8.6Monetary union in Europe

A monetary union consists of a group of politically independent countries with a

single currency. It follows from the acceptance of a single currency that the countries

must have a joint monetary policy, implying a single base rate of interest. The Treaty

on Economic and Monetary Union (the Maastricht treaty), which established the

conditions for monetary union in Europe, determined that the single monetary

policy in Europe would be operated by a politically independent central bank, the

European Central Bank (ECB). The constitution of the ECB followed quite closely

that of Germany’s Bundesbank, the most successful European central bank in terms

of the maintenance of low ination and the retention of market condence in

the value of its currency. Thus, the principal duty of the ECB is to maintain price

stability across the monetary union, although it is meant to do this while support-

ing the general economic objectives of the EU. That is, the ECB is required to pay

some attention to levels of unemployment, rates of economic growth and the com-

petitiveness of EU goods in foreign markets.

The major argument for the establishment of a monetary union in the EU was

that it was a necessary adjunct to economic union. The idea behind the Single Market

Treaty of 1986 was that the removal of all trade barriers across the EU would play a

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major role in ensuring that goods and services in Europe would be produced by the

most efcient producers. This would allow EU countries to make the best possible

use of their economic resources and would help them to remain competitive with

other countries, such as the then rapidly expanding Asian economies. The hope was

that by encouraging efcient production, Europe could remain competitive with-

out sacricing the higher wages and better working conditions that had come to

be accepted in many EU countries. However, in a world of variable exchange rates,

inefcient producers can be protected by the falling value of their domestic currency.

In other words, variable exchange rates act as a barrier to trade. In addition, the

volatility of oating exchange rates creates uncertainty for producers and traders

and may lead to lower investment in the economy.

This establishes only an argument for a tight system of xed exchange rates, but,

as we have seen above, xed exchange rate systems face many problems, especially

when capital is highly mobile internationally as was required by the Single Market

Treaty. The further step to a single currency overcomes a number of the problems

of xed exchange rate systems. In particular, it removes the possibility of destabilis-

ing speculation within the economic union and removes the possibility of member

countries’ seeking to devalue their currencies within the xed exchange rate system

for competitive purposes. It removes the foreign exchange risk premiums that con-

tinued to be attached to some currencies within the xed exchange rate European

Monetary System. In addition, it removes the costs of currency exchange and it allows

EU citizens to compare more easily the prices charged for the same products across

the whole of the single market. This price transparencyis important because it makes

it more difcult for rms to deny to consumers the potential benets of a single

market by engaging in anti-competitive and restrictive practices.

There are, however, several problems associated with the establishment of a

single currency across the EU, principally because of the wide differences in living

standards across the union. If the single market is effective and goods and services

are produced by the most efcient producers, it is highly likely that some regions in

the EU will prosper while others suffer from the closure of rms and the loss of jobs.

It is also probable that the regions that suffer will be concentrated more in some

member countries than in others. Thus, the EU as a whole might benet from the

single market while some countries within the union do not. This is more likely to be

the case if the countries forming the single market are very different from each other

at the outset in terms of productivity, standards of living, levels of unemployment

and the provision of infrastructure such as transport and communications networks.

We can say, in other words, that the full operation of the single market might produce

real divergenceamong member economies, with the gap between richer and poorer

member countries growing.

You should note two things about this argument. Firstly, there are a number of

‘mights’ and ‘probables’ in the preceding paragraph. It is by no means certain that

the formation of a single market produces real divergence among member countries.

Economic theory does not help much. Orthodox economic theory is more likely to

support the proposition that real convergencewill result from a single market, but this

is based upon a number of dubious assumptions. In any case, even if convergence

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does occur it is very likely to take a long period of time and may well follow an

initial, quite long period of divergence. Spanish workers who become unemployed

are not likely to be much comforted by the idea that the same forces that caused

them to lose their jobs might produce a higher standard of living for other Spanish

citizens in twenty or thirty years’ time. Empirical evidence on the issue is also far

from clear and will always be difcult to interpret because we shall always be com-

paring the present state of the world (say, after the formation of the single market)

with a hypothetical view of what might have happened under different circumstances

(if the single market had not been formed). Such a comparison always requires a

number of contestable assumptions to be made.

The second point to note is that we are talking about the single marketnot the

single currency, and the single market is accepted by all EU members, including those

countries that have not joined the single currency. The single currency enters the

argument because it removes the last remaining element of protection for those

countries that might suffer from the single market by removing the possibility that they

can remain competitive through changing exchange rates. In a sense, then, countries

that reject the single currency are rejecting the full implications of something they

have already accepted. Nonetheless, the argument remains a powerful one in the

minds of many people, especially if there is distrust among member countries.

One possible counter argument to the idea that it is desirable for a country to

maintain its own currency and, with it, the right to change the rate of exchange

between its currency and those of its partners within the union is to point to large

countries with a single currency. The US has a single currency in an economy with

much the same GDP as the EU and with wide differences in per capita income

levels across the country. If a single currency is acceptable for the US, why should it

not be so for the EU?

It is usual to point to two differences between the EU and the US in this context.

Firstly, as well as having a common monetary policy, the US has a single federal

government and a single scal policy (although there are variations in local and state

taxes). This means that there are automatic transfers through the central budget from

rich to poor regions. High-income regions pay more in taxation to the central govern-

ment and, on balance, are likely to receive less in central government expenditure

than do the poorer regions. This is, of course, also true of the UK. It may still be

the case that these automatic transfers are insufcient to offset the increase in the

differences in standards of living that arise from the existence of a single market.

However, a single government is also able relatively easily to support these automatic

transfers among regions with a discretionary regional policy to support poorer regions.

Naturally, this does not always happen and almost never happens to the extent desired

by poorer regions, but it is well within the scope of a national government.

The EU does not have a single scal policy and automatic transfers do not occur

among EU regions through the normal operation of taxation and government spend-

ing. An EU regional policy has existed since 1975, and the Maastricht treaty stressed

the importance of cohesion funds to help all countries to benet from the single

market process. However, the central EU budget is small and offers little possibility

of meaningful discretionary payments to poorer regions. Experience has shown

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