Report on Euro Currency, Exchange Rate, EMS, and Economic Union

This report provides a comprehensive analysis of the Euro currency, delving into its role as the official currency of the Eurozone and the benefits and drawbacks of a single currency. It explores exchange rate theories, particularly Purchasing Power Parity (PPP), and its implications. The report further examines the European Monetary System (EMS), its elements, and its function in maintaining currency stability within the European Union. It also discusses the challenges faced during economic crises and the potential future trends of the economic and monetary union, including the impact of the sovereign debt crisis, the role of the European Central Bank, and the need for fiscal transfers. The report concludes by referencing relevant literature on the subject.

THE SINGLE EUROPEAN CURRENCY
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Euro can be determined as the official currency of eurozone. In this context, it includes
19 member states of EU. Institution of European Union also make use of the currency officially.
It was in the year 1998 when European leaders agreed on introducing 11 countries with euro
(Hanf and Soetendorp, 2014). There are many benefits that individuals get with single currency.
With this respect, it includes the cost related to change currencies is eliminated. Further, there is
price transparency and eliminates exchange rate uncertainty. On the other hand, there are
disadvantages that includes transition cost, single policy effects other countries. Present report
covers theory related to exchange rate. Further, it covers elements that make up EMS (European
Monetary System). Lastly, it also includes problems associated with recent crisis.
Exchange rate theory
PPP (Purchasing Power Parity) is a type of economy theory in which the price level of
two countries need to be same to each other and that also after exchange rate adjustment. Main
aim of this theory is the law of one price. For example, they aim at making the cost identical
good to be same in the world (Wallace, Pollack and Young, 2015 ). As per this theory, if there is
large difference between the price of same products among two countries even after exchange
rate adjustment, then there is arbitrage opportunity created. This is because the product can be
purchased from any other country at lower price. Further, the connection between commodity
price and exchange is known as the law of one price. With this respect, one price states that
absence of friction that includes shipping tariffs and costs. When the price of product is
converted in currency, then the final product should be same for every country (Farina and Croci
Angelini, 2016 ). This is also helpful in order to control inflation rate. For example, if a country
say ABC has inflation rate of 10% and another country XYZ where the inflation rate is 5%, then
the rate of inflation for XYZ will be calculated is 4.76% against ABC.
There are benefits with single currency in which it includes improvement in inflation
performance, transparency in price, eliminating exchange rate uncertainty and reduction in
transaction cost. On the other hand, there are also disadvantages. With this respect, it includes
implementation of single monitory policy for the countries where they follow single currency
(Howarth and Quaglia, 2014). In other words, it is important to set out interest rate centrally for
Euro countries. In order to move into single currency, it incurs short term transition costs. For
example, all the old notes needs to be changes with new once. For this process time is consumed.
Further, it also includes installation of vending machines so that people may not face difficulties.
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In addition to this, there is inverse impact due to external economic shocks (Wallace, Pollack,
and Young, 2015 ). This can be understood in conditions in which the price of oil or any other
commodity increases rapidly.
European Monetary System (EMS) is considered as the system that is adopted by
European Community members with the purpose to promote stability by minimizing the
exchange rate fluctuation. There are 3 different principal elements such as European Currency
Unit, monetary unit and Exchange rate mechanism and thus all such elements helps in carrying
out the desired operating in country (John Pinder, 2014). However, it has been analysed that
those EU members who states taking part agreed to maintain currency fluctuation within certain
agreed limit and thus identifies several issues faced by them. All the identified elements are
involved in making EURO and thus helps in coordinating the economic and monetary policy of
EU. It has been analysed that in order to stabilize the currencies of the member states it helps in
carrying out European Monetary System and thus it carries out the same Snake system.
However, currencies would fluctuate around. Thus, EMS is one of the major element and thus it
helps in attaining success. Through this inflation was stabilized, capital were controlled and thus
gradually it helps member states to undertake collective decision making so that best results
could be attained (John McCormack, 2014).
While, at the time of global crisis it ensures that economic problems were faced and thus
EMS needs to be carried out so that policies could be made evident. However, without national
currencies all these countries could not carry out devaluation and thus were allowed to spend in
regard to offset unemployment rates. While, carrying out EMS policy within EU countries it
assesses that it helps in becoming the economies stronger and this finally established bailout
measures in regard to provide relief to other struggling members. Further, European Stability
Mechanism undertakes a permanent fund in order to help and carry out struggling in the
economies of EU member countries (Hanf and Soetendorp, 2014). Therefore, several strict
actions need to be undertaken so that regulations could be maintained and it does not impact
upon the countries. Another important element of EMS is European Currency Unit and thus it
helps in developing EURO. ECU helps in determining exchange rate within participant countries
so that they are able to officially sanctioned accounting methods. In the early years, EMS were
marked through uneven currency values and thus adjustments need to be made so that stronger
currencies could be build and thus lower down the weaker ones.
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European Monetary System helps in arranging all the member nations of EU and thus
link their currencies to protect large fluctuations relative to each other. ECU was one of the
effective element and thus carries out the strategy to determine exchange rate among the other
nations currencies so that strong currencies could be valued more and weaker currencies could be
lowered down (E Bomberg, Peterson and Corbett, 2014). Thus, EMS was strained through
differing economic policies and condition of its members and thus permanently withdraw from
the system. Thus, EMS was crested in order to establish the European Central Bank so that single
monetary policy and interest rate for the EuroZone nations needs to be maintained.
Understand potential future trends of the economic and monetary union
From the past several quarters in Europe, there has been a developing recovery which
aids in obtaining more stringer and sustained growth in different areas. Thus, decisive policy
action is required beyond the current mix and the optimistic contribution by the ECB policy
stance. The current policy mix in the EU seems to be moving in the right direction and it also has
a positive impact on the interest rates and financial markets (Making Progress In Economic And
Monetary Union. 2015). Thus, the weakening of the euro could also be considered as an indirect
consequence of quantitative estimate. Therefore, it is also important to note that there must be a
move towards a more proactive monetary policy stance lies in Eurozone which is also facilitated
by the execution of responsible fiscal policies and national reform program in the EU Member
States.
The Eurozone will experience significant challenge in coming years because of sovereign
debt crisis that leads to a stagnation in GDP or a recession in all countries in the Economic and
Monetary Union (Lamps out over Europe as Brexit marks the end of the European Union. 2016).
Various key economies are also required to refinance large amounts of government bonds that
come due in the first quarter and which have also rolled over €149 billion of bonds. Most likely,
some government might have to pay high premiums for newly issues debt or they even struggle
to find buyers. Thus, it can be said that The European Central Bank may therefore need to scale
up the securities market programmes as they play stronger role in the same. At the same time,
this can also develop liquidity squeeze which would prove temporary beneficial aspect (Brexit
and the future of the Euro. 2016). Apart from that investors have to begin again so as to regain
confidence out events which continue to erode the trust of investors while making debt rollover.
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Therefore, it is not counteracted by adequate liquidity support, then this might lead to the
break- up of EMU. However, at the same time it has several flaws as well because Eurozone has
lacked suffice adjustment mechanism to cope up with the diverging performance of its members
(E Bomberg, Peterson and Corbett, 2014). Therefore, without the possibility of currency
devaluation, members could face an uphill battle for the purpose of balancing any loss of
competitiveness due to increase in unit labour costs. On the alternate side, fiscal transfers
between member countries can also assist in reducing economic imbalances. Therefore, it is
evident that none of these mechanisms are sufficient in placing the Eurozone which also results
in diverging competitiveness (The future of the euro. 2012). Hence, it could bring large
eventually unsustainable and current account imbalances which exists particularly between
Southern and Northern EMU members.
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REFERENCES
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E Bomberg, J., Peterson, R. and Corbett, 2014. The European Union. How does it work?,
Oxford. pp. 110 – 112.
Farina, E. C. and Croci Angelini, E., 2016. Integration without Convergence in the European
Currency Area. A monetary hope for Europe. pp.41-63.
Hanf, K. and Soetendorp, B., 2014. Adapting to European integration: small states and the
European Union. Routledge.
Howarth, D. and Quaglia, L., 2014. The steep road to European banking union: Constructing the
single resolution mechanism. JCMS: Journal of Common Market Studies. 52(S1).
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John Pinder, 2014. The Building of the European Union. Oxford.
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<https://www.socialeurope.eu/2015/10/making-progress-in-economic-and-monetary-
union/>. [Accessed on 29th March 2017].
Wallace, H., Pollack, M. A. and Young, A. R. eds., 2015. Policy-making in the European Union.
Oxford University Press, USA.
The future of the euro. 2012. [Pdf]. Available through: <https://www.mckinsey.de/files/The
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