1. -: A PROJECT REPORT ON:-
EURO AND ITS IMPACT ON
EUROPEAN
ECONOMY
PREPARED BY:- SUBMITTED TO:-
SUPRIYA 35
AFSANA 36 DEVANG KALE
YOGESH 37 (SCHOOL OF
LILA 38 MANAGEMENT-SVU)
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2. ABOUT EUROPE ECONOMY
The economy of Europe comprises more than 731 million people in 48 different states. It
contributes 11% of the world's population. Like other continents, the wealth of Europe's
states varies, although the poorest are well above the poorest states of other continents in
terms of GDP and living standards. The difference in wealth across Europe can be seen in a
rough East-West divide. Whilst Western European states all have high GDPs and living
standards, many of Eastern Europe's economies are still rising from the collapse of the
communist Soviet Union and former Yugoslavia. Throughout this article "Europe" and
derivatives of the word are taken to include selected states whose territory is only partly in
Europe such as Turkey, Azerbaijan, and the Russian Federation and states that are
geographically in Asia, bordering Europe such as Armenia and Cyprus.
Europe was the first continent to industrialize led by the United Kingdom in the 18th
century and as a result, it has become one of the richest continents in the world today.
Europe's largest national economy is that of Germany, which ranks fourth globally in
nominal GDP, and fourth in purchasing (PPP) GDP; followed by the UK, which ranks sixth
globally in nominal GDP and fifth in PPP GDP; France, ranking seventh globally in nominal
GDP, followed by Italy. The end of World War II has since brought European countries
closer together, culminating in the formation of the European Union (EU) and in 1999, the
introduction of a unified currency the euro. If the European Union was taken as a single
country, today it would be the world's largest economy see List of countries by GDP. In
2009 Europe remained the wealthiest region. Its $37.1 trillion in assets under management
represented one-third of the world s wealth. It was one of several regions where wealth
surpassed its pre crisis year-end peak.
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3. THE EORO CURRENCY:-
The euro was introduced to world financial markets as an accounting currency in 1999 and
launched as physical coins and banknotes in most of the above countries in 2002. Slovenia
joined the Euro zone on 1 January 2007, Malta and Cyprus a year later, and Slovakia on 1
January 2009. All EU member states are eligible to join if they comply with certain
monetary requirements, and eventual use of the euro is mandatory for all new EU member
states.
The euro is managed and administered by the Frankfurt-based European Central Bank
(ECB) and the European System of Central Banks (ESCB) (composed of the central banks of
its member states).
As an independent central bank, the ECB has sole authority to set monetary policy. The
ESCB participates in the printing, minting and distribution of notes and coins in all member
states, and the operation of the Euro zone payment systems.
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4. CHARACTERISTICS OF THE EURO
Coins and banknotes
The euro is divided into 100 cents (sometimes referred to as eurocents). All euro coins
(including the 2 commemorative coins) have a common side showing the denomination
(value) with the EU-countries in the background and a national side showing an image
specifically chosen by the country that issued the coin. All coins can be used in all member
states. The euro coins are 2, 1, 50c, 20c, 10c, 5c, 2c and 1c (known as tinies for their
small size), though the latter two are not minted in Finland or the Netherlands (but are still
legal tender). Many shop owners in the Euro zone prefer having all their prices end in 0 or
5 Cents, so that 1c and 2c coins are not needed. All euro banknotes have a common design
for each denomination on both sides. Notes are issued in 500, 200, 100, 50, 20, 10,
5. Some of the higher denominations, such as 500 and 200, are not issued in a few
countries, though are legal tender. The ECB has set up a clearing system for large euro
transactions (TARGET). All intra-Euro zone transfers shall cost the same as a domestic one.
This is true for retail payments, although several ECB payment methods can be used. Credit
card charging and ATM withdrawals within the Euro zone are also charged as if they were
domestic. The ECB hasn't standardized paper based payment orders, such as cheques;
these are still domestic-based.
The currency sign
A special euro currency sign ( ) was designed after a public survey had narrowed the
original ten proposals down to two. The European Commission then chose the final design.
The eventual winner was a design allegedly created by a team of four experts who have not
been officially named. The official story of the design history of the euro sign is disputed by
Arthur Eisenmenger, a former chief graphic designer for the EEC, who claims to have
created it as a generic symbol of Europe.
The glyph is (according to the European Commission) "a combination of the Greek epsilon,
as a sign of the weight of European civilization; an E for Europe; and the parallel lines
crossing through standing for the stability of the euro". The European Commission also
specified a euro logo with exact proportions and foreground/background color tones.
Although some font designers simply copied the exact shape of this logo as the euro sign in
their fonts, most designed their own variants, often based upon the capital letter C in the
respective font so that currency signs have the same width as Arabic numerals.
Placement of the currency sign varies from nation to nation. While the official
recommendation is to place it before the number (contravening the general ISO
recommendation to place unit symbol after the number), people in many countries have
kept the placement of their former currencies.
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5. ECONOMIC AND MONETARY UNION
History (1990-2006)
The euro was established by the provisions in the 1992 Maastricht Treaty on European
Union that was used to establish an economic and monetary union. In order to participate
in the new currency, member states had to meet strict criteria such as a budget deficit of
less than three per cent of their GDP, a debt ratio of less than sixty per cent of GDP, low
inflation, and interest rates close to the EU average. Economists that helped create or
contributed to the euro include Robert Mundell, Wim Duisenberg, Robert Tollison, Neil
Dowling and Tommaso Padoa-Schioppa. (For macro-economic theory, see below.)
Due to differences in national conventions for rounding and significant digits, all conversion
between the national currencies had to be carried out using the process of triangulation via
the euro. The definitive values in euro of these subdivisions (which represent the exchange
rates at which the currency entered the euro) are shown as:-
Currency Abbr. Rate Fixed on
Austrian schilling ATS 13.7603 31/12/1998
Belgian franc BEF 40.3399 31/12/1998
Dutch gulden NLG 2.20371 31/12/1998
Finnish mark FIM 5.94573 31/12/1998
French franc FRF 6.55957 31/12/1998
German mark DEM 1.95583 31/12/1998
Irish pound IEP 0.787564 31/12/1998
Italian lira ITL 1936.27 31/12/1998
Luxembourg franc LUF 40.3399 31/12/1998
Portuguese escudo PTE 200.482 31/12/1998
Spanish peseta ESP 166.386 31/12/1998
Greek drachma GRD 340.750[4] 19/06/2000
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6. The rates were determined by the Council of the European Union, based on a
recommendation from the European Commission based on the market rates on 31
December 1998, so that one ECU (European Currency Unit) would equal one euro. (The
European Currency Unit was an accounting unit used by the EU, based on the currencies of
the member states; it was not a currency in its own right.) These rates were set by Council
Regulation 2866/98 (EC), of 31 December 1998. They could not be set earlier, because the
ECU depended on the closing exchange rate of the non-euro currencies (principally the
pound sterling) that day.
The procedure used to fix the irrevocable conversion rate between the Drachma and the
euro was different, since the euro by then was already two years old. While the conversion
rates for the initial eleven currencies were determined only hours before the euro was
introduced, the conversion rate for the Greek Drachma was fixed several months
beforehand, in Council Regulation 1478/2000 (EC), of 19 June 2000.
The currency was introduced in non-physical form (travellers' cheques, electronic transfers,
banking, etc.) at midnight on 1 January 1999, when the national currencies of participating
countries (the Euro zone) ceased to exist independently in that their exchange rates were
locked at fixed rates against each other, effectively making them mere non-decimal
subdivisions of the euro. The euro thus became the successor to the European Currency
Unit (ECU). The notes and coins for the old currencies, however, continued to be used as
legal tender until new notes and coins were introduced on 1 January 2002.
The changeover period during which the former currencies' notes and coins were
exchanged for those of the euro lasted about two months, until 28 February 2002. The
official date on which the national currencies ceased to be legal tender varied from member
state to member state. The earliest date was in Germany; the mark officially ceased to be
legal tender on 31 December 2001, though the exchange period lasted two months. The
final date was 28 February 2002, by which all national currencies ceased to be legal tender
in their respective member states. However, even after the official date, they continued to
be accepted by national central banks for several years up to forever in Austria, Germany,
Ireland, and Spain. The earliest coins to become non-convertible were the Portuguese
escudos, which ceased to have monetary value after 31 December 2002, although
banknotes remain exchangeable until 2022.
Current Euro zone
y The euro is the sole currency in Austria, Cyprus, Belgium, France, Finland, Germany, Greece,
Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. These 16
countries together are frequently referred to as the eurozone or the euro area, or more informally
'Euro land' or the 'Euro group'. The euro is also legal currency in the Euro zone overseas territories
of French Guiana, Reunion, Saint-Pierre et Miquelon, Guadeloupe, Martinique and Mayotte.
y By virtue of some bilateral agreements the European microstates of Monaco, San Marino, and
Vatican City mint their own euro coins on behalf of the European Central Bank.
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7. y Andorra, Montenegro and Kosovo adopted the euro as their legal currency for movement of
capital and payments without participation in the ESCB or the right to mint coins. Andorra is in the
process of entering a monetary agreement similar to Monaco, San Marino, and the Vatican City.
EFFECTS OF A SINGLE CURRENCY
The introduction of a single currency for many separate countries presents a number of
advantages and disadvantages for the participating countries. Opinions differ on the actual
effects of the euro so far, as most of them will take years to understand. Theories and
predictions abound.
Removal of exchange rate risk
One of the most important benefits of the euro will be lowered exchange rate risks, which
will make it easier to invest across borders. The risks of changes in the value of respective
currencies have always made it risky for companies or individuals to invest or even
import/export outside their own currency zone. Profits could be quickly eliminated as a
result of exchange rate fluctuations. As a result, most investors and importers/exporters
have to either accept the risk or "hedge" their bets, resulting in further costs on the
financial markets. Consequently, it is less appealing to invest outside one's own currency
zone. The Euro zone greatly increases the potentially "exchange-risk free" investment area.
Since Europe's economy is heavily dependent on intra-European exports, the benefits of
this effect can hardly be overstated. This is particularly important for countries whose
currencies have traditionally fluctuated a great deal such as the Mediterranean countries.
At the same time, this is likely to increase foreign investment in countries with more liberal
markets and reduce that in those with rigid markets. Some people worry that thus will see
profits flowing away from particular member states to the detriment of their traditional
social values. It might also result in the reduction of local decision makers in businesses.
Removal of conversion fees
A benefit is the removal of bank transaction charges that previously were a cost to both
individuals and businesses when exchanging from one national currency to another.
Although not an enormous cost, multiplied thousands of times, the savings add up across
the entire economy.
For electronic payments (e.g. credit cards, debit cards and cash machine withdrawals),
banks in the Euro zone must now charge the same for intra-member cross-border
transactions as they charge for domestic transactions. Banks in France have attempted to
circumvent this regulation by charging for all bank transfers (domestic and cross-border)
unless the transfer is instructed via online banking a method unavailable to cross-
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8. border payments. In this way, banks in France continue to charge more for cross-border
transfers than for domestic transfers.
Deeper financial markets
Another significant advantage of switching to the euro is the creation of deeper financial
markets. Financial markets on the continent are expected to be far more liquid and flexible
than they were in the past. There will be more competition for, and availability of financial
products across the union. This will reduce the financial servicing costs to businesses and
possibly even individual consumers across the continent. The costs associated with public
debt will also decrease. It is expected that the broader, deeper markets will lead to
increased stock market capitalization and investment. Larger, more internationally
competitive financial and business institutions may arise.
Price parity
Another effect of the common European currency is that differences in prices in
particular in price levels should decrease. Differences in prices can trigger arbitrage, i.e.
speculative trade in a commodity between countries purely to exploit the price differential,
which will tend to equalise prices across the euro area. It is held that this is supposed to
result in increased competition or consolidation of companies, which should help to
contain inflation and which therefore will be beneficial to consumers. Similarly, price
transparency across borders should help consumers find lower cost goods or services. In
reality, the effects of the euro over the level of the prices in Europe are disputable. Many
citizens cite the strong increase in prices in the years after the introduction of the euro,
although numerous empirical studies have failed to find much real evidence of this. It is
speculated that the reason for this perception is that the prices of small, everyday items
were rounded up significantly. For example, a cup of coffee that once cost two German
Marks might now cost 1.50 or even 2.00 - a 50-100% increase. At the same time, a large
appliance or rent payment rounded up to the next obvious euro level would be a negligible
proportional increase. The fact that the prices people see every day were affected more
strongly might explain why so many people perceive the "euro effect" as being significant,
while official studies which look at the breadth of expenditures, in proportion would
downplay it.
Competitive funding
Competitive funding is also a benefit for many countries (and companies) that adopted the
euro. National and corporate bonds denominated in euro are significantly more liquid and
have lower interest rates than was historically the case when denominated in legacy
currency. Likewise, companies have greater freedom to borrow competitively from cross-
border banks without incurring exchange rate risk. This has forced the incumbent banks to
reduce their rates to compete.
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9. Macroeconomic stability
Improved macroeconomic stability is an important benefit of the euro for the entire
continent. Much of Europe has been susceptible to economic problems such as inflation
throughout the last 50 years. Because a high level of inflation acts as a highly regressive tax
(Seigniorage) and theoretically discourages investment, it is generally viewed as
undesirable. In spite of the downside, many countries have been unable or unwilling to deal
with serious inflationary pressures. Some countries have successfully contained by
establishing largely independent central banks. One such bank was the Bundesbank in
Germany; since the European Central Bank is modeled on the Bundesbank, it is
independent of the pressures of national governments and has a mandate to keep
inflationary pressures low. Member countries join the bank to credibly commit to lower
inflation, hoping to enjoy the macroeconomic stability associated with low levels of
expected inflation. The ECB (unlike the Federal Reserve in the United States of America)
does not have a second objective to sustain growth and employment.
Less-specific monetary policy
Some economists are concerned about the possible dangers of adopting a single currency
for a large and diverse area. As the euro-Zone has a single monetary policy and a single
interest rate set by the ECB, it cannot be fine-tuned for the economic situation in each
individual country. Prior to the introduction of the euro, however, exchange rate volatility
had reduced substantially after the European currency crisis in the early 1990s. Public
investment and fiscal policy in each country is thus the only way in which government-led
economic stimulus can be introduced specific to each region or nation. This inflexible
interest rate might stifle growth in some areas, while over-promoting it in others. The
result could be extended periods of economic depression in some areas of the continent,
disadvantaged by the central interest rate. Given such a situation, resentment and friction
within the community and toward the bank might increase. Others point out that in today's
globalised economy; individual countries do not really have power to effectively manage
their monetary policy, as it creates other imbalances. This effect was already visible in the
last European currency crises of 1992, when the Bundesbank was effectively coordinating
monetary policy for the whole continent.
Some proponents of the euro point out that the Euro zone is similar in size and population
to the United States, which has a single currency and a single monetary policy set by the
Federal Reserve. However, there are also substantial differences between the two regions.
The US has a common fiscal policy (Fiscal federalism) that it can use as an instrument to
smooth out regional differences. The countries of the EU that may not all be 'in sync'
each may be at a different stage in the boom and bust cycle, or just be experiencing
different inflationary pressures cannot appeal to a centralized fiscal authority for
remedy. Furthermore, Labor mobility is also much lower in the Euro zone than across the
United States, largely due to the vast differences in language and culture between European
nations despite labor, capital and goods full mobility rules.
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10. A new reserve currency
The euro will probably become one of two, or perhaps three, major global reserve
currencies. Currently, international currency exchange is dominated by the US dollar
(USD). The US dollar is used by banks world-wide as a stable reserve on which to ensure
their liquidity and international transactions and investments are often made in US dollars.
A currency is attractive for foreign transactions when it demonstrates a proven track record
of stability, a well-developed financial market to dispose of the currency in, and proven
acceptability to others. The euro will almost certainly be able to match these criteria at
least as well as the US dollar, so given some time to become accepted, it will likely begin to
take its place alongside the dollar as one of the world s major international currencies.
Since money is effectively an interest free loan to the government by the holder of the
currency foreign reserves act as subsidy to the country minting the currency (see
Seigniorage). As the euro assumes status a reserve currency, the EU member states stand to
gain a share of this benefit.
Euro and petroleum
The Euro zone consumes more imported petroleum than the US, meaning more Euros than
US dollars would flow into the OPEC nations. However, oil is priced by those member states
in US dollars only. There have been frequent discussions at OPEC about pricing oil in Euros.
In 2006, Iran announced its plans to open an International Oil Bourse for the express
purpose of trading oil priced in other currencies, including petroeuros. This would require
countries to hold stores of Euros to buy oil, rather than the US dollars they hold now. If
implemented by OPEC, the changeover to the euro would be a transfer of a 'float' that
presently subsidizes the United States to subsidies the European Union instead.
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11. EURO EXCHANGE RATE
Flexible exchange rates
The ECB targets interest rates rather than exchange rates and in general does not intervene
on the foreign exchange rate markets, because of the implications of the Mundell-Fleming
Model, being the fact that a central bank cannot maintain an interest rate target and an
exchange rate target simultaneously, as increasing the money supply would result in a
depreciation of the currency. In the years following the Single European Act, the EU has
liberalized its capital markets, and as the ECB has chosen for monetary autonomy, the
exchange rate regime of the euro is flexible, or floating. This explains why the exchange rate
of the euro vis-à-vis other currencies is characterized by strong fluctuations. Most notable
are the fluctuations of the euro vs. the US dollar, another freely floating currency. However
this focus on the dollar-euro parity is partly subjective. It is taken as a reference because
the European authorities expect the euro to compete with the dollar. The effect of this
selective reference is misleading, as it give to the observers the impression that a rise in the
value of the euro vs the dollar is the effect of an increased global strength of the euro, while
it may be the effect of an intrinsic weakening of the dollar itself.
Against other major currencies
After the introduction of the euro, its exchange rate against other currencies, especially the
US dollar, declined heavily. At its introduction in 1999, the euro was traded at US$1.18; on
26 October 2000, it fell to an all time low of $0.8228 per euro. It then began what at the
time was thought to be a recovery; by the beginning of 2001 it had risen to nearly $0.96. It
declined again, although less than previously, reaching a low of $0.8344 on 6 July 2001
before commencing a steady appreciation. The two currencies reached parity on 15 July
2002, and by the end of 2002 the euro had reached $1.04 as it climbed further.
On 23 May 2003, the euro surpassed its initial ($1.18= 1.00) trading value for the first time.
At the end of 2004, it had reached a peak of $1.3668 per euro ( 0.7316 per $) as the US
dollar fell against all major currencies, fuelled by the so called twin deficit of the US
accounts. However, the dollar recovered in 2005, rising to $1.18 per euro ( 0.85 per
dollar) in July 2005 (and stable throughout the second half of 2005). The fast increase in US
interest rates during 2005 had much to do with this trend.
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12. EUROPEAN EXCHANGE RATE MECHANISM (ERM)
The European exchange rate mechanism (or ERM) was a system introduced by the
European Community in March 1979, as part of the European Monetary System (EMS), to
reduce exchange-rate variability and achieve monetary stability in Europe, in preparation
for Economic and Monetary Union and the introduction of a single currency, the Euro,
which took place in January 1999. All 9 member states of the Community at the time joined
the EMS.
Until 1999, all member states that participated in the ERM, also participated in the ECU.
European Currency Unit
The European Currency Unit ( ; ECU) was a basket of the currencies of the European
Community member states, used as the unit of account of the European Community, before
being replaced by the Euro. The European Exchange Rate Mechanism attempted to
minimize fluctuations between member state currencies and the ECU. The ECU was also
used in some international financial transactions. Just as the dollar was at the center of the
BW system and was its de facto numeraire and reserve asset (dollar is as good as gold ),
the ECU was designed to be the unit of account and the reserve asset at the center of the
European Monetary System (EMS).
The ERM is based on the concept of fixed currency exchange rate margins, but with
exchange rates variable with those margins. It was a new institutional framework for
maintaining stability between Community currencies while allowing them to float against
the other currencies.
Before the introduction of the Euro, exchange rates were based on the ECU, the European
unit of account, whose value was determined as a weighted average of the participating
currencies. It was just more than a unit of account as ECU was also an official reserve asset
held by the European Monetary Cooperation Fund (later replaced with a European
Monetary Fund).
A grid of bilateral rates was calculated on the basis of these central rates expressed in ECUs,
and currency fluctuations had to be contained within a margin of 2.25% either side of the
bilateral rates (with the exception of the Italian lira, which was allowed a margin of 6%).
For example: FF/ECU divided by DM/ECU is the FF/DM bilateral central rate as a ratio of
two ECU central rates and the margin of fluctuation between FF and DM bilateral central
rate could not exceed the + or 2.25 percent.
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13. The structure of the bilateral central rates was to be agreed unanimously by the Ecofin
Council, composed of the Finance Ministers and by the Governors of the Central Banks of
the participating countries. The bilateral central rates were aligned 11 times between 1979
and 1987, once in 1990 and 5 times between 1992 and 1993 (due to the speculative attack
on the weaker currencies of the ERM). Last realignment was in 1995.
ECU also provided an early warning signal to participating member States that their
macroeconomic policies are inconsistent with the established ECU parities (central
parities).
ERM assigned more evenly the obligations between Member States with strong and weak
currencies: They both had a legal obligation to intervene in unlimited amounts to defend
these margins. The country with the strong currency had the obligation to prevent further
appreciation and the country with the weak currency had the obligation to prevent further
depreciation in excess of the predetermined margin of 2.25% either side of the bilateral
rates. Determined intervention and loan arrangements protected the participating
currencies from greater exchange rates fluctuations.
For example: Suppose that bilateral central rate for FF and DM is set at 335.386FF=100DM
(or 3.35 FF=1DM) as of 1995. This is a fixed parity with 2.25% margin of fluctuations on
each side: The FF can go as low as 343.050FF=100DM or as high as 327.92FF=100DM).
If the actual FF/DM bilateral rate hits or exceeds 343.050FF=100DM, then FF is about to
cross the bilateral margin on the low edge (weak FF and strong DM), then Banque de
France is required to buy its own currency against the DM on the Paris foreign exchange
market and the Bundesbank is required to lend DMs to Banque de France so that the latter
can purchase FF using the DMs at its disposal. Since Banque de France has to repay its
intervention credit in DMs or ECUs, its reserves at the EMCF is immediately reduced or its
liability is recorded while Bundesbank s reserves at the EMCF are immediately increased.
In support of this intervention, Bundesbank is required to sell its currency against the FF on
the Frankfurt exchange market. As a result of these transactions, the monetary base and
foreign exchange reserves in Germany increase and the monetary base and foreign
exchange reserves of France decreases.
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14. ADVANTAGES AND DISADVANTAGES OF ERM
ADVANTAGES:-
1. Transaction costs will be eliminated: - For instance, Uk firms currently spend about
£1.5 billion a year buying and selling foreign currencies to do business in the EU With the
EMU this is eliminated, so increasing profitability of EU firms. Advice to young people: You
can go on holiday and not have to worry about getting your money changed, therefore
avoiding high conversion charges.
2. Price transparency: - EU firms and households often find it difficult to accurately
compare the prices of goods, services and resources across the EU because of the distorting
effects of exchange rate differences. This discourages trade. According to economic theory,
prices should act as a mechanism to allocate resources in an optimal way, so as to improve
economic efficiency. There is a far greater chance of this happening across an area where
E.M.U exists.
Advice to young people: We can buy things without wrecking our brains trying to calculate
what price it is in our currency.
3. Uncertainty caused by Exchange rate fluctuations eliminated: - Many firms
become wary when investing in other countries because of the uncertainty caused by the
fluctuating currencies in the EU. Investment would rise in the EMU area as the currency is
universal within the area; therefore the anxiety that was previously apparent is there no
more.
4. Single currency in single market makes sense: - Trade and everything else should
operate more effectively and efficiently with the Euro. Single currency in a single market
seems to be the way forward.
5. Rival to the "Big Two": - If we look out in the world today we can see strong
currencies such as the Japanese Yen and The American $. America and Japan both have
strong economies and have millions of inhabitants. A newly found monetary union and a
new currency in Europe could be a rival to the "BIG TWO".
EMU can be self-supporting and so they could survive without trading with anyone outside
the EMU area.
This fact makes the Euro very strong already, and even George Soros couldn't affect it (well,
hopefully!!!!).
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15. The situation that EMU is in is good as it seems that it can survive on its own, with or
without the help of Japan and U.S.A.
6. Prevent war: - The EMU is, and will be a political project. It's founding is a step
towards European integration, to prevent war in the union. It's a well known fact that
countries that trade effectively together don't wage war on each other and if EMU means
more happy trade, then this means, peace throughout Europe and beyond (we hope).
7. Increased Trade and reduced costs to firms : - Proponents of the move argue that it
brings considerable economic trade through the wiping out of exchange rate fluctuations,
but as well as this it helps to lower costs to industry because companies will not have to
buy foreign exchange for use within the EU. For them, EU represents the completion of the
Single European Market. It is vital if Europe is to compete with the other large trading blocs
of the Far East and North America.
8. The Political agenda: - There is also a political agenda to European bank (the
European System of Central Banks -ESCB), the complete removal of national control over
monetary policy and the partial removal of control over fiscal policy. Individual nation
states will lose sovereignty (i.e. the ability to control their own affairs). It will be a
considerable step down the road towards political union. There are many in the EU who
favors economical den political union and they are very much in factor to EMU. There are
also many who wish to keep national sovereignty and are struggling to prevent EMU,
whatever its merits might be, from going ahead.
9. Inflation: - From the mid-1980s onwards, there were a number of economists and
politicians who argued that, for the UK at least, EMU provided the best way forward to
achieve low inflation rates throughout the EU. During the first half of the 1980s high
inflation countries, such as France and Italy were forced to adopt policies which reduced
their inflation rates to something approximating the German inflation rates to something
approximating the German inflation rate. If they had not done this, the franc and the lira
would have had to be periodically devalued, negating the fixed exchange rate advantages of
the system. Effectively, the German central bank, the Bundesbank, set inflation targets and
therefore monetary targets for the rest of the EU. At the time, there was much discussion of
why Germany had a better inflation record than many other European countries. The
consensus emerged that it was because the Bundesbank, the German central bank, was
independent of the German Government. In countries such as the UK and France, central
banks were controlled by governments. If the UK government decided to loosen monetary
policy, for example, by reducing interest rates, it had the power to order the Bank of
England to carry out this policy on its behalf. There have always been especially strong
pressures before an election for UK governments to loosen the monetary reins and create a
15

16. boom in the economy, with the subsequent increase in inflation following the election. The
Bundesbank, in contrast, was independent of government. By law it has a duty to maintain
stable prices. It can resist pressures from the German government to pursue reflation
policies if it believes that these will increase inflation within the economy. Events of the
early 1990s have shaken the naive faith that linkage to the independent ESBC, the central
bank of Europe would solve all inflationary problems. This is because German inflation
rates in the early 1990s rose to over 4% as Germany shrugged with the consequences of
unification. In 1993, inflation was nearly three times as high in Germany as in the UK and
twice as high as that in France. Some countries, such as France, have made their central
banks independent on the Germany model and therefore arguably don't need to the EMU
link to Germany to maintained low inflation. The UK has gone a little way towards giving
more power to the central bank by publishing reports neither of monthly meetings
between the Chancellor of the Exchequer and the Govern nor of the Bank of England. This
forces the Government to justify its monetary policy publically and makes it harder for it to
use interest rates for short term political ends.
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17. DISADVANTAGES:-
1. The instability of the system: - Throughout most of the 1980s the UK refused to join
the ERM (Exchange rate mechanism). It argued that it would be impossible to maintain
exchange rate stability within the ERM, especially in the early 1980s when the pound was a
petro-currency and when the UK inflation rate was consistently above that of Germany.
When the UK joined the ERM in 1990 there had been three years of relative currency
stability in Europe and it looked as though the system had become relatively robust. The
events of Sept. 1992, when the UK and Italy were forced to leave the system, showed that
the system was much less robust than had been thought.
2. Over estimation of Trade benefits: - Some economists argue that the trade and cost
advantages of EMU have been grossly overestimated. There is little to be gained from
moving from the present system which has some stability built into it, to the rigidities
which EMU would bring.
3. Loss of Sovereignty: - On the political side, it is argued that an independent central
bank is undemocratic. Governments must be able to control the actions of the central banks
because Governments have been democratically elected by the people, whereas an
independent central bank would be controlled by a non elected body. Moreover, there
would be a considerable loss of sovereignty. Power would be transferred from London to
Brussels. This would be highly undesirable because national governments would lose the
ability to control policy. It would be one more step down the road towards a Europe where
Brussels was akin to Westminster and Westminster akin to a local authority.
4. Deflationary tendencies: - Perhaps the most important economic argument relates
to the deflationary tendencies within the system. In the 1980s and 90's France succeeded
in reducing her inflation rates to German levels, but at the cost of higher unemployment,
For the UK, it can be argued, that membership of the ERM between 1990 and 1992
prolonged unnecessarily the recessional period. This is because the adjustment mechanism
acts rather like that of the gold standard. Higher inflation in one ERM country means that it
is likely to generate current account deficits and put downward pressure on its currency.
To reduce the deficit and reduce inflation, the country has to deflate its economy. In the UK,
it could be argued that the battle to bring down inflation had been won by the time the UK
joined the ERM in 1990. However, the UK joined at too high an exchange rate. It was too
high because the UK was still running a large current account deficit at an exchange rate of
around 3 Dm to the pound. The UK government then spent the next two years defending
the value of the pound in the ERM with interest rates which were too high to allow the
economy to recover. Many forecasts predicted that, had the UK not left the ERM in Sept
1992, inflation in the UK in 1993 would have been negative (ie prices would have
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18. fallen).The economic cost of this would have been continued unemployment at 3million
and a stagnant economy. When the UK did leave the ERM and it rapidly cut interest rates
from 10% to five and a half %, there was strong economic growth and the current account
position improved, but there was an inflation cost.
Another problem that the early 1990s highlighted was that the needs of one part of Europe
can have a negative impact on the rest of Europe. In the early 1990s, the Germans struggled
with the economic consequences of German reunification. There was a large increase in
spending in Germany with a consequent rise in inflation. The Bundesbank responded by
raising German interest rates. As a result, there was an upward pressure on the DM as
speculative money was attracted into Germany. Germansy's ERM partners were then
forced to raise their interst rates to defend their currencies. However, higher interest rates
forced most of Europe into recession in 1992 - 1993. Countries such as France couldn't
then get out of recession by cutting interest rates because this would have put damaging
strains on the ERM. The overall result was that Europe suffered a recession because of local
reunification problems in Germany. Critics of the ERM and EMU argue that this could be
repeated frequently if EMU were ever to be achieved. Local economies would suffer
economic shocks because of policies, forced on them, designed to meet the problems of
other parts of Europe.
One way around this would be to have large transfers of money from region to region when
a local area experienced a recession, e.g. N. Ireland which suffered structural
unemployment for most of the post war period, has had its economy propped up by large
transfers of resources from richer areas of the UK with lower unemployment. However,
regional transfers are very small at the moment unfortunately. Moreover to approximate
the regional transfers which occur at the moment in, say, Britain, there would have to be a
huge transfer of expenditures from national governments to Brussels - just what anti
Europeans are opposed to.
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19. IMPACT OF CURRENCY RISE IN EUROPEAN ECONOMY
While few believe that this increase will have a positive impact on some of the sectors in
the country, others voiced their concerns over the negative repercussions that this will
have on the overall economy.
Obviously the increase in euro exchange rate will affect the price structure in Lebanon,
said head of Beirut traders association Nicolas Chammas who explained that traders will,
to some extent, be able to eat the extra cost for a while but once the euro becomes very
expensive they will not be able to sacrifice their margin anymore. They will have to relay
the impact of the increase in the exchange rate of euro on their selling prices, Chammas
told The Daily Star.
Chammas believes that this will be translated into higher inflation in the country. This
takes us back to the year 2008 when the euro climbed to $1.50 and inflation rate was
eating away the purchasing power of the population at that time, he added. It seems that
we are getting there again.
Despite the euro s fundamental weakness over the past year, the past few days have seen
strongly resurgent growth for the 16-nation single currency. The EUR/USD has recently
touched an eight-month high mark and climbed above $1.40; the EUR/JPY and EUR/GBP
are both at five-month highs, and still climbing; and the EUR/CAD ascended to a seven-
month high to currently trade at 1.417.
As far as exports are concerned, Chammas said that Lebanon s export of goods and services
should benefit from the weakening in the US dollar since the Lebanese pound is pegged to
the dollar. When you export to Europe for instance and you have a weakening US dollar
you will be able to export at more competitive prices, he added. However, the fact that the
US dollar is weakened is not enough by itself to be able to export your way out of the
crisis.
Chammas noted that the climb in the euro will create social tensions in Lebanon because a
large chunk of exports are euro denominated. So this promises to cause more demands
from the unions and other stakeholders in order to increase wages and perhaps subsidize
some products and this is not very good news, he added.
Moreover, when the dollar is weakened the price of commodities such as oil will increase
because it moves in opposite to the dollar exchange rate, he said. Since oil is such an
important component of our imports, this will also cause some problems as far as the
national budget is concerned because you will have to have more transfers to EDL, he said.
You cannot increase oil price for consumption and the state will be losing some of its tax
revenues, he added.
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20. Chammas concerns were echoed by the head of the association of food importers Adel Abi
Shaker who said that prices have not increased yet with the latest hike in the euro
exchange rate but if the latter continues to go up, merchants are expected to increase their
prices by around 5 percent. Importers do not have the hobby of constantly increasing their
prices, and the process is not easy because they have to inform supermarkets every time
they do that, he said. But when the euro increases then prices will automatically go up
and this is normal.
Shaker said that merchants normally would want to increase their profits. However, he
added, it is fair to say that with the presence of a high competition in Lebanon it is hard for
them to generate a great profit.
Shaker doubted that some merchants attempt to hide their food products when the euro
gets higher for them to increase their prices and generate higher profits. They have to
stick to the date of production displayed on the commodities. Moreover, manufacturers
usually give only a period of two years for the expiry date for them to be able to sell more,
he said.
From his side, head of the consumers protection
association Zouhair Berro said that prices movement in Lebanon has nothing to do with the
change in international prices. He argued that even when the euro goes down, prices in
Lebanon remain the same. However, when it climbs, merchants tend to take advantage of
the situation and increase their prices.
Berro cited the example of the price of wheat which dropped from $600 per ton in 2008 to
$180 per ton in June 2010 while the price of bread remained the same in Lebanon at that
time. Today, the price of wheat reached $330 per ton and the price of bread increased in
parallel, he said.
Meanwhile, economist Ghazi Wazneh believes that this increase will impact the prices of
goods and services in addition to affecting the inflation rate. This increase will lead to a
further deficit in trade while negatively impacting the surplus in the balance of payments,
not to forget that the number of Lebanese tourists to Europe will go down, he said.
Wazneh said that the prices will stay the same for the time being but he believes that they
will go up if the euro exchange rate climbs above $1.50. We still don t know if it will keep
on increasing but if it does then traders will probably resort to the US for their imports.
However, Wazneh s view of the situation was not totally pessimistic because this increase,
in his opinion, will not have any negative impact on the public debt. Moreover, if the euro
keeps on increasing, Lebanese products will be more able to compete and exports will
consequently go up, he said.
Likewise, president of the Lebanese industrialists association Nemat Ifram expressed his
optimistic view on the increase of euro and its impact on the Lebanese industrial sector.
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21. If we sell to countries who originally import from the euro zone, our goods will then be
able to compete because European products will be much more expensive, he said.
Moreover, he added that at the time of increase in the euro exchange rate, if Lebanon sells
its products to markets dealing with the euro currency, then it will be able to increase its
prices using the US dollar currency because the Lebanese economy is dollarized. Lebanon
will then be able to benefit from better selling prices.
However, Ifram said that if euro climbs to more than $2 then demand in the European
countries will go down and the European economy will witness a slowdown. However, we
are still on the safe side because the euro exchange rate did not even reach $1.70 yet.
According to the statistics of the European commission, total EU-Lebanon trade amounts to
approximately 4.4 billion Euros ($6.12 billion), but is its third largest market for exports
(12.4 percent), behind Syria (24.9 percent) and the United Arab Emirates (12.9 percent). It
said that EU goods exports to Lebanon in 2009 amounted to 4.2 billion Euros while EU
goods imports from Lebanon during the same year reached 0.25 billion euro.
As a result of the recent increase in the euro exchange rate, money exchange companies in
Lebanon agreed that the demand on the euro currency by businesses and companies
dropped since the currency started to climb. The demand on euro dropped by 40 percent
compared the same period of the year 2009, said Wissam Mallah, representative of Cash
United.
His comments were echoed by Khaled Shouman, one of the owners of Shouman exchange
in Beirut, who said that demand on euro by businesses has dropped lately due to this
sudden increase.
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22. DECLINE IN VALUE OF CURRENCY COULD LEAD TO INCREASE IN
EXPORTS
Many economists think the 16-country currency is headed for a significant decline
because of Europe's government debt crisis.
Some are even predicting that by next year the euro will sink to what's called parity
against the U.S. dollar ² ¼1 equals $1, a level last seen in July 2002 and an 18 percent
slide from Friday's $1.23.
Such a decline would take some of the shine off Europe's vaunted project in a shared
currency. And it would cut European's purchasing power for imports. But if it happens
gradually enough, the slide in the euro's exchange rate could help exports and provide
the boost Europe's troubled economy needs.
Export-focused companies would be more competitive on price outside the eurozone,
likely boosting their revenue and helping to remove the threat that Europe will drag
down the global economy and stock markets.
With a lower euro, Parisian hotel owners could sell more Left Bank hotel rooms to
tourists from North America, while Italy would surely sell more shoes and textiles. And
Spain just might be able to turn over some of that vacant seaside property left from a
U.S.-style real estate bubble.
And since China and other Asian countries link their currency to the dollar, the euro
would weaken in that direction as well and help trade with Asia.
All that would come as a relief to U.S. officials and investors, who have seen Europe's
troubles weigh on stocks and expectations for the world economy in the past several
weeks.
Exports have been a key factor lifting Europe out of recession. In the fourth quarter of
2009, exports from the euro zone rose 1.9 percent over the prior quarter and totaled
¼838 billion ² or 36 percent of euro zone economic output.
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