Money Matters - One Money, Greater Europe

With a European Union of 25 states, more than a few pundits are wondering how the world's largest open and competitive free trade area will manage to function more smoothly. The probable adoption of the Euro by all members means that exchange rate policies and price stabilisation is now a matter of common interest. Professor of International Political Economy Jonathan Story presents a fascinating account of how the entire history of European monetary union has been characterised by political cajoling and convoluted deal making between various European and American governments, even when their ideological outlooks were extremely different, and when the overall tone of discussions was less than entirely cordial.

by Jonathan Story
Last Updated: 23 Jul 2013

With the enlargement of the European Union to its present 25 states, more than a few pundits are wondering how the world's largest open and competitive free trade area will manage to function. Naturally, the eventual adoption of the Euro by all members will mean that exchange rate policies and price stabilisation is now a matter of common interest. However, as this case study illustrates, that is already one of the most significant challenges facing the EU, and looks likely to be of even more pressing concern in the coming years.

Professor of International Political Economy Jonathan Story presents a fascinating account of how the entire history of European monetary union has been characterised by political cajoling and convoluted deal making between various governments, both in Europe and in the USA, even when their ideological outlooks were extremely different, and when the overall tone of discussions was less than entirely cordial. The creation of the European Central Bank (ECB), for example, resulted in large part because of the determination of France's socialist government of the 1980s to see the influence of Germany's Bundesbank over exchange rates throughout Western Europe weakened.

Meanwhile, the wider political transformations sweeping Europe as the Cold War drew to a close were greatly affecting monetary policies. Story describes the 1990 promise by German Chancellor Helmut Kohl to voters in the former GDR, participating in open elections for the first time, for conversion parity with the Ostmark - a proposal that horrified the Bundesbank. In 1996, the Stability Pact, largely the creation of German Finance Minister Theo Waigel, was introduced. This agreement has greatly weakened in recent years, as France, Germany, Portugal and other Western European governments have regularly violated its terms.

The author explains the essential differences between the ECB and other central banks, such as the US Federal Reserve, on determining economic policies. He also details how the European System of Central Banks (ESCB), consisting of the ECB and 12 national banks, play a central role in determining Eurozone policy.

The case study provides a concise but thorough consideration of the real meaning of monetary union, both for EU members and the world at large. The wider policy implications of the union were partially confirmed by a special meeting of the European Council in Lisbon in 2000. This event produced a list of strategic goals regarding nurturing a knowledge-based economy, implementing economic reforms and boosting employment which, in retrospect, look decidedly ambitious.

Story goes on to consider the 1999-2003 economic performances of various EU countries. The results show that healthy economic performance has had less to do with the adoption of the Euro, and more to do with "market friendly" labour market reforms within the individual member states. The author also suggests that the most attractive feature of EU membership for its newest members - guaranteed access to such an enormous market for goods and capital - may be "just the icing on a cake they have been eating for some time". But challenges for the near future abound, as wages and exchange rates in the new member states rise over time, and the costs of implementing the EU's massive rulebook, the acquis communitaire, add to the already considerable pressures facing fiscal policy makers, particularly in Central and Eastern Europe.

Moreover, many analysts have expressed their hope that entry into the Eurozone by new EU members - neither a requirement for EU entry, nor likely before the end of the decade at the earliest - might re-impose some budgetary discipline on their governments. Of course, there is a certain degree of hypocrisy in the criticisms being levelled by some larger Western European governments in this matter, since they have proven so unable or unwilling to live within the restrictions imposed by the Stability Pact as to render the agreement practically toothless.

INSEAD 2004

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