Economic and Monetary Union - Current Fiscal Disturbances and the Future

By Bukowski, Slawomir I. | International Advances in Economic Research, August 2011 | Go to article overview

Economic and Monetary Union - Current Fiscal Disturbances and the Future


Bukowski, Slawomir I., International Advances in Economic Research


Abstract At the moment of its setting up the Economic and Monetary Union did not meet the criteria of the optimum currency area. Neither does it today. The crisis of public finance in the euro zone results from the abandonment public finance reforms, lack of consistency in enforcing the decision of the Stability and Growth Pact and, additionally, economic recession and financial crisis. Further functioning of the eurozone will depend on radical reforms of public finance and structural reforms enhancing efficiency of the market as an adjustment mechanism, and competitiveness of economies. The very establishment of the European Stabilization Mechanism and European Financial Stability cannot make up for the above mentioned necessary undertakings. It is important to change the socioeconomic model existing in the EU member countries.

Keywords Monetary union - OCA criteria Fiscal policy Monetary policy Recession Sovereign debt Public debt Fiscal destabilization

JEL F33 * F36

Introduction

The 2008 to 2009 global recession and the financial crisis exerted a significant impact on the functioning of the euro zone. Many controversies have broken out over issues such as the rules of the euro zone functioning, the future of the EMU, the status of the countries affected by the fiscal crisis, the legitimacy of a monetary union encompassing countries of different levels of development and degrees of fiscal discipline, as well as the legitimacy of further enlargement of the euro zone. In light of the numerous discussion topics related to the above subjects, it is worthwhile to go back to the origins of the monetary union in Europe--its political and economic bases and, first and foremost, the economic theories which underlay that undertaking. Thus, it is justified to ask the following question: Did politics have the upper hand over economic reasoning and common sense when the euro zone was created and then enlarged? Can the Economic and Monetary Union survive and if yes, on what conditions? If the euro zone is to function effectively, is a larger scope of federalism than just fiscal policy coordination necessary and is this increased scope of federalism at all possible?

EMU-Economic Theory Fundamentals and Political Project

Fundamentals of the Monetary Union Theory

A Monetary Union, with a single currency area and monetary policy implemented by a supra-national central bank, can be a source of substantial benefits for its member countries. The benefits include the disappearance of exchange rate costs and risk in economic relationships among the union member countries, price and employment stability, and real GDP growth (About cost--benefit analysis, see: Grubel 1970, pp. 318-324; Krugman and Obstfeld 2000, pp. 622-630; De Grauwe 2003, p. 15-32; Bukowski 2003, pp. 65-66). Countries forming a monetary union resign from their own monetary policy (including exchange rate policy) as an instrument of macroeconomic stabilization. Thus, restoring economic equilibrium in the case of economic shocks can be achieve through a market adjustment mechanism and, to some degree, the use of fiscal policy. The latter, however, is not a sufficiently effective or particularly refined tool of macroeconomic stabilization because, while it temporarily eases the problem of unemployment, it leads to an increase in budget deficit, public debt, and interest rates in the medium and long run (Bukowski 2003, pp. 61-62; Mortimer-Lee 2001; Krugman 1999, pp. 201-202). It is also worth mentioning that its effectiveness is also low in the case of the supply-side shocks (Bukowski 2003, p. 35).

The Optimum Currency Areas (OCA) theory indicates criteria which should be met by economies of monetary union member countries. Meeting these criteria is the sine qua non of ensuring efficiency of adjustment mechanisms to restore economic equilibrium in both individual countries and the whole union as a monetary area. …

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