The Euro Essay, Research Paper

On January 1, 1999, eleven European countries replaced their national currencies and introduced a single European currency, the Euro. As of then, the Euro is considered to be the official currency in the eleven participating countries. Bills and coins of the national currencies will remain in circulation as sub-denominations of the Euro until January 1, 2002, when they will be exchanged against new Euro coins and bills. However, all inter-bank commerce and stock exchange trade is now denominated in the official currency.

Conversion Rates

The irrevocable conversion rates of the participating currencies have been fixed through a unanimous vote of the European Council. The external value of the Euro corresponds to the external value of the ECU, which means that the conversion rate between them is one to one. In order to avoid speculation, the bilateral market rates were taken as the basis for the conversion. Thus the conversion rates protect the external value of the participating currencies. Furthermore, to avoid misuse of rounding in carrying out conversions, conversion rates have six significant digits. The rates shown in the table below are the official conversion rates announced on December 31, 1998. In carrying out the conversion, only the official conversion rate will be used, but not its reciprocal value. That is, to change local currency into Euro, divide by the conversion rate.

Euro Conversion Rates

Country Currency 1 Euro =

Austria ATS 13.7603

Belgium BEF 40.3399

Finland FIM 5.94573

France FRF 6.55957

Germany DEM 1.95583

Ireland IEP 0.787564

Italy ITL 1936.27

Luxembourg LUF 40.3399

Netherlands NLG 2.20371

Spain ESP 166.386

Portugal PTE 200.482

The Euro Symbol

The dollar, the pound, and the yen all have symbols to denote their currency. A new symbol has been created for the Euro: a stylized e, with two dashes instead of one in the middle. It is usually displayed in yellow color on a blue background:

Pros and Cons

Arguments for a single European currency

-Transaction Costs

Having to deal with only one currency will reduce the cost of converting one currency into another. This will benefit businesses as well as tourists.

-No Exchange Rate Uncertainty

Eliminating exchange rates between European countries eliminates the risks of unforeseen exchange rate reevaluations or devaluation’s.

-Transparency & Competition

The direct comparability of prices and wages will increase competition across Europe, leading to lower prices for consumers and improved investment opportunities for businesses.

-Strength

The new Euro will be among the strongest currencies in the world, along with the US Dollar and the Japanese Yen. It will soon become the 2nd-most important reserve currency after the US Dollar.

-Capital Market

The large Euro zone will integrate the national financial markets, leading to higher efficiency in the allocation of capital in Europe.

-No Competitive Devaluation’s

One country can no longer devalue its currency against another member country in a bid to increase the competitiveness of its exporters.

-Fiscal Discipline

With a single currency, other governments have an interest in bringing countries with a lack of fiscal discipline into line.

-European Identity

A European currency will strengthen European identity.

Arguments against a single European currency

-Cost of Introduction

Consumers and businesses will have to convert their bills and coins into new ones, and convert all prices and wages into the new currency. This will involve some costs as banks and businesses need to update computer software for accounting purposes, update price lists, and so on.

-Non-Synchronicity of Business Cycles

Europe may not constitute an “optimum currency area” because the business cycles across the various countries do not move in synchronicity.

-Fiscal Policy Spillovers

Since there will only be a Europe-wide interest rate, individual countries that increase their debt will raise interest rates in all other countries. EU countries may have to increase their intra-EU transfer payments to help regions in need.

-No Competitive Devaluation’s

In a recession, a country can no longer stimulate its economy by devaluing its currency and increasing exports.

-Central Bank Independence

Previously, the anchor of the European Monetary System has been the independence of the German Bundesbank and its strong focus on price stability. Even though the new European Central Bank (ECB) will be nominally independent, it will have to prove its independence. This will at the very least incur temporary costs, as it will have to be extra-tough on inflation.

-Excessive Fiscal Discipline

When other governments exert pressure on a government to reduce borrowing, or even pay fines if the budget deficit exceeds a reference value, this may have the perverse effect of increasing an existing economic imbalance or deepening a recession.

An important aspect in the debate about the pros and cons is what part of Europe would constitute an “optimum currency area” (OCA). There are several criteria which determine this; the two most important are synchronicity of the business cycles and high bilateral trade intensities. R.A. Mundell originally proposed the concept of OCAs in an 1961 paper in the American Economic Review. According to Mundell, an OCA is an economic unit composed of regions affected symmetrically by disturbances and between which labor and other factors of production flow freely. In an OCA, policymakers balance the savings in transaction costs from the creation of a single money against the consequences of diminished policy autonomy from the loss of the exchange rate and monetary policy as instruments of responding to economic shocks. That loss will be more costly when economic shocks are more region-specific. Countries qualify for membership in an OCA if its benefits outweigh its costs.