to a lower placepinning the success of the EMU. Th e Council Regulation 1466/97 set out the flesh out of stability programs (i.e. submission and monitoring regulations) and convergence programs. The ultimate purpose of the multilateral surveillance by the Council is to prevent, at an early stage, the occurrence of excessive general government deficits and to promote the surveillance and coordination of economic policies. The purpose of regulation 1467/97 is to clarify the excessive deficit procedure to deter excessive government deficits (European Navigator 1997, 2). However, the SGP is not sustainable due to the lack of accountability of the EU commission. Hence, the national governments are bound to win when conflict arises. The problem will exist as long as national governments continue to possess the sovereignty over spending and taxation.Political desegregationDe Grauwe (2006) acknowledged that the EMU is a remarkable accomplishment, but the absence of a political union is a major weakness in the Eurozone governance. Grauwes view is consistent with the findings of Nitsch on the political integration. He conclude that political integration is not rapidly followed by economic integration (Nitsch and Wolf 1). Grauwe point out in his article that national governments holding most economic policies purpose creates asymmetric shocks. The asymmetric shocks truly affect the sustainability of the monetary union. For example, member countries of the Eurozone have different competitive positions due to the uncoordinated policies of each member country in relation to national wage.Italy, Ireland, Portugal, Greece and Spain were in constant financial and economic turmoil before the adoption of the euro. The turmoil situation disappeared due to the economic booming of the knightly years. These five countries have barely met the requirements of monetary and economic stability and are becoming increasingly difficult to maintain the stability. For the past years, these countries are not only suffering from excessive deficits and debts, but also economic unbalances (i.e. excessive current account deficits). The current account positions are becoming worse due to, among other reasons, their extremely uncompetitive trade position. As a consequence, they are beginning to blame the euro.The problem that these countries are facing originates from the fact that monetary union amplifies fiscal imbalances. Opting for devaluation of a competitive currency is not an option and the only other alternative stems from forcing differentials of bond mother reduced. In 2005 there were almost no yield differentials between the German Bund and the yields of those countries with excessive current-account deficits. In 2009, however, yield spreads has increased government default risks measured by a sudden increase in the get for credit default swaps. Hence, the current economic crisis has demonstrated that currency risk is replaced by default risk in a monetary union. There are two reasons for this situation 1) th e sovereign debt of each member country is issued under the control of each Ministry of Finance, 2) there is no European Ministry of Finance.The Germans has profferd the creation of a European Monetary Fund, the French league has proposed the creation of a European Debt Agency which required that the capital of Portugal Treaty were amended or that a new agreement were negotiated. Many heap blamed this situation due to the lack of a common bond market which would help to put all members together. several(prenominal) people reject the suggestion based on the fact that a common bond market would lower borrowing costs for weaker countries and increase costs for stronger countries such as Germany. In addition, the common bond market would obtain the budget rights from each governments which would not be able to make national budgets by themselves. happen clauseFor years some countries have not respect or followed the requirements listed in the Maastricht Treaty and are now facing e xtremely difficult economic situations. It is obvious in the current crisis that there is no political homogeneity among member countries from a political point of view. As a result, each member country has implemented its own particular economic model and how to conduct its own economic model. In addition, Greece, Spain, and Portugal do not truly realise that their economic models are embedded in a globalised economy and these countries need to implement a set of painful structural reforms to keep them competitive. From the economic point of view, the countries in trouble have two major common reasons. The reasons are the lack of respect for the requirements and the lack of appropriate implementation of the structural reforms required under an economic recession.Currently there are debates on what should or should not be done with these countries. However, there are not room to manoeuvre this situation under the current legal framework.Expulsion of these countries from the Eurozone is not a good choice as it would definitely hurt the image of the EU and its member countries. Many scholars, economists propose that voluntary withdrawal from only the Eurozone while staying in the EU to would be the most beneficial option.The legal framework the Treaty of Lisbon, does not provide the needful methods to deal with problems of withdrawal, expulsion from Eurozone nor any other similar problem that might arrive soon. First, the Treaty of Lisbon has the no-bailout clause to prevent a budgetary problem in one country spilling over the EU as a whole. The no-bailout clause prohibits member countries from rescuing other countries or from accepting the debts of other countries. However, the Article 122 of Lisbon Treaty states that any member country seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control can bugger off financial assistance from other members. The question is whether a member countrys current debt crisis could qualify as an exceptional occurrence and not a man-made issue. This clause was inserted to strengthen unity and commitment of Eurozone. But the reality is that some countries are possessing extremely high level debts and deficits far exceeding the requirements. Therefore, there are not many methods for to assist these financial troubled countries under the current circumstances. The Articles 4(2), 118, and 123(4) explicitly indicates that the process for adoption of the Euro is irreversible. Participation of the EMU becomes a legal obligation due to the irrevocability of the agreement and the monetary union process. Thus, the exit option of leaving EMU while staying in the EU is impossible. The exit option is only allowed to exit the EU and EMU altogether.In addition, there is no clear mechanism by which members could expel a fellow country. The expulsion could only be possible if the agreement were amended and provided that all member countries respond favourabl y to this amendment.ConclusionThe EU and the Eurozone are suffering not only a financial crisis, but also a totally lack of appropriate structural reforms. The proper functioning of the EMU depends on the compliance with requirement provided in monetary and fiscal policies. Some member countries need to adopt urgently a number of structural reforms to promote economic growth of its own country and to stable euro as part of the EMU. Most importantly, the EMU should take this crisis as an opportunity to create a restructuring mechanism to strengthen and reform the economic, political foundations of the euro project.