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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:   •  December 4, 2010  •  1,220 Words (5 Pages)  •  405 Views

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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'. (www.wikipedia.org). 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.

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