The European Economic Community And The Euro — страница 4

to the Stability and Growth Pact, an agreement that strictly limits government borrowing and forces governments to shape up their public finances. The pact also fines countries that borrow too much. “The euro is modernizing European economies, shrinking the size of their welfare states, and encouraging a modern, global view.” There exists the possibility that the euro will become a major international reserve currency. Reserve currencies are use by central banks, governments, and private firms worldwide as long-term store of value and to meet their ongoing financial requirements. The dollar is currently the world’s premiere reserve currency. Historically only currencies that are highly liquid, stable, and accepted as payment in a large economic area have the potential to

become major reserve currencies. Reserve currencies are highly demanded and therefore benefit from high liquidity and extremely low transaction cost in foreign exchange markets. Reserve currency status similarly benefits a nation’s securities markets, because buyers interested in holding a reserve currency buy assets denominated in that currency. This in turn lowers the cost of borrowing for firms and governments raising money in that currency. The advantages of having a currency, which is used as a unit of account and a medium of exchange in the rest of the world, are significant. There are two benefits. First, when a currency is used internationally, the issuer of that currency obtains additional revenues. For example, in 1999 more than half of the dollars issued by the

Federal Reserve were used outside of the USA. This doubles the size of the balance sheet of the Federal Reserve. Therefore the profits double and go on directly to the US government. In turn citizens enjoy the benefits of the worldwide use of the dollar in the form of lower taxes needed to finance a given level of government spending. If the euro reaches the same level as the dollar, citizens of Euroland will enjoy similar benefits. Also if the euro becomes an international currency, activity will boost for domestic financial markets. “Foreign residents will want to invest in assets and issue debt in that currency. As a result, domestic banks will attract business, and so will the bond and equity markets. This in turn will create jobs.” Therefore if the euro becomes an

international currency like the dollar, there will likely be the creation of new opportunities of financial institutions in Euroland. Finally, the euro has also encouraged economic growth within the European Economic Community. Lower transaction costs and exchange rate risk, coupled with price transparency and a single means of payment, have increased the effective size of the product markets across euroland. As a result, some multinationals can now achieve economies of scale, which is “the ability to produce products at a lower average cost than competitors due high volume”. Economic historians know that economies of scale have been a key determinant of the United States industrial success for centuries. Euroland now hopes to benefit form the lower average costs, higher

productivity, and enhanced competitiveness promised by a large internal market. Although the euro has proven to be successful since it was integrated in January 1999, there are two major ongoing risks associated with monetary union. These risks are not one-time costs that will soon disappear. Instead, they will threaten the sustainability of the euro for decades to come. These shocks involve susceptibility to economic shocks and political discord. Economic shocks are “unexpected changes in the macroeconomic environment of a country or region that disrupts the careful balance of production, consumption, investment, government spending, and trade.” The most threatening type of economic shock for the single currency area is known as an asymmetric shock, so called because such

shocks affect countries unequally. They can be caused by sharp declines or increases in demand for the primary goods and services of a specific country. “Before the arrival of the euro, Euroland countries could handle asymmetric shocks and the recessions that often followed them in three primary ways: interest rate adjustment, exchange rate intervention, and fiscal adjustment.” Of these, interest rate adjustment was the most important. The euro, however, makes independent interest rate adjustments impossible, because Euroland’s national central banks surrendered monetary policy authority to the European Central Bank in Frankfurt as of January 1999. There is now a single set of short-term interest rates for all euro participants. Therefore, unless economic shocks hit all