European Monetary Union (2)

Welcome back to this topic. As I’ve already announced, I’m now going to write about some fundamental issue regarding the choice for European Countries to become a unique monetary area.

European economies are, by nature, very open. The rate of exchanges between countries has historically accounted for a relevant part of EU country’s GDP and, as a consequence, fluctuations in exchange rates strongly influenced entire economies. There are also some economists who actually state these fluctuations exercised a rather relevant influence on the fall of European democracies during the 20s and 30s. By reading those considerations it’s not difficult at all to understand how Europeans could be adverse to exchange rate fluctuations, but, is this only reason capable at explaining the choice of abandoning their own currencies?

Obviously, not. Explanations are usually more complicated than someone would prefer to. Renouncing to each monetary policy is an expensive choice, in terms of freedom and easy control of price levels between different countries. Each Central Bank in Europe was, before the introduction of the Euro, free to set its own exchange rate for the specific requirements of the country. The most striking example I can give you concerns Italy. The Italian Central Bank, during the 70s used to systematically depreciate the ITL (Italian Lira) in order to foster exports which were experiencing, especially after ‘73 Oil Crisis, a significant slump.

Why renouncing to a powerful tool such as a ad hoc monetary policy?

Political Reasons. The European Union as a matter of fact is not an optimal monetary area. Several asymmetric shocks affect its economic system, making the control of many macro-variables as rather difficult. The installation of big and alternative monetary area in respect to that one of USA was necessary to enhance all those residual potentials and economies of scale for European Companies. In addition to this reason, the easily predictable increase in Oil prices would have been faced better with a stronger currency in respect to the USD (Us Dollar), the latter being the currency used to set oil’s barrels prices.