Is common currency Euro[1] and are confronted with

Is the Euro Area an optimal currency


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Objective of this paper is to analyse and
determine if the Euro area is the optimal currency area. In order to do that it
must, in a first place, be determined what optimal currency area is, we have to
determine its factors and analyse its effects. Acquiring required answers
enables them to be later implemented in the case of this paper, that is in the
case of Euro area.

Euro area certainly presents advantages and
disadvantages to the member states. In year 2017 around 338.6 million people in
19 out of 28 EU countries are using the common currency Euro1
and are confronted with these advantages/disadvantages.  Because of variety of different economies and
different cultures, presently running and maintaining Euro area in good
condition, that presents a big challenge to all actors involved. If they are
properly challenged and recognised, that will also be considered and analysed
in this paper. 

In order to get the
“big picture” Euro area will be the presented from general and historical
perspective. Because of the words limitation in this paper it has to be stated,
that both above mentioned introductions will be presented as short as possible.

After the general picture of Euro area and
what the optimal currency area is, the paper will focus on the current state of
the area and the implementation for the future, so that the theoretical
knowledge can be integrated with actual situation and the conclusion, that is
the topic of this paper, can be drawn.

Introduction of the Euro area     

General introduction

A single currency means that all the
countries in the monetary union, in case of this paper all of the countries in
the Euro area, have the same basic interest rate and the same monetary policy.
Interest rates should differ among borrowers only due to the perceived
differences in credit risk. A common characteristic of a single currency is a
fixed exchange rate within the monetary union and the same exchange rate that
is relative to all other currencies. The exchange rate stays relative to all
other currencies even if individual countries in the monetary union would
possibly profit from differences in relative values.  2

Certain criteria had to be fulfilled in
order for a country to enter in the Euro area. They are called The euro
convergence criteria or the Maastricht criteria. It was signed on February 1992
and implemented on 1.10.1993. It determined the 5 conditions EU members had to
fulfil in order to adopt the new European currency3:

Public depth shouldn’t exceed
60% GDP from the country

The members of EU shouldn’t
have devalued the central rate of their euro pegged currency within the last
two years.

Inflation shouldn’t be higher
than 1,5% from average of three countries with lowest inflation rates.

Average yields for 10-year
government bonds shouldn’t be more than 2% higher than the arithmetic average
of the similar 10-year government bond yields in the 3 European Union member
countries with the lowest inflation rate.

The ratio of the annual general
government deficit relative to gross domestic product (GDP) at market prices,
must not exceed 3% at the end of the preceding fiscal year


Ambition to establish Monetary union for
the European Union started from the late 1960s onwards.  The union should bring stability and an
environment for higher economic growth and employment. The development of the
Economic and Monetary Union and subsequently the euro area can be divided into
four phases4:

From the Treaty of Rome to the
Werner Report (1957-1970)

From the Werner Report to the
European Monetary System (1970-1979)

From the start of EMS to
Maastricht (1979-1991)

From Maastricht to the euro and
the euro area, 1991 to 2002

Bretton Woods system provided the
international framework for stability of a currency with gold and the US dollar
as the main monetary standard and presented the post-war order for the market
economies of North America, Japan and Europe. The assumption was that stable
currencies would remain the norm, and that Europe’s construction could be
securely based on achieving a customs union and a common market. That would
allow the free movement of services, goods, people and capital. The Bretton
Woods system had already begun to show signs of strain in the late 1950s, and
the economic instability that was shown, in a revaluation of the Deutschmark and
the devaluation of the French Franc, endangered the common price system of the
common agricultural policy, which presented at that period one of the main
achievements of the European community.5

European Monetary System was created in March 1979 and exchange rates were at
the same time  linked to the European
Currency Unit (ECU), an accounting currency, introduced with a purpose to
stabilise exchange rates.  In July 1990,
the next step in paving the way for a single currency took place, then exchange
controls were abolished as a part of the Delors report. This meant that capital
movements  were no longer restricted in
the European Economic Community. With agreement on the goal (EMU) and the
conditions (the Maastricht criteria), the European Union could now move
forward. in July 1994  stage two of EMU
began  and lasted until 1999, the
introduction of the single currency. A wide variety of preparatory activities were
initiated  within stage two.6

On the 1st 
of January 2002 Euro banknotes and coins eventually came into being, with 7.4
billion notes and 38.2 billion coins beeing produced, in readiness / ?e si s tem mislil da je pripravljeno za ta
momentous date, bi jaz raje dala  HAVING PREPARED the necessary  for this
momentous date in European monetary history.7



Characteristics of Optimal currency area

Optimal currency areas theory presents us a
good framework for thinking about considerations that determine if members of
the area will lose or gain by fixing their mutual exchange rates. A loss or
gain from pegging its currency to an exchange rate are for a country are hard
to measure with numbers, but by combining the theory of Optimal currency area
with information on actual economic performance the claim can be evaluated,
that the Europe, most of which is probably going to adopt or peg to the single
currency euro, is an optimal currency area. 8

With the help of theory of optimal currency
area, we can determine if the countries, that significantly differ between each
other in economic growth and financial mechanisms, had to go through the
process of relative convergence. That means that they have to change and
integrate structural and institutional characteristics, that contribute to
better convergence of economic development, business cycle and criteria of
optimal currency area.

 Theory of optimal currency area tells us which
criteria should the individual participants of optimal currency area fulfil.
These criteria are high mobility of workforce, flexibility of markets,
salaries, and prices, accessibility of economy and diversification of
production. As further important factor we can also mention the similarity of
business cycles. In order to achieve optimal currency area the fulfilment of
these criteria is crucial. Below the characteristics of optimal currency area
will be detailed, analysed and presented.

Currency risk sharing

Currency risk sharing is “An agreement by the parties to a transaction to share the currency risk associated with the transaction. The arrangement involves a
customized hedge contract embedded in the underlying transaction.”

In Optimal currency area it is vital, that
the money is distributed to the regions that are having financial problems.
These criteria raised a lot of policy/ beseda policy ki si jo uporabil mi ni vše?,
ti tu si verjetno mislil razprave/debate tako da bi jaz morda dala debate/uproar- to pa je nezadovoljstvo 
as the countries with financial surpluses were not willing to
give financial help to the countries without surpluses. The unwillingness of
the European Economic and Monetary Union to bail out the countries in the
European sovereign debt crisis starting in 2009 is considered as a failure and
showed the unwillingness of wealthier and financially more stable countries to
help the countries that are financially inferior. 9

Price flexibility, capital mobility and wage flexibility

Price flexibility, capital mobility and
wage flexibility are  contributing to
help the market forces of supply and demand to transfer the financial founds to
the segments of optimal currency area where it is needed. The ability of
finances to move between areas that are trading with each other can boost the
trade and have overall positive effects on economy.10

Similar business cycle

The business cycle is a repeated five-stage
sequence of stagnation, growth and decline in the chosen economy. Growth leads
to a peak, which is followed by recession. Recession is period of decline
leading to a trough which is the bottom of the cycle. Trough is than followed
by a recovery which subsequently leads to a period of growth and with it  the business cycle is complete.

It is vital that all members of the
currency area have similar business cycles. So economic booms  can be 
shared. This gives also power the Central Bank to offset or diffuse the
recession. The tools to do that are promotion of economic growth and containing
the inflation.11

Labour mobility

Capability for a working force to move
within the currency area is very important criteria as it helps reducing
unemployment in region with high unemployment rate. Mundel (1961,659) says,
that this is the task of a central government. As an example we can take two
regions. First one we Name Region A and the second one Region B. Both of them
have their own currencies that are flexible. If for example international
exchange from region B to region A raises, depreciation of currency from region
A or appreciation of currency B would contribute to balancing the external
unbalance and contribute to lowering the unemployment rate in region B and to
lower inflation in region A. However, when those two regions use the same
currency, this adaptability of currency exchange rate is not possible,
therefore the only way to reduce the unbalance is  to allow the free flow of factors inside of
optimal currency area, which includes also mobility of working force.12


State of Euro area

In the last 25 year European union has
developed into a community where around 500 million are living. 315 Million are
sharing the same currency. Although the financial crisis  had negative effect on the area, the European
union stayed united and the Euro is still in use although much worst scenarios
were also being predicted.13

arrival of financial crisis some problems or better to say shortcomings arise
that need to be abolished. In order for European countries to being able to
restore the power on world markets in order to receive higher negotiation power
about deciding on their future,  the
members of European union, in particular members of euro area, have decided,
that they have to form even more bounded financial alliance. Although the
European union is using common currency, 
this currency is not supported by European budget in order to being able
to effectively execute the goals of their economic policy. Debates on how high
should be the European budget, 1,00 or 1,05% of GDP, are still very active. As
a comparison it can be stated, that in united states of America, federal budget
consists of around 35% GDP. If in European Union European budget will be
formed, than there will be a need to have a financial minister that will
respond to European parliament and have clear power of intervention connected
with the member states.14

Euro area economy is rising and furthermore predictions for near future
are very positive.  In September 2017 the
economic sentiment rose to the highest level in 
last ten years.15
At the same time  the unemployment rate
was kept on a multi-year low point with industrial productivity soaring. With
the economic picture looking good it is more trouble for euro-zone present
political situation,that became more turbulent in last weeks with a push for
independence of Catalonia. Although the actual independence of Catalonia is
quite unlikely and they will rather achieve higher state of autonomy, this
crisis has a significant effect on economic activities such as investment flows
to other parts of Spain and reduction of income from tourisms in Catalonia. Latvia, Luxembourg and Slovakia.
Three countries that are expected to have the fastest-growing economies in
the euro zone in the year 2018 are Slovakia, Luxembourg and Latvia. All three
of them are predicted to expand their economies for 3,5% or more. On the other
side will Italy record the lowest growing rate at around 1,2%. The German
economy is expected to grow significantly in the next year, due to improvement
of labour market conditions, what is projected to be translated in solid growth
of salaries.16


Labour mobility remains problematic though.
Language and cultural differences discourage workers’ migrations between Euro
area members to a greater extent than for example the movements of labour
force  between States in United states of
America. Government regulations are also contributing to lower mobility with
the requirement that in some countries the workers have to establish residence
before receiving unemployment benefits, what makes it harder for unemployed
labour force to search for jobs that are further away from their home countries.


Implications for the future

With transfer of competence to common
European institution the European community is becoming stronger and is having
more influence. The question of political union demands process of decision
that well be clear and easily understandable in the eyes of the European
citizens as without cooperation of the individuals in European union the whole
project loses its meaning. As in the case of united states of America,  also the European union  would need the two-chamber political system
which would allow us to vote the president directly. In that case it would
be  be achieved, that the citizens would
feel more connected with the European union which is closely connected and in
correlation with Euro Zone. 18

As mentioned above, stronger credibility of
commitments of national policy and common policies can be achieved either by
total decentralisation of decisions on the national level and hard enforcement
of the no-bail out Treaty clause or centralisation at the EU level of key
budgetary and economic policy decisions, with significant transfers of
sovereignty of individual member of the Union.19

The problem of long term competitiveness of
the Eurozone shouldn’t be neglected. Even if the problem of large budget
deficits and the related problems of the commercial banks, that have invested
in government bonds, would be reduced it would still not totally solve the
long?term competitiveness problem caused by Euro zone. That more basic problem
is the difference among Economic and Monetary Union members in long?term
competitiveness trends and the resulting differences in trade balances.  To give an example, Germany had a trade
surplus of nearly 200 billion dollars while the other, economically not so
strong members of the Monetary Union had trade deficits totalling around 200
billion dollars. 20

Although the economical differences between
member states it is safe to say, that the majority of citizens of the
countries, that are members of Euro zone, are still willing to stay. According
to Eurobarometer survey that European citizens are unhappy about the direction
taken by the European Union and the Eurozone but  still consider it as an appropriate
institution to deal with financial crises. They still believe in Euro but are
reluctant to move further with transfer powers to the European level. Although
according to the research the EU citizens are reluctant to move forward they
don’t want to go backward either due to dislike of their national political
participants and the fear of the negative effects of an unravelling of the
common currency. The results of the research were clearly indicated and
confirmed in the recent financial crisis in Greece.21

The transformation of economic resources
and mobility of quality workers is also consideration worth. The ability of the
Euro area to transform economic resources from members with healthy economy to
those with weak ones. In United states 
for example their welfare benefits system functions quite well while in
Europe it has still certain setbacks due to limited taxation power. This
problem, in combination with sending high quality (and low-cost) workers to the
countries where they are needed, remains one of the biggest challenges of Euro
area. 22


With Euro area being in relatively good
economic shape it can be sad that the unity of markets, labour forces and other
attributes that are characterising the economic union are bringing on their
positive effects. From the perspective of the theory of Optimal currency area
it is hard to say that Euro area has reached its potential. The combination of
rapid capital migration with limited migration of working force can raise the
cost of adjusting to product market shocks.

The European economic unification has to
decentralise its power. At the same time the strong political EU centre has to
be formed to present strong political Instance in the eyes of Euro area
residence.  The balance between strong
authority of the EU centre and a feeling that the individual members have the
power has to be achieved as a contributor that euro area is presented in a
positive light to the “normal population”.

To sum it all, it is safe to say that the
Euro area brings more advantages than disadvantages,  but undeniably has its flaws. Those flaws
have to be addressed and worked on in order for a Euro area not only to keep
its members satisfied, but also to present a good platform for further










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