European Monetary Union: Will It Really Contribute to Stability?

By Neu, C. Richard | Business Economics, January 2000 | Go to article overview

European Monetary Union: Will It Really Contribute to Stability?


Neu, C. Richard, Business Economics


IN THE INTERMEDIATE RUN, AT LEAST, MONETARY UNION IS LIKELY TO INCREASE RISKS FOR THOSE WHO DO BUSINESS WITH EUROPE FROM OUTSIDE ITS BORDERS.

In the long run, European monetary union will almost surely prove beneficial--economically and politically--for Europe and probably for the rest of the world. For the next several years, though, monetary union is likely to increase three kinds of risks facing firms doing business with, from, and in Europe. First, increased risks arise from the reduced predictability, coherence, and quality of overall macroeconomic policy making in Europe. Second, real economic conditions within Europe are likely to be more variable and volatile. Finally, monetary union may lead to increased uncertainty about--and maybe even increased strife over--social policies.

The first year of the (almost) common European currency has gone generally smoothly. For the most part, businesses, governments, and financial markets are adapting to operations in a new currency. And a year into this grand experiment, nothing has transpired to undermine the widespread belief that, over the long haul, monetary union will be economically and politically beneficial for Europe and probably for the world at large. But over the intermediate term--the next ten years, say--monetary union has created some significant new risks to doing business with, from, and in Europe.

The Good News

Let us begin by giving credit where it is due.

In both symbolic and practical terms, monetary union has been an important addition to the collection of institutions and arrangements that contribute to the creation of a unified, cooperating, and democratic Europe where national differences are resolved peacefully and constructively, and within which goods, investment, and people can move freely. By removing the possibility of competitive currency devaluations, monetary union has also eliminated a potentially troublesome threat to the long-run sustainability of the single European market.

In economic terms, too, monetary union promises some real--although initially modest--advantages. Within Europe, cross-border transactions have become simpler and less risky. In the longer run, this may result in more efficient patterns of investment and perhaps in deeper and more liquid financial markets, which in turn will lower the cost of capital. Overall, there seems little reason to question the conventional wisdom that monetary union is already a good thing and that the benefits of monetary union will grow over time.

We must also credit monetary union with some reduction in the risks arising from misguided or whimsical national macroeconomic policies. Responsible policy among nations is a lot like greatness among individuals. Some are born with it. Some achieve it. Others have it thrust upon them. Europe has long had its examples in the first two categories. The arrival of monetary union has created some in the last category as well. By taking monetary policy out of the hands of national authorities, monetary union has almost certainly eliminated the worst and the most uncertain of European monetary policies. To a lesser but still important degree, the Stability Pact that has accompanied monetary union has accomplished something similar for fiscal policy. This should be counted as an unambiguous benefit.

The Bad News

Against these benefits, however, we must set three kinds of risks that arguably have been exacerbated by monetary union. The first category of increased risks are those that arise from the reduced predictability, coherence, and quality of overall macroeconomic policy making in Europe. Monetary union may have eliminated the worst of European policy making, but it may have also compromised the best. The second set of increased risks are those that arise from increased variability and volatility in local real economic conditions within Europe. Finally, monetary union may lead to increased uncertainty about--and maybe even increased strife over--social policies. …

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