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Weaknesses WITH THE Eurozone Economics Essay

Robert Mundell described the Bretton Woods System as Hamlet with no Prince because of the insufficient a unified money in the form of a financial union expressed as Bancor or Unitas. Given the experience of EMU, does indeed this research still hold theoretically and/or empirically? Discuss.

Introduction of EMU

In 1999, the European Central Loan company (ECB) launched the solo currency (euro) alongside the base of the Economic and Monetary Union (EMU). The EMU is based on the lifestyle of the euro as a currency. The ECB supervises the execution of the common monetary coverage. At the beginning of 2002, euro substituted the countrywide currencies of 12 member countries for those deals. Sweden, Denmark, and the uk joined European Union (European union) but did not become a member of the euro. In 2004, there have been ten new member countries joined the EU, five of them joined up with the euro.

The prior monetary unions don't succeed as they rested on the worthiness of metals (i. e. gold or sterling silver). The money printed out should be determined by the magic of rare metal stored, therefore the Metallism financial system is a well balanced system since gold and silver are scarce resources.

The EMU rests on the euro or chartalism, as fiat money which is released by a central national loan company. The credit degree of the issuing is important to determine the value and stability of the fiat money. The steadiness of the country in terms of economical and political will subsequently determine the credit level. However, when the treasury struggles to financing the deficit, fiat monies can become unstable because of the enticement of the inflationary duty or seigniorage. To be able to achieve and preserve the balance, the EMU needs an economic union and a economic union. Economical union is achieved by complying with the Stability and Progress Pact (SGP). The goal of SGP is to keep up fiscal balance through execution of specific fiscal requirements among member state governments of EMU.

The durability of the Eurozone rests completely on the credibility of the requirements place when the EMU was being implemented and the ECB was set up. However, if member areas are not value or follow the set requirements, the reliability degree of Eurozone will be affected and therefore negatively impact the euro.

Mundell's Theories

The original notion of a common money in Europe was produced from the idea of Robert Mundell on the regions of optimal currency. In his newspaper "An idea for a European Money" in 1973, Mundell clarified the gains of European countries if they choose a common currency. The works of Mundell have been categorised into two categories by Ronald McKinnon (2004).

Mundell I

In 1961, Mundell released his paper entitled "A Theory of Optimal Money Areas" which is rooted in Keynesian ideas. The theory of Optimum Money Areas (OCAs) studies how countries with a economic union and common money adjust, if these countries are afflicted by asymmetric economical shocks. Mundell point out that adjustments are based on whether wages are rigid, labour range of motion is bound, income exchanges are difficult, and dissimilarities are present in the labour market and development rates. Mundell stated that whenever countries are in a financial union and use a currency, they can not absorb asymmetric shocks properly unless, among other circumstances, labour mobility is unlimited.

Mundell II

In Mundell's article "Uncommon arguments for common currencies" which publicized in 1973, an alternative solution theory is illustrated. Mundell emphasised "the normal currency guarantees an automatic and equal posting of the chance of the fluctuation", a money has advantages in overcoming monetary shocks. Mundell II argues that it is easier for member countries to remain inside a financial union than outside it because the private insurance would assist against asymmetric shocks. More specifically, it will be easier for member countries to borrow in the administrative centre marketplaces of the economic union when reaching by a negative shock, because of this it will be easier for member countries to smooth consumption. Furthermore, the exchange rate would be a source in arising asymmetric disturbances; especially capital flexibility of financial market is high.

The criticism of Mundell II becomes more apparent in terms of political framework. If financial markets in a financial union provide insurance to reduce asymmetric shocks, the need to integrate national finances for politics means becomes weaker. Hence the motive to create a political union is even weaker. However, the Mundell II explain that when there is no budgetary union, it would be optimistic to state that private financial marketplaces would provide insurance against asymmetric shocks. The financial marketplaces will only provide insurance to the people who own high property stock in the financial marketplaces. Since riches is not similarly sent out, the private provision of insurance will overwhelmingly support the prosperous and keep the poor relatively uninsured. In addition, the Mundell II theory disregarded the likelihood that countries may entail in a position of the 'bad equilibrium'. If there aren't adequate devices to lead the economy out of the bad equilibrium, countries would get found in the bad equilibrium after a poor shock. It is a major problem for the future of EMU if there is no adequate instrument in a economic union. This is reinforced by the actual fact that different member countries of EMU continue to work in different directions because of the absence of a politics union.

Weaknesses of the Eurozone

In the previous a decade, the euro has exhibited that we now have many efficiency benefits by adopting a typical currency (i. e. reduced transaction costs of exchanging currencies, taken out exchange rate doubt, and increased transparency in prices), particularly if the currency becomes not only a global money but also a global currency. However, retaining various criteria requires difficult changes and constant security of every single member status in Eurozone.

As the economical crisis has strike the globe, certain Eurozone Member State governments - Greece, Portugal and Spain are being significantly affected. The Greek tragedy is making the EU recognize that highly indebted countries can position the EMU vulnerable and that steps must be taken without delay.

Institutional Weakness

Article 102. a of the Maastricht Treaty establishes that member expresses and the community should "conduct their financial plans with a view to adding to the achievement of the goals of the Community". To be able to guide Article 102. a, Article 103 shows that the correct implementation of monetary procedures is a subject of common, proclaiming that "Member States [are to] coordinate them within the Council, relative to the procedures of Article 102a". Article 103 also highlights that it is important to avoid increased deficits of every government. There can be an obvious institutional weakness in terms of monetary insurance policies. The Maastricht Treaty acquired defined the goals of the ECB which is price stableness. ECB has described an inflation rate below 2% as the aim of price stability. Furthermore, in conditions of unemployment, the others of culture is not convinced and can not easily agree to the attempt of the ECB to release itself from any responsibility for unemployment. However, the delegation of the duty of unemployment to the government authorities of each member country creates a political problem.

The purposes of SGP contain that member countries should avoid extreme debt and deficits and each member country should maintain fiscal balance. You will find two important two Council Regulations in SGP (i. e. Laws 1466/97 and 1467/97). Both of these legislation require member countries of the EU must adhere to to help "donate to the overall weather of stability and financial prudence underpinning the success of the EMU". The Council Legislation 1466/97 set out the facts of stableness programs (i. e. distribution and monitoring rules) and convergence programs. The ultimate reason for the multilateral security by the Council is to avoid, at an early on stage, the incident of excessive standard government deficits also to promote the surveillance and coordination of financial policies. The purpose of rules 1467/97 is to clarify the unnecessary deficit method to deter increased federal government deficits (Western european Navigator 1997, 2). However, the SGP is not ecological because of the insufficient accountability of the EU commission. Hence, the nationwide governments are bound to earn when conflict occurs. The situation will exist as long as national governments continue to have the sovereignty over spending and taxation.

Political integration

De Grauwe (2006) acknowledged that the EMU is a remarkable accomplishment, but the lack of a political union is a significant weakness in the Eurozone governance. Grauwe's view is consistent with the results of Nitsch on the political integration. He conclude that "political integration is not rapidly followed by economic integration" (Nitsch and Wolf 1). Grauwe explain in his article that countrywide governments holding most economic policies decision creates asymmetric shocks. The asymmetric shocks truly affect the sustainability of the financial union. For instance, member countries of the Eurozone have different competitive positions because of the uncoordinated policies of every member country in relation to national wage.

Italy, Ireland, Portugal, Greece and Spain were in regular financial and economical turmoil before the adoption of the euro. The turmoil situation vanished due to the monetary booming of days gone by years. These five countries have scarcely met certain requirements of monetary and economic stableness and are becoming increasingly difficult to keep up the steadiness. For days gone by years, these countries aren't only suffering from excessive deficits and debt, but also economic unbalances (i. e. extreme current accounts deficits). The existing account positions are becoming worse due to, among other reasons, their extremely uncompetitive trade position. As a result, they are starting to blame the euro.

The problem that these countries are facing originates from the actual fact that financial union amplifies fiscal imbalances. Opting for devaluation of the competitive money is not an option and the only real other alternative is due to forcing differentials of bond produce reduced. In 2005 there have been almost no produce differentials between the German Bund and the yields of those countries with high current-account deficits. In '09 2009, however, produce spreads has increased authorities default risks assessed by a sudden increase in the demand for credit default swaps. Hence, the existing economic crisis has confirmed that money risk is substituted by default risk in a economic union. You can find two reasons for this example: 1) the sovereign personal debt of each member country is released under the control of each Ministry of Money, 2) there is absolutely no Western Ministry of Funding.

The Germans has proposed the creation of any European Monetary Account, the French category has proposed the creation of any European Debt Agency which required that the Lisbon Treaty were amended or that a new treaty were negotiated. Many people blamed this situation due to the lack of a standard relationship market which would help put all users together. Some people reject the suggestion based on the actual fact that a common bond market would lower borrowing charges for weaker countries and increase costs for better countries such as Germany. In addition, the common connection market would obtain the budget rights from each governments which would not be able to make national costs independently.

Exit clause

For years some countries havent respect or adopted the requirements outlined in the Maastricht Treaty and are actually facing extremely difficult financial situations. It is obvious in the current crisis that there is no politics homogeneity among member countries from a politics viewpoint. Because of this, each member country has put in place its own particular financial model as well as how to conduct its economic model. In addition, Greece, Spain, and Portugal do not truly realize that their monetary models are embedded in a globalised current economic climate and these countries need to use a set of agonizing structural reforms to keep them competitive. From economic perspective, the countries in trouble have two major common reasons. The reason why are the lack of respect for certain requirements and having less appropriate execution of the structural reforms required under an financial recession.

Currently there are debates on what should or should not be done with these countries. However, there are not room to manoeuvre this example under the current legal platform.

Expulsion of the countries from the Eurozone is not a good choice as it would definitely damage the image of the European union and its member countries. Many scholars, economists propose that voluntary withdrawal from only the Eurozone while residing in the European union to would be the very best option.

The legal platform - the Treaty of Lisbon, will not provide the necessary methods to offer with problems of withdrawal, expulsion from Eurozone nor other similar problem that might appear soon. First, the Treaty of Lisbon has the "no-bailout" clause to avoid a budgetary problem in a single country spilling in the EU as a whole. The no-bailout clause prohibits member countries from rescuing other countries or from taking the obligations of other countries. However, this article 122 of Lisbon Treaty states that any member country "really threatened with severe problems induced by natural disasters or exceptional occurrences beyond its control" can obtain financial assistance from other associates. The question is whether an associate country's current arrears crisis could qualify as an "exceptional occurrence" rather than a "man-made" concern. This clause was put to improve unity and dedication of Eurozone. However the the truth is that some countries are having extremely advanced bad debts and deficits considerably exceeding the requirements. Therefore, there are not many options for to assist these financial stressed countries under the existing circumstances. The Articles 4(2), 118, and 123(4) explicitly suggests that the process for adoption of the Euro is irreversible. Contribution of the EMU becomes a legal responsibility due to the irrevocability of the contract and the financial union process. Thus, the leave option of leaving EMU while residing in the European union is impossible. The exit option is merely allowed to exit the European union and EMU altogether.

In addition, there is absolutely no clear mechanism where participants could expel a fellow country. The expulsion could only be possible if the treaty were amended and so long as all member countries reply favourably to the amendment.


The EU and the Eurozone are struggling not just a financial crisis, but also a completely insufficient appropriate structural reforms. The correct performing of the EMU is determined by the conformity with necessity provided in monetary and fiscal procedures. Some member countries need to adopt urgently a number of structural reforms to market economic progress of its own country and to stable euro within the EMU. Most of all, the EMU should take this turmoil as an possibility to develop a restructuring device to enhance and reform the financial, politics foundations of the euro task.

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