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Integration In The Eu And Monetary Policy

2438 words - 10 pages

Integration in the EU and Monetary Policy

The creation of the European Union (EU) is a great political and economic feat. For it is the ultimate sign of cooperation between nations that had been in constant rivalry before. Nevertheless, the ideals of such a union cannot stand alone without having a strong foundation and continuos rational decision making by all of the actors involved. If we assume that the European Central Bank’s (ECB) principle role is to guarantee the well-being of all EU members, then policy making becomes a very complex issue since it must consider such a large and diverse area. I believe there needs to be more economic integration between EU countries for monetary [and fiscal] policy of the ECB to be beneficial to all participants.

Even before World War II, the dream of a unified Europe existed. This ideal emerged from the desire to guarantee peace, for a common political and economic system would, in theory, lower the chances of war. This is because by slowly erasing countries’ borders and making them intra-dependent, states are forced to work with each other rather than oppose one another. A unified economy would also turn Europe into one market and increase the continent’s role in the international monetary system. In March of 1979, eight countries officially participated in the European Monetary System (EMS) by pegging their currency to the German mark. By tying their monetary policy to the Bundesbank’s well known monetary targeting policy, they were able to import German credibility to reduce their own inflation. Indeed, EMS members considerably reduced their inflation by exchange-rate targeting, making Germany the anchor country. France reduced inflation from about 5% in 1987 to 2% in 1992, while the United Kingdom reduced from 10% to 3% in two years.[1] The system worked well until 1992 when political events caused the German government to fiscally expand. At the same time an increase in consumption in Germany caused inflation. The Bundesbank reacted by raising its interest rates to fight their inflation. Subsequently, EMS partner countries were transmitted the pressure of raising their own interest rates, but because not all were simultaneously experiencing a boom, it cost them recession. This is a perfect example of how countries have different needs because of internal dissimilarities, therefore the same monetary policy can benefit one state while hurting another. The strain of contradicting needs between EMS members and the desire to continue toward a common currency caused a series of speculative attacks. Eventually the EMS was forced to widen its exchange rate “bands” to ±15%.[2]

[1] Mishkin, Frederic S. The economics of Money, Banking, and Financial Markets. Sixth Edition. Boston:Addison Wesley. p.509

[2] Krugman, Paul and Obstfeld, Maurice. International economics. Reading, Mass.: Addison Wesley Longman, 5th Ed. 2000. pp. 611-618

Not only was there an interest...

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