Euro as a New Currency has Changed the Economic Landscape of the World

Paper Info
Page count 7
Word count 1883
Read time 7 min
Subject Economics
Type Essay
Language 🇺🇸 US

The creation of the European Economic and Monetary Union, or EMU, has often been called the biggest change in the international monetary system since the collapse of the Bretton-woods system in the early 1970s. The creation of an economic and monetary union among countries representing a GDP almost as large as that of the United States has brought a fundamental change to the international monetary and economic system that used to be dominated by the dollar for decades.

The creation of EMU was the final stage of a long process. It is the result of 50 years of ever closer economic integration in Europe. It started in 1951 with sectoral cooperation in the European Coal and Steel Community. Gradually this Community became a Union of 25 European countries with common approaches to economic, social, environmental policies and some aspects of home affairs and foreign policies.

The culmination of the integration process came with EMU, on the first of January 1999. EMU is innovative in many ways. Its most visible component is the creation of a single currency, the euro. In 2002, new banknotes and coins were introduced, replacing national currencies, such as the French Franc, the Deutsche Mark and the Italian Lira. The euro now serves as the common currency of twelve European Union Member States and, in the future, many more as the ten new European Member States are expected to adopt the euro, once they have met the necessary convergence criteria.

EMU also triggered a fundamental change in monetary and economic governance in the euro area, with a unique, new assignment of policy responsibilities. An independent European Central Bank was set up to implement the single monetary policy and to ensure price stability for the euro area as a whole. Fiscal policies and structural policies remain under the responsibility of Member States, but within common rules and strengthened coordination at the European level.

More than six years of EMU existence have proven that this innovative assignment of policy responsibilities delivers positive results even if it is not accompanied by a full political union. I have to recognize though that considerable challenges remain for the euro area to reach its full potential. I will talk about these challenges later. First, I would like to elaborate on the benefits the euro has brought to the euro area and to the global economy.

What are the benefits?

The euro has created a greater sense of unity among the countries that share this new currency. It has brought their economies closer, has led to more trade and FDI flows within the euro area, enhanced financial market integration and given the euro a growing international role.

Indeed, with its emphasis on price stability and sound public finances, EMU has provided a stable macroeconomic policy environment, which was previously lacking in many European countries. An impressive degree of budgetary consolidation was achieved in the run-up to the launch of the euro. On average, public finance deficits fell by more than 5% of GDP during the 1993-1998 period. The run-up to the launch of the euro also saw a significant reduction in inflation rates, from an average of over 4% in 1991 (more than 10% in some countries) to 1.5% in 1998.

During the first 6 years of the euro’s existence, inflation expectations have been remarkably stable and within the price-stability definition of the ECB. Long-term rates also fell dramatically and some countries experienced a very important compression of the interest rate spread with the creation of the euro. As a consequence, the servicing of the public debt was made a lot lighter. And it reflects the high credibility of the ECB’s monetary strategy. This is a major achievement given that the ECB was a new central bank without any track record.

The elimination of the exchange rate risk within the euro area is, of course, a key feature of EMU. It was the key reason for creating the euro. The elimination of intra EMU exchange rate changes has significantly reduced transaction costs for cross border activities in the euro area, paving the way for an increase in trade and investment.

In the past, external shocks such as rising oil prices or the Mexican crisis in 1994/95 often triggered intra-European exchange rate tensions leading frequently to exchange rate misalignments within Europe. These episodes had negative consequences for cross border trade and investment and were therefore costly in terms of growth and employment. With EMU, by definition, these exchange rate tensions have disappeared. Furthermore, the pricing of goods and services in a single currency has enhanced transparency and increased competition within EMU. As a consequence, trade within EMU has increased. Between 1998 and 2004, the trade among EMU members has increased at an annual rate of 5.7%, while the trade between EMU members and the other members of the EU has only increased by 4.7%. And the euro area has become a more attractive destination for foreign direct investment. The share of FDI inflows into the euro area members in the total FDI inflows into the EU has increased steadily since 1999 from about 65% in 1999 to 93% in 2003.

I would like to conclude on this point by mentioning a specific sector: the financial services sector. Financial market activity in EMU has also benefited from the elimination of the exchange rate risk. The euro has clearly increased the depth of financial market. At the same time, the euro has highlighted the opportunity cost of the remaining financial market fragmentations. As a consequence, efforts to complete the Single Market in financial services have been significantly accelerated.

This leads me to the impact that the euro is having outside the euro area itself.

This international impact results from the size of the euro area economy and from the stability oriented framework that has been in place and that has functioned well. It is therefore no surprise that the euro has rapidly become the second most important international currency and that the euro area has become one of the most relevant economic entities at the international level, accounting for 23% of world GDP and world trade (this excludes intra euro area trade).

The enhanced macroeconomic stability, the improved economic efficiency and the closer financial integration within EMU have inspired confidence in the euro among consumers, producers and investors, not only in the euro area but well beyond its borders. The euro has provided the possibility for international public and private investors to diversify their asset allocation, and for borrowers to diversify their sources of funding.

A few examples illustrate the status of the euro as the second most important international currency. By mid-2004, the euro accounted for almost a third of the outstanding amounts of international debt securities. In foreign exchange markets, the euro accounted for almost a fifth of all foreign exchange transactions last year. Also, in international trade, the share of euro as quoting, invoicing and settlement currency exceeded 50% in 2003 for both imports and exports in most euro area countries where data is available. Thus, though the US dollar remains the international currency of choice in many other areas, it is no longer the sole international currency. The euro represents a valuable alternative.

The aggregate fiscal and monetary policy stance of the euro area is also becoming increasingly relevant for the world economy. In their surveillance and assessment of global economic, monetary and financial developments, international financial institutions, like the IMF, BIS and OECD, as well as private banks focus on euro area developments. These institutions conduct regular reviews of the macro-economic situation and policy mix of the euro area and have established a close dialogue with the European Commission and the European Central Bank. The change is also reflected in G7 Finance Ministers statements that no longer refer to specific euro area Member States but to the euro area overall.

The increasing influence of the euro area in the world economy implies an increased responsibility, on our side, for the state of the global economy. The economic weight of the euro area makes it a key actor when global coordination of national policies is at stake, on issues such as macroeconomic surveillance, financial market stability, trade liberalization, official development assistance or humanitarian aid.

The Full Potential of Euro Has Yet to Be Reached

the success of the European single currency over the last 6 ½ years has been remarkable. But the full potential of the EMU has yet to be reached. I see three major areas where the euro has not yet delivered in full its expected benefits.

These three areas are: raising the potential growth rate of the euro area, strengthening our economic governance and enhancing the euro area’s visibility on the international scene.

The growth performance of the euro area has fallen short of expectations. The sluggishness is particularly striking when comparing euro area growth rates with growth in the US: between 1999 and 2004, i.e. during the first 6 years of EMU: 1.9% in the euro area compared to 3.1% achieved by the US. This comparison is, however, misleading to some extent. The growth differential between Europe and the US is partly explained by demographic developments: the population of the euro area does not grow much while the US population increases by more than 1% each year.

Comparing the growth of GDP per capita, the difference between the euro area and the US gets smaller – 0,5% on average since EMU began in 1999. In a longer-term perspective, the difference has been even smaller. Nevertheless, we are convinced that we can do better, as the GDP per capita levels in the euro area have stagnated at around 70% of the US-levels since the mid-90s. This is clearly unsatisfactory. Some catching-up should be possible in the future. The forthcoming ageing of the European population that will become visible in 2010 makes it all the more urgent to increase productivity in order to avoid a further decrease in Europe’s potential growth rate.

It is in the EU’s own interest to implement reforms, in order for Europe to fully reap the benefits of the ongoing globalization. We must indeed strengthen the key drivers of economic growth, namely employment and productivity. To that end, the EU launched the Lisbon Strategy in 2000, a comprehensive attempt to create a more dynamic and competitive European economy through a broad range of structural reforms. The pace of implementation of the reforms has been insufficient, but progress is being made.

The euro, despite its short existence, has already proven its worth.

The euro has contributed to the prosperity of the EMU by providing a stable macroeconomic policy environment that was lacking in many European countries, by spurring EU financial integration, and by inspiring confidence among consumers, producers and investors in the euro area and well beyond its borders. The euro has established itself as the second most important international currency. Its existence has already changed the global economic and monetary landscape. Whether the euro can develop its potential further will depend on the economic policies and the institutional arrangements that we will put in place. We are actively working onimproving these policies and I am optimistic about the continued success of the euro and about the capacity of EMU to become a truly global player in the world economy.

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Reference

EduRaven. (2021, November 6). Euro as a New Currency has Changed the Economic Landscape of the World. Retrieved from https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/

Reference

EduRaven. (2021, November 6). Euro as a New Currency has Changed the Economic Landscape of the World. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/

Work Cited

"Euro as a New Currency has Changed the Economic Landscape of the World." EduRaven, 6 Nov. 2021, eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.

References

EduRaven. (2021) 'Euro as a New Currency has Changed the Economic Landscape of the World'. 6 November.

References

EduRaven. 2021. "Euro as a New Currency has Changed the Economic Landscape of the World." November 6, 2021. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.

1. EduRaven. "Euro as a New Currency has Changed the Economic Landscape of the World." November 6, 2021. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.


Bibliography


EduRaven. "Euro as a New Currency has Changed the Economic Landscape of the World." November 6, 2021. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.

References

EduRaven. 2021. "Euro as a New Currency has Changed the Economic Landscape of the World." November 6, 2021. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.

1. EduRaven. "Euro as a New Currency has Changed the Economic Landscape of the World." November 6, 2021. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.


Bibliography


EduRaven. "Euro as a New Currency has Changed the Economic Landscape of the World." November 6, 2021. https://eduraven.com/euro-as-a-new-currency-has-changed-the-economic-landscape-of-the-world/.