How has the Advent of Euro Affected the Euro Zone

INTERNATIONAL FINANCE ASSIGNMENT: Submitted to MADAM SARWAT AHSON

NOMAN ISMAIL VERYAMANI:ID 9114 12/13/2011

Contents
INTRODUCTION ............................................................................................................................................. 3 CONSUMER BENEFITS ............................................................................................................................... 3 1. 2. 3. 4. COMPETIVENESS ........................................................................................................................... 3 Price stability ................................................................................................................................. 3 Borrow easily ................................................................................................................................ 3 Easy to Travel ................................................................................................................................ 4

BUSINESS BENEFITS................................................................................................................................... 4 5. 6. 7. Increase in Investment .................................................................................................................. 4 Economic stability ......................................................................................................................... 4 Increase in Trade ........................................................................................................................... 4

MEMBER STATES ....................................................................................................................................... 4 8. 9. Financial Integration ..................................................................................................................... 4 Europe has greater presence ........................................................................................................ 5

HAS THE EURO INCREASED TRADE ........................................................................................................... 5 TRADE IN FINANCIAL ASSETS ................................................................................................................ 6 Euro during recession ............................................................................................................................... 6 COSTS AND CRTICISMS ............................................................................................................................. 7 The Current Euro zone crisis-Timeline ...................................................................................................... 8 2008 ...................................................................................................................................................... 8 2009 ...................................................................................................................................................... 8 2010 ...................................................................................................................................................... 9 2011 .......................................................................................................................................................... 9 CONCLUSION........................................................................................................................................... 12 References .............................................................................................................................................. 12

INTRODUCTION
On January 1st 1999 the Euro came into circulation as a single currency for 15 European nations. Although Euro came into being in 1999 but the ideas for a single monetary unit came into existence in 1993 when Maastricht Treaty was ratified which led to creation of European Monetary Union)EMU). The main job of EMU was to ensure price stability, the result came with the introduction of Euro. The most important benefit of Euro was that the need to exchange different currencies within the EMU members was eliminated; problems such as high transaction costs ad volatility in the exchange rates were solved. With the introduction of Euro the member countries cannot engage themselves in competitive devaluation and speculation about the currencies. The following are the benefits that are achieved by the people, businesses, and to the member states:

CONSUMER BENEFITS
1. COMPETIVENESS Consumers can shop across borders they can easily compare prices and thus there is more competitiveness between shops and suppliers 2. Price stability Introduction of Euro has boright down level of inflation between the member states, as in the 1970s and 1980s they were facing high inflation levels, but as they started to make reforms to introduce as single currency(Euro) the inflation rates started to drop down to 2%

3. Borrow easily

Due to decrease in inflation rates the interest rates have also fallen, as can be seen in the figure. Mortgage rates were between 8-14% before Euro after Euro they dropped to 5%

4. Easy to Travel Before Euro someone travelling across different countries and exchanging currency at every border, he/she would loose half of the amount he/she pwns due to exchange losses. Euro has made life easier for travelers, students, holiday makers as now they can travel with just one currency in hand without of hassle of exchanging it.

BUSINESS BENEFITS
5. Increase in Investment With low inflation and interest rates, the businesses can borrow more cheaply, this would increase productivity and there would be new job creation. Since the inception of Euro in 1999 more than 10 million jobs have been created 6. Economic stability With stability in the interest rates now there is more room for investors to invest for long term as can be seen form the figure below. 7. Increase in Trade Trade within the Euro area has increased between 4% and 10% since the introduction of the single currency.

MEMBER STATES
8. Financial Integration The single currency makes it much easier for investment capital move around the euro area to where it can be used most efficiently. And the size of the euro-area financial market makes more capital available for investment and allows investors to

Spread risks more widely. And for citizens, the cost of sending money to another euro area country has been slashed by as much as 90%%. 9. Europe has greater presence Euro is the second largest traded currency in the world financial markets.

HAS THE EURO INCREASED TRADE

The Euro was predicted to increase trade within the Euro zone countries in large amount, by Andrew Ross(2000). He had predicted a model which is assumes a gravity model according to which the treade between two countries is proportional to the economic mass and inversely proportional to the distance between them, he further predicted that the increase in trade would triple after the introduction of Euro, however trade did increase but at lower levels than expected. The cumulative increase in intra-EU exports increased by 3.9%, 6.9% and 9.6% in 1999, 2000, and 2001 respectively. In the first ten years of its existence the trade increased by just 10-15%, the reason behind it can be attributed to two factors language and time(HAVEL). The growth rates of Euro zone countries have increased since Euro but they are not in par with growth rates of United States and non Euro members. As can be seen from the figure

Although the growth rates in trade are not phenomenal but yet trade has increased, as now the intraEuro trade accounts for one third of GDP of the region. The trade boost should not be credited to just one factor i-e hange in currency but other factors such as low levels of interest rates, low transaction costs , price transparency in the form of a single currency are also the reasons behind it.

As we can see from the above graph more trade has increased in the intra-Euro region. TRADE IN FINANCIAL ASSETS The lowering of transaction costs are key to financial integration, after the formation of European goods the transactions cost on bonds and equity are lower by14% and 17% respectively. These figures are much larger for intra-Euro countries lower by 27% on equity and 17% on bonds.

Euro during recession

In the recession of 2008 investors drained out the capital from those currencies which they saw as risky, example Iceland and many eastern European countries which had high current account deficits large public borrowings or both. However the Euro member countries were spared from this. The Eurozone was not immune to the recession. The wage costs in member states rose sharply and the competitive advantage due to low exchange rate were lost. It was an asymmetric shock but the eurozone remained intact.

COSTS AND CRTICISMS

The biggest cost of adopting Euro was that each member country was giving up its right to form an independent monetary and economic policy in order to solve the economic problems at home. The control of monetary policy was centralized. The countries also cannot adjust exchange rates as per their needs, however with all types of trade barriers removed the trade barriers removed this problem was solved. If a country faces recession it has no other option but just to wait till its over as it has no control over its economic policies, however there was an option of bailout from recession by stable countries if one country is in recession. The reforms in the labor market had to be done as to avoid downward stickiness of wages. There was a urgent ned to ensure workforce integration as workers could find jobs in different countries, but one of main barrier was language. There is a general perception that the benefits of adopting Euro are more to the core countries of eruozone such as Germany, France, Austria, Belgium and Netherlands. These countries were more synchronized which means that they had more to gain and less to loose.

As we can see from the above graph that Germany`s trade surplus has risen continuously since the inception of Euro.

The Current Euro zone crisis-Timeline

The following timeline summarizes the events which led to present day Euro zone debt crisis. 2008 The year 2008 was the year of global financial crisis which occurred due to default on mortgage loans given by large banks based in United States. Euro zone was also not spared form this crisis and in December 2008 the EU approved a 200Bn Euro stimulus plan in order to increase growth in the European states 2009 In April the European Union issued warnings to France, Spain, Irish Republic, and Greece to reduce their budget deficits as the difference between their tax receipts and expenditure increased. In October there was a change in the government in the Greece and socialists party had won the election. In November there was growing concern in the EU of a Euro debt crisis after the Dubai sovereign debt crisis. In December Greece admitted that it had accumulated debt to 300bn Euros which is the largest in the modern day history. The debt amounted to 113% of GDP which was very high when compared with the debt limit prescribed by EU of 60%.But the Greek government insisted that it was not on a verge of default.

2010 In January there were sever accounting irregularities reported in the Greek system. The Greek budget deficit was allowed to move to 12.7% from3.4% limit. In February the Greece government announced austerity measeure to control its souring budget deficits. There was also concern growing for the other highly indebted countries such as Portugal, Ireland and Spain. The EU issues tough warnings to Greece to implement austerity measure and to cut spending which ignited protests in the country. The Euro continued to loose value against the Pound and Dollar EU and IMF agree to form a 22BN euro safety net to Greece but not give any further loans In April due to declining finicial markets protests erupted in Euro zone countries. The EU approved emergency loans worth 30Bn euros. Greek debt crisis worsened as its debt reached 13.7% of GDP, Finally on May 2 the EU announced a 110bn Euro bailout for Greece. In November a bailout package worth 85Bn Euro was approved for the Irish Republic.

2011
In February the Euro zone members approved a fund called European Stability Fund worth 500Bn Euros. In April Portugal admits that it cannot deal with its financial woes and asks help from EU. In May a 78Bn Euro bailout package was approved for Portugal In June, eurozone ministers say Greece must impose new austerity measures before it gets the next tranche of its loan, without which the country will probably default on its enormous debts. Talk abounds that Greece will be forced to become the first country to leave the eurozone. In July, the Greek parliament votes in favour of a fresh round of drastic austerity measures, the EU approves the latest tranche of the Greek loan, worth 12bn euros. A second bailout for Greece is agreed. The eurozone agrees a comprehensive 109bn-euro ($155bn; 96.3bn) package designed to resolve the Greek crisis and prevent contagion among other European economies. In August, European Commission President warns that the sovereign debt crisis is spreading beyond the periphery of the eurozone.

The yields on government bonds from Spain and Italy rise sharply - and Germany's falls to record lows as investors demand huge returns to borrow. On 7 August, the European Central Bank says it will buy Italian and Spanish government bonds to try to bring down their borrowing costs, as concern grows that the debt crisis may spread to the larger economies of Italy and Spain. The G7 group of countries also says it is "determined to react in a co-ordinated manner," in an attempt to reassure investors in the wake of massive falls on global stock markets. During September, Spain passes a constitutional amendment to add in a "golden rule," keeping future budget deficits to a strict limit. Italy passes a 50bn-euro austerity budget to balance the budget by 2013 after weeks of haggling in parliament. There is fierce public opposition to the measures - and several key measures were watered down. The European Commission predicts that economic growth in the eurozone will come "to a virtual standstill" in the second half of 2011, growing just 0.2% and putting more pressure on countries' budgets. Greek Finance Minister says his country has been "blackmailed and humiliated" and a "scapegoat" for the EU's incompetence. On 19 September, Greece holds "productive and substantive" talks with its international supporters, the European Central Bank, European Commission and IMF. The following day, Italy has its debt rating cut by Standard & Poor's, to A from A+. Italy says the move was influenced by "political considerations". That same day, in its World Economic Outlook, the IMF cuts growth forecasts and warns that countries are entering a 'dangerous new phase'. The gloomy mood continues on 22 September, with data showing that growth in the eurozone's private sector shrank for the first time in two years. The sense of urgency is heightened on 23 October, when IMF head Christine Lagarde urges countries to "act now and act together" to keep the path to economic recovery on track. On the same day, UK Prime Minister David Cameron calls for swift action on the debt crisis.

The next day US Treasury Secretary Timothy Geithner tells Europe to create a "firewall" around its problems to stop the crisis spreading. A meeting of finance ministers and central bankers in Washington on 24 September leads to more calls for urgent action, but a lack of concrete proposals sparks further falls in share markets. After days of intense speculation that Greece will fail to meet its budget cut targets, there are signs of a eurozone rescue plan emerging to write down Greek debt and increase the size of the bloc's bailout fund. But when, on 28 September, European Union head Jose Manuel Barroso warns that the EU "faces its greatest challenge", there is a widespread view that the latest efforts to thrash out a deal have failed. The sense that events are spinning out of control are underlined by Foreign Secretary William Hague, who calls the euro a "burning building with no exits". On 4 October, Eurozone finance ministers delay a decision on giving Greece its next instalment of bailout cash, sending European shares down sharply. Speculation intensifies that European leaders are working on plans to recapitalise the banking system. On 6 October the Bank of England injects a further 75bn into the UK economy through quantitative easing, while the European Central Bank unveils emergency loans measures to help banks. Financial markets are bolstered by news on 8 October that the leaders of Germany and France have reached an accord on measures to help resolve the debt crisis. But without publication of any details, nervousness remains. Relief in the markets that the authorities will help the banking sector grows on 10 October, when struggling Franco-Belgian bank Dexia receives a huge bailout. On 10 October, an EU summit on the debt crisis is delayed by a week so that ministers can finalise plans that would allow Greece its next bailout money and bolster debt-laden banks. On 14 October G20 finance ministers meet in Paris to continue efforts to find a solution to the debt crisis in the Euro zone. On 21 October Euro zone finance ministers approve the next, 8bn euro ($11bn; 7bn), tranche of Greek bailout loans, potentially saving the country from default.

On 26 October European leaders reach a "three-pronged" agreement described as vital to solve the region's huge debt crisis. After marathon talks in Brussels, the leaders say some private banks holding Greek debt have accepted a loss of 50%. Banks must also raise more capital to protect them against losses resulting from any future government defaults. On 9 December, after another round of talks in Brussels going through much of the night, French President Nicolas Sarkozy announces that eurozone countries and others will press ahead with an intergovernmental treaty enshrining new budgetary rules to tackle the crisis. Attempts to get all 27 EU countries to agree to treaty changes fail due to the objections of the UK and Hungary. The new accord is to be agreed by March 2012, Mr Sarkozy says

CONCLUSION
In the end we can conclude that the introduction of Euro was a significant step in the history of Europe. As it was a source of increase in trade, price transparency, easy travel, low interst rates, high investment, source of dominancy for Europe, but it has fallen prey to the bad economic policies of its member countries. The countries in Euro zone which are well off are reluctant to help those countries which are highly troubled and indebted. The Euro is fighting a tough battle for its survival.

References
1) 2) 3) 4) Portone(2004) Costs and Benefits of Euro in the European Monetary Union Countries Havel(2008) The Euro at Ten: Its effect on intra-Euro Zone trade. Ross(2000) One money one market: The effect of common currencies on trade The Euros influence on trade: European Commission Working Paper series No 941, September 2008 5) Publication No 9869:European commission directorate for economic and financial affairs 6) www.bbc.co.uk