Social Issues / What Do You Understand By Economic And Monetary Union? To What Extent Does Membership Of An Economic And Monetary Union Constrain A Country'S Use Of Monetary And Fiscal Policy

What Do You Understand By Economic And Monetary Union? To What Extent Does Membership Of An Economic And Monetary Union Constrain A Country'S Use Of Monetary And Fiscal Policy

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Autor:  anton  04 December 2010
Tags:  Understand,  Economic,  Monetary
Words: 1220   |   Pages: 5
Views: 388

An economic and monetary union is a single market with a common currency. It is to be distinguished from a mere currency union (e.g. the Latin Monetary Union in the 1800s), which does not involve a single market’. ( What I understand of an Economic and Monetary Union I feel is summarised by the term ‘pooling of policies’. Decisions such as interest rates (monetary) and taxation (fiscal) are grouped and controlled by a single commission acting as one on behalf of all member states/countries. A clear example of this is the European Union (formerly known as the ‘Economic Coal and Steel Community’ and also the ‘European Economic Community’). A Monetary Union could also be described as, ‘the permanent fixing of exchange rates between member countries’ (Begg & Ward330).

In 1952, five countries signed the Treaty of Paris uniting them on trade fronts. The countries were Belgium, Holland, Luxembourg, Italy and France. From this cohesion of countries, many more were to join and in the late 1970’s the ‘European Monetary System’ was born where it later developed and became the ‘European Monetary Union’. By March 1979, the EMU had two main principal elements:

1. The European Currency Unit – a common currency to be used for transactions throughout the Union.

2. The Exchange Rate Mechanism – which links domestic currencies to the ECU and to each other.

On 1st January 2002, the ECU’s dream of a single currency throughout Europe was implemented with many of the member states using the Euro as their common currency. Such countries included Germany, France and Italy. Although, this was nearly never a realisation when in 1992, the ERM failed and brought about doubts the feasibility of a single currency. Details of this failure are abounding later in my essay.

The European Monetary Union has changed and influenced a lot of principles that were in place before one centralised decision making body was in place. For example the removal of transaction costs through the members of the single currency has made it cheaper to buy and sell goods within themselves. This also means there is now no need to worry about exchange rate fluctuations when buying within the EU. Comparing prices has become a great deal easier across boarders of the respected countries for obvious reasons.

Through research and common knowledge I believe that membership of an Economic and Monetary Union by a country/state, constrains their use of the Monetary and Fiscal policies to a great extent. For example, with regards to the constraint affecting the Monetary policy, sovereign Governments cannot deal so effectively with their own 'economic cycles' due to the loss of interest changing abilities. The ‘Free movement of Labour’ within the EU can also be seen as a constraint on a countries monetary policy. Although it could also be argued it helps to stabilise employment when experiencing a shortage of workers.

A definition of the Monetary Policy is as follows, ‘the Monetary Policy is the use of interest rates or money supply, to control aggregate demand’ (*eco book for business page 288). A good example of how country’s involved in the EMU have been constrained regarding their monetary policy is with the creation of the European Central Bank (ECB). This Bank, similar to the Bank of England, has the powers to change interest rates. This means the interest rates are the same for all the single currency countries, thus helping to control inflation. The ‘pooling’ of such policies should allow for advantages such as a stable economic power to be formed, counteracting the economic superpowers such as the United States of America and China. However, through such a Monetary Union, a government loses the ability to increase or decrease interest rates. When their economy is overheating (inflation etc) or experiencing a slump, a country with interest rate changing ability can change interest rates as necessary to counteract the inflation (increase interest rates to encourage saving) or a slump (decrease interest rates to encourage spending). A clear example of how this constraint is of negative effect is the illustration of the ERM crisis in 1992, where the UK, Italian and Spanish Governments who were unable to support their currencies, (due to the ERM’s aim of restricting currency fluctuations to no more than 2.25%) had to consequently withdraw from the ERM and its interest rate policies.

A matter that also falls into the monetary policy is the issue of unemployment. During an Article on BBC Radio 4 on 24th April 2006, the topic of conversation was, 'free movement of labour and its effect on Monetary Policy’. It was said that although Western Europeans do not move from their countries to find work, persons from places such as Poland and Romania have done. A given example was where Eastern Europeans have travelled to this country filling jobs that British people don’t want and/or where they are needed. The movement of workers like this should effect each country’s’ employment ratings (theoretically decrease in the country they have left from and increase in the country they have gone to) and thus its policy (regarding they are not part of the single currency) on unemployment when using interest rates. Although the UK is subject to many of the EMU’s policies, it is not forced to obey them, however, it is clear to see from this example that it is still influenced by the policies even though not a complete member of the Monetary union.

The definition of the Fiscal Policy I feel is appropriately described as, ‘the Governments decisions regarding taxation and spending’. (*eco book for bus p 265). The constraints on a country’s monetary policy were clear to see in the previous paragraphs. However they are not mirrored to the same extent regarding the Fiscal Policy. Any member state (with the single currency or not) of the European Union, is not subject to common taxation from a single centralised body. Currently each sovereign government implements taxation in its own country. For example in the UK, the current Government of Labour, enforces its own taxation rules and brackets to help raise money to fund its spending (this is the Fiscal Policy). However, a common taxation will most definitely be needed if the European Union and the single currency are to work successfully.

The "Growth and Stability" Pack could be described as an important 'economic constraint' or 'straight jacket' when discussing Economic and Monetary Union. This Pack was proposed to the Commission by Germany to make the introduction of the Euro more stable. They were worried that the poorer countries adopting the Euro would let their economies run wild by spending more than they had got, so weakening the fledgling currency by inflation and so on. They proposed and the Commission then directed in the form of the Maastricth treaty, that no member of the European Union could borrow more than 3% of GDP in any particular period. It is clear to see that in practice this should be a constraint, but no one has kept to the Pack including Germany!

In conclusion, to the question of, ‘to what extent does membership of an Economic and Monetary Union constrain a country's use of monetary and fiscal policy?’, I feel it is of great extent to which membership of an Economic and Monetary Union constrains a country’s use of monetary and fiscal policy.

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