Question: Assess the benefits of joining the European Monetary Union.
One benefit of joining the European Monetary Union (EMU) is lower transaction costs. Transaction costs are the costs of trading currencies. In the EMU, all euro member share the same currency, the €. An agent in one member country can buy from a firm in another member country with the same currency. Agents do not need to change their currency to buy from another member country, so there are no charges or commission. However, there are also transitional costs to consider. All new euro members must change their currency to the €, so they must adjust their prices to the €, this involves costs because money, menus, catalogues, websites and shop signs must all be changed. But, if a country is experiencing high inflation then it will have to change its menus and websites anyway, adding a € symbol will not be that much more costly.
Another possible benefit of joining the EMU is a lower exchange rate risk. All euro members share the same currency, the €, so there is no risk that one member’s exchange rate will change. This makes it easier to plan and easier to invest in each country. But, firms that exist to speculate in currencies will be harmed. But, joining the EMU will lead to a loss of independent exchange rate policy. Because the ECB controls all euro members’ exchange rate, members lose control of their own exchange rate so members cannot manipulate their own exchange rate to affect their current account, AD and real GDP. However, a country may not be able to devalue its currency anyway because other countries will retaliate by devaluing too.
Moreover, joining the EMU may help an economy attract multinational companies. Multinational companies may set up in member countries because it could be more profitable to invest and trade in a monetary union. Members share the same currency so there are no exchange rate fluctuations between members, it is easier and less risky to plan and invest. Transaction costs, tariffs and quotas are reduced or removed so it is more profitable for multinational companies to produce and sell output within the monetary union. Although, a negative of joining the EMU is a loss of independent monetary policy. Monetary policy is no longer under the control of each euro member’s domestic central bank. The ECB controls monetary policy for all euro members. One euro member may need to use loose monetary policy to boost AD and real GDP but all other members may need a tight monetary policy to reduce AD and inflation. Members do not control their own monetary policy and so the monetary policy set by the ECB for the majority of the Eurozone may be unsuitable for some particular members.
Additionally, another benefit of joining the EMU is a better macroeconomic management. The ECB, who control the currency and monetary policy for all members, may provide sounder macroeconomic management than the domestic central banks of the member countries. The stability and growth pact should also mean that euro members do not build up too much debt. On the other hand, joining the EMU will restrict an economy’s fiscal policy. A euro member may need to use expansionary fiscal policy to boost AD in a recession but the stability and growth pact’s 3% fiscal deficit rule will restrict the ability of a country to use fiscal policy. AD may remain too low and the economy may remain in a recession. This was arguably a cause of the Euro crisis and the destabilising effects of some EMU members falling into debt may be a major negative to joining the EMU.