economics theme 3 : monetary unions

what is a monetary union

a group of countries that agree to share a common currency

what is an example of this

the euro

5 main features of the euro

• co-ordination of macro economic policies

• European financial stability facility

• fiscal impact

• single interest rate

• asymmetric inflation target

co-ordination of macro economic policies explanation

• members work together to ensure big financial decisions are in sync

• designed to enable economies within the euro area to converge

• stability pact - members agree to keep their economies stable and budget deficits under control

• agreed limit for a deficit was no more than 3% of gdp

european financial stability facility explanation

• formed to help stabilise the economies after the 2008 finical crisis, subsequent recession / sovereign debt crisis - now a key element of the reformulated euro system

• like a giant piggy bank to help members having money problems e.g. Greece

• lends them finance so they can keep running schools, hospitals and other important services

fiscal impact explanation

• to prevent eurozone from running up further debts, the majority of EU states signed a fiscal compact which opened up their domestic budgets to collective scrutiny

• agreements to ensure countries dont overspend

single interest rate explanation

• the European central bank (ECB) sets interest rates across the whole euro area

• no single national central bank has the ability to alter interest rates itself

asymmetric inflation target

• target rate for inflation of 2% but there is flexibility for members to diverge

• focuses more on stopping prices from going too high, but isn’t as strict if prices go low

• in the UK intervention occurs at rates 1% above and 1% below target rate

4 advantages of the euro that are primarily derived from the benefits of fixed exchange rates

• transparency

• lower transaction costs

• certainty and investment

• increased trade

transparency explanation

• producers and tourists can more easily compare the prices of international goods, services and resources

lower transaction costs explanation

• reduces costs because there are no commission payments to financial intermediaries

certainty and investment explanation

• firms can predict the cost of imported raw materials and can set the price of exports which means they can plan and are more likely to invest

increased trade explanation

• increased exports, increased profits, increased employment and increased tax revenue

3 disadvantages of the euro

• economic conditions of each country is different

• loss of financial autonomy of a country

• brewing up an economic crisis

different economic conditions explanation

• establishing a single currency means forming a central bank that has the sole authority to print currencies and set interest rates

• but economic conditions prevailing in each country are different and unique so not practical

loss of financial autonomy explanation

• govs would have to give up their autonomy over drafting economic policies benefiting them

• e.g. they cannot alter interest rates / devalue currency

brewing up an economic crisis explanation

• a central bank has to act in a fair and unbiased manner with a uniform policy

• however economic circumstances will vary across regions

• e.g. what’s good for Germany might not be good for Greece