Completion of the Economic and Monetary Union (EMU) and the introduction of a single currency in Western Europe are one of the most significant events in the world economy at the turn of the century, which certainly had a major impact on both the European and the international economy.
With the advent of the single European currency, another large currency zone has been formed, which has extended its reach to many countries outside the EU. For the first time in decades, there is a real alternative to the U.S. dollar. Consequently, the global monetary system shifts towards bipolarity. The new currency contributes to the strengthening of the position of the European continent as a major center of the world economy. The euro area is a single internal market with a population of nearly 300 million people, accounting for 15.8 % of world GDP (compared with 7.6 % in Japan and 21.9 % in the U.S.) and about 19 % of world export, which exceeds that of the United States (15%) and Japan (8%). That said, the processes occurring in Europe are very important not only for the EU Member States, but also for the whole world. However, the formation of the European Monetary Union is a unique experiment. Despite the fact that this is not the first attempt of monetary integration in history, it has not an absolute precedent in the history of monetary unions. For the first time, a group of politically and monetary independent states voluntarily sacrificed a portion of their sovereignty, including national currency, transferring powers to conduct monetary and exchange rate policies to single supranational organization while retaining their political independence.
EU monetary and fiscal policies
From the standpoint of the theory of economic integration of the European Union is the first and only example of reaching the absolute unity in financial and economic terms. Integration process that combined 6 countries in the 1950s has covered 27 states by now. At the stage of integration EU members constantly faced crisis, overcoming it through radical reforms.
Having a profound impact on the European Union, the euro crisis still poses a significant threat. Inadequate provision of conditions for the monetary unity led to the growth of inconsistencies that in contrast to the cherished goal did not help the convergence of Member States in the long term. Differences in approaches to resolve the crisis in France and Germany, reluctance to provide economic independence of member countries show that the way out of the crisis is not such a simple one.
Although today the euro crisis poses a threat to the future of the European Union, currency cohesion within the scientific approaches can be regarded as a success. However, giving the member countries the possibility to independently control their fiscal policy justified the worst fears of a number of European economists. The urgent need for the EU is the formation of a single fiscal and monetary policy.
Monetary unity is one of the higher stages of economic integration
Stage defined as monetary and economic unity opens the way towards political unity, which is final. Monetary unity provides liberalization not only of goods and services, but also of many other factors. At the same time, the EU Member States must form a single economic policy.
To be able to ensure the implementation of the above-mentioned steps, as noted, it is necessary to form single fiscal and monetary policies, as well as a strong center from which the management would be carried out. Achieved success in forming of a custom policy was continued in monetary policy through the creation of the European Central Bank. However, achieving unity in fiscal policy has failed because of problems connected with the crisis risks. Lack of interest in the distribution of powers in the area of fiscal policy, as well as the definition of the principles of this policy on the basis of private political interests have turned the region into the euro area in which the scenarios of disintegration are discussed. In 2008, budget deficits and increased debt burden revealed the inability of the EU to establish effective control mechanisms. In this regard, the authorities of member countries were able to hide the real situation and even used fake statistics (such as in Greece).
In order to ensure the unity of fiscal policy, the lack of which is considered the main cause of the euro crisis, the European Union signed the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, and formed a European Stability Mechanism. The above-mentioned agreement was signed by 25 member countries of 27. Great Britain and the Czech Republic did not sign the agreement because it was considered contrary to their own economic interests.
Efforts to strengthen the economic and monetary unity need to actualize the new configuration of the EU. In this regard, the signed contract provides a more realistic perspective of unity in the struggle against the crisis. The formation of a union that mobilizes joint efforts, able to act more effectively in the decision-making process, in compliance with common rules for all members and may impose appropriate sanctions in case of non-compliance.
Testing all possible ways out of the crisis, the EU was forced to discuss techniques such as reducing government spending, wage cuts, and tax increases. These classical methods that have been applied to date, have not been able to resolve the situation of the debt crisis, and led to social unrest. Protests in Greece, Spain and Italy have further aggravated the situation and pose risks for political unity.
The European Monetary System
Formation of the European Monetary System was a logical result of economic integration of the European states and consisted of several stages.
European Economic Community is in operation since January 1, 1958 on the basis of the Treaty of Rome, signed in March 1957 by six countries – Germany, France, Italy and the Benelux countries. In November 1993, the Maastricht Treaty was signed, establishing the basis of European political, economic and monetary union.
An essential element of economic integration - monetary integration – is the process of coordination of monetary policy, the formation of a supranational currency regulation mechanism, the establishment of interstate financial, monetary and credit institutions. Its necessity is defined by several reasons:
- Demand for currency stabilization for increasing interdependence of national economies to liberalize the movement of goods, capital and labor;
- Desire to create own regional area of monetary stability in order to solve problems of regional integration;
- Desire to make the Western Europe a world economic center with a single currency, limit the dollar’s influence, and counter the growing competition from Japan.
Monetary integration mechanism consisted of a set of monetary and credit management techniques, through which the rapprochement and mutual adjustment of national economies and currency systems. The main elements of monetary integration are:
- Mutual floating currency rates;
- Currency intervention, in order to maintain market exchange rates within the agreed deviation from the central rate;
- Collective creation as an international currency payment and reserve funds;
- Mutual crediting of member countries to maintain exchange rates;
- International and regional monetary and financial institutions for foreign exchange and credit regulation.
The European Monetary System was created as a subsystem of the Jamaican Monetary System with some of its features, which at the initial stage of its existence were the following:
- The European Monetary System is based on the ECU - European Currency Unit, the notional value of which is determined by the method of the currency basket consisting of 12 currencies of countries outside the EU. In September 1993, in accordance with the Maastricht Treaty the “absolute weight” of currencies in the ECU has been frozen, and their “relative weight” fluctuated depending on market exchange rates.
- Jamaican currency system demonetized gold while EMU used it as a real reserve asset: ECU issue was partially backed by gold from a specially created joint gold fund, which accumulated 20% of the official gold reserves of the EMU countries and the European Monetary Cooperation Fund.
- Exchange rate regime was based on a joint “floating” exchange rate in the form of the “European Currency Snake”.
- EMU included implementation of interstate regional currency regulation by central banks providing loans to cover temporary shortfalls in the balance of payments and settlements associated with foreign exchange intervention.
The main goal of the EU is the conduction of monetary policy within the EMU. Basic tools of monetary control are:
- Targeting the major monetary aggregates to control the level of inflation;
- Identification of ranges of major fluctuations in interest rates;
- Establishment of minimum reserve requirements for commercial banks;
- Determination of short-term operations to regulate liquidity in the financial markets;
- Conduction of open market operations (credit auctions).
The ECB is in charge of the European System of Central Banks, which brings together central banks of the European Union.
Currently, the monetary unit of the European monetary system is the euro, divided into 100 cents. Name the single European currency was adopted finally in December 1995 at a conference of Prime Ministers of the European Community in Madrid.
The European Monetary Union
Prior to the establishment of the Economic and Monetary Union the influence on the mutual economic policies of the Member States was carried out mainly through the instruments of trade and structural policies (Pan-European transport projects, ecology, science and research assistance, etc.) or microeconomic regulation (individual aspects activities of enterprises). In 1990 by the decision of the Maastricht Treaty the entire set of tools was involved, including tools of macroeconomic regulation.
Maastricht Treaty in 1992 was a subject of strict convergence criteria necessary for the introduction of the single currency - the euro, with certain limits:
- The rate of inflation shall not exceed more than 1.5 % of an average level in member countries with the smallest increase in prices;
- Rates on long-term loans must not exceed more than 2% of average values of three countries with the smallest increase in prices;
- The budget deficit should not exceed 3% of GDP;
- Government debt should not exceed 60% of GDP;
- The currency must not devalue within two years, and its exchange rate must not exceed the limits of variation under the European Monetary System.
Stability and Growth Pact, established in 1997 at the insistence of the government of Germany, provided a guarantee of the Maastricht criteria, introducing an obligation for Member States in the case of excess deficit limit of 3% to improve the situation during the year, or receive financial penalties in the form of a fine of up to 0.5% of GDP.
EMU formation occurred in three stages and was finished with the introduction of the single European currency, which gradually replaced the national currency.
Inside EMU economic and monetary integration elements are organically linked and cannot exist separately. The single economic policy is needed to make the territory of all member countries a common economic space and monetary union, for this space cannot operate at substantially different national inflation rates, public debt levels, etc.
Fiscal policy and the Stability and Growth Pact
Stability and Growth Pact (SGP) is the main basis of coordination between fiscal policies of the Economic and Monetary Union. The purpose of the SGP is to protect the financial stability of the European Union, to achieve compliance with fiscal discipline and coordinate economic and fiscal policies implemented by European Union countries, in order to facilitate the success of the single monetary policy.
In accordance with the requirements of the Covenant EU member states are required to submit annual stability programs (convergence), which shows how they plan to achieve or protect financial stability in the medium term.
Under the Stability and Growth Pact, EU members must comply with the requirements of the medium relative to the state government's budget, which should be close to balance or in surplus, ensuring that the state budget deficit does not exceed 3% of GDP. These commitments countries have made under the Maastricht Treaty.
In case a member state violates the maximum allowable level of the budget deficit or public debt actions are taken against it in accordance with the procedure for correcting the excessive deficit.
The SGP refers to the third stage of the formation of the Economic and Monetary Union, which began in January 1, 1999. The Pact further ensures the compliance of Member States’ fiscal discipline, including periods after the introduction of the single currency, the euro.
The Pact on Stability and Growth Pact provides that the Council may impose sanctions on a member state to the European Union, which did not take the necessary steps to eliminate the excessive deficit. At first, the Community requires the introduction of interest-free deposit, which can be converted into a fine if the excessive deficit is not eliminated within two years. However, there are no clearly documented rules in the system of sanctions: what the Council decides what sanctions will be applied on the basis of assessment of the circumstances of a particular case.
The financial markets and the euro
Transition to a single currency gave the following advantages to the financial markets of the euro area countries:
- Euro resulted in the elimination of foreign exchange risk associated with exchange operations and reduced transaction costs related to intra-zonal trade;
- Euro contributed to price stability over the last five years, for inflation does not exceed 2-4% per year in the euro area, which is the main objective of the ECB;
- A clearly articulated priority in the activities of the ECB - price stability - to dramatically reduce the size of the risk premium, which is reflected in the level of interest rates, as a result of the fruits of stability to fully enjoy European businesses and households : low values of long-term interest rates create a very favorable environment for investment and economic growth in whole;
- Euro accelerates the financial integration of the European Union. Nowadays, many financial market segments are characterized by sufficient depth and liquidity which ensures a better distribution of resources and risk;
- Euro plays a vital role as the second (after the United States dollar) world currency serving in international trade and financial turnover.
Direct impact of the euro on the financial market is manifested in reducing currency risk and eliminating organizational, technical, legal and regulatory obstacles in the territory of the euro area, which in the past led to the segmentation and fragmentation of national markets. European financial market has become larger and more homogeneous.
However, time has clearly revealed some flaws in the architecture of EMU. This is particularly true for developing standards of currency and monetary policy, under which governments have to act in the euro area. Before the launch of the euro into circulation, most experts expected that the rate of new currency to the dollar will continue to grow as investors and central banks will switch to the euro. In fact, the new currency has fallen by approximately 7% compared to its initial rate.
This hardly can be called a currency crisis, as the euro still stands stronger than the old European currencies. At the time of launch of the currency Europe has predicted a solid economic growth. The combined forecast predicted annual growth by 2.6 % in the euro area and 1.9% in America. However, the most recent statistics show that GDP in Germany fell by 1.8% in annual terms while in the U.S., it has increased by 5.6%. Ascent has also slowed down in France and Italy. Acceleration of economic growth in America and its slowdown in Europe should induce the U.S. Federal Reserve to raise interest rates, and the ECB to reduce them, which makes the dollar more attractive for investors than euro.
As a conclusion, it can be said that despite the risks of the 2000s, Europe will not lose its economic position in the world in the next 25-30 years. The EU will continue as somewhat effective interstate association. However, high unemployment rate and the continuing stagnation in the Eurozone led European leaders to reconsider ways of dealing with the ongoing crisis. For three consecutive years, the leaders of Europe pursue a policy of “fiscal restraint”, which aim is to reduce the level of debt in various countries. Still, many people criticize this policy and argue that it is harmful because it constrains economic growth in the euro area. European governments have remained indifferent to this criticism. Recently, there has been noticed a definite change in attitude towards a tight fiscal policy. For example, a number of countries, including France and Spain, have postponed the timing of the next stage to reduce their budget deficits. Italy is in the process of abolishing the previously scheduled tax increases, and Spain has announced new economic program, which provides large-scale investments in order to support the business sector.
Simultaneously with the appearance of signs of change in the approach to fiscal policy, there is evidence that the European Central Bank is considering measures that would be appropriate to accept the situation. After another rate cut the ECB seems prepared to take new steps to stimulate the economy trampling on the spot. Management of the European Central Bank hopes that lower interest rates will encourage commercial banks in Europe to increase the supply of credit to the business sector, which would entail the strengthening of economic activity and improving employment indicators in European countries.