Home > Applying Political Science, International Relations > The European Monetary Union: ‘Til Debt do Us Part

The European Monetary Union: ‘Til Debt do Us Part

German Logo of the ECB.

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A monetary union without a concomitant political union is a bit like a marriage without a commitment to monogamy, and not just because both are prevalent among Europeans. The degree to which eurozone states have surrendered sovereignty  to Greater Europe is only a partial commitment. By adopting the euro, they have given up monetary sovereignty; individually,
eurozone states cannot print their own money, change their interest rates, or adjust the value of their currency. In other words, these states cannot increase their money supplies in order to stimulate short-term economic growth, they cannot lower their interest rates to spur investment or raise them to halt inflation, and they cannot devalue their currency in order to stimulate exports.

What they have given up in order to share a currency is substantial, but so are the benefits of that shared currency. Primary among them is the lowering of the transaction costs that decrease flows of goods and capital across borders. No longer does Germany trading BMWs to Italy for the latest from
Armani, Versace and Prada involve an exchange of currencies. This greatly lowers both the costs and risk of the trade. Similarly, if BMW opens a factory in Italy, it no longer needs to worry that all of its profits from sales there might be consumed by a depreciating lira (which would buy fewer deutsch marks then when the initial investment in the plant was made). Thus, both intrastate trade of goods and flows of capital in the eurozone have increased substantially since the euro was adopted at the beginning of 2001, despite falling during the recent financial crisis (see: http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=133.TRD.M.I6.Y.M.TTT.I6.4.VAL
and http://www.ecb.int/pub/pdf/scpops/ecbocp126.pdf)

But the eurozone states were not willing to jump into the deep end in their commitment to each other. They were only willing to get their feet wet to see if they liked the water (and some of them are liking it less and less of late). This was to be the first step toward a longer-term goal of a much greater commitment: political union.

Partial commitment to anything presents problems. In this case, sharing monetary and exchange rate policies without sharing fiscal (tax and spending) policies makes the success of the former more difficult. In order to join the European Economic and Monetary Union (EMU), wannabe member states have had to achieve the Maastricht criteria. These are a number of criteria related to exchange, inflation and interest rates, as well as government deficits and debt, which are to be kept below 3% and 60%, respectively. However, these criteria present a major commitment problem: prior to joining, states have incentives to meet the criteria, but after they have adopted the euro, there are weaker incentives for member states to continue to meet them. Thus, a number of member governments have deficits and debt levels far beyond those “allowed” by the EMU.

This really should not be a surprise. First, governments have surrendered monetary policy to the European Central Bank and, therefore, only have fiscal policy left to try to stimulate the economy during downturns. Second, there is no current method of automatically penalizing states that
violate the criteria (see: http://www.spiegel.de/international/business/0,1518,724239,00.html).

The data here (http://www.ecb.int/stats/gov/html/dashboard.en.html) show that in 2010, twelve eurozone countries were over the deficit target, with Ireland at 32.4%, Greece at 10.5% and Spain and Portugal at about 9%. Twelve countries are also over the debt ceiling.

This fiscal problem, which has led to the recent debt crisis in Greece and similar problems in Portugal and Ireland (two of the major beneficiaries of eurozone membership) in recent years, is indicative of a broader problem in the European integration experiment: the fundamental tensions in trying to have monetary integration without broader political integration, especially with regards to other economic policies.

Imagine, for example, that there is an economic downturn in the United States (that should not be too difficult to do). Let’s further imagine that Michigan is hit harder by this downturn than Texas. Due to political integration among the states that comprise the USA, there will be a kind of natural shift of revenues from Texas to Michigan. Relatively more taxes will be collected in Texas and relatively more spending, on safety nets like unemployment insurance and other government programs, will be in Michigan. This is one of the advantages of the American states having joined in political union.

The need for fiscal integration in order to preserve the extent of European union so far is increasingly on the minds of leaders of both the European Union and European states (see, for example: http://online.wsj.com/article/SB10001424053111904265504576564801620551890.html). What is required is the further surrendering of state sovereignty to Greater Europe. In the short term, there needs to be deficit and debt level criteria with teeth (meaning a firm punishment mechanism).  But this means the inability of politicians to respond to calls by their constituents for greater spending during economic downturns, or greater social spending in general.

The benefits of union come at significant costs; however, in the long-run, Europe cannot succeed as a monetary union unless it is also committed to political union.

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  1. Yesenia Gutierrez
    November 7, 2011 at 9:02 am

    I agree that a greater political union would be helpful in the long run as it would help establish fiscal policy in accordance with each state’s needs. Although I do see the point that a greater political union would also raise problems in the long run for elected officials as change (such as more spending on social programs) would not come as easily as before. If you think about it, it is a double edge sword, on one end the short term that will help and hinder and on the other the long term which will help and hinder, consequences have actions and a greater political union would add to these. In the long run it will help, but it is getting people now to see it this way and accepting it that is the problem.

  2. Hillary
    November 7, 2011 at 6:01 pm

    http://www.nbc.com/saturday-night-live/video/weekend-update-a-closer-look-at-europe/1366743

    This video is the only way i know how to respond. I know it’s SNL but Seth actually makes good points.

  3. Sarah B.
    November 9, 2011 at 11:10 pm

    I agree that Europe needs to find political unity in order to move forward with a monetary union because it will lead to beneficial revenue and a better economy for Europe.

  4. Jocelyn
    November 10, 2011 at 12:26 pm

    I agree that the Union will benefit Europe significantly, but I also think that they need to get a handle on their economy, in seeing that only fiscal policy is left to try to stimulate the economy.

  5. Emma Fonseca
    November 10, 2011 at 1:07 pm

    Before the example of the US came up in the article, I was comparing the European Union to the US. The problem for Europe is that they were independent from one another for so long before the idea of united money came into the picture. Whereas America learned quickly that different currencies wouldn’t work well if they wanted to be a place with one union of the states that were under the name, America.

  6. Neil S.
    November 10, 2011 at 1:10 pm

    That SNL clip sums it up pretty well, it brings up some very good points.

  7. Irain J.
    November 10, 2011 at 2:33 pm

    Europe does need a united monetary union , however they should fix the flaws in the system before integrating with anyone else. A common currency is just easier to work with.

  8. Hannah
    November 10, 2011 at 2:39 pm

    The snl clip made everything easier to understand but I agree that a greater political union would benefit their economy. Until they do that, I’m not sure how they will possibly proceed.

  9. Lauren Barrera
    November 10, 2011 at 2:53 pm

    That clip really did make everything clear! thanks! but yes, as Hannah said, a political union would benefit their economy!

  10. daniel kemether
    November 10, 2011 at 2:55 pm

    the SNL clip actually does help alot, i didnt think it would but it did… i also agree with Irain, a single currency would be very helpful, but first the system needs changes

  11. Samuel Park
    November 10, 2011 at 2:59 pm

    I loved the SNL clip. i don’t agree with a common currently as Irain suggested because of inflation in a certain nations,etc but a political union would probably benefit the economy.

  12. Spearchucker
    November 10, 2011 at 9:32 pm

    If the Maastrict criteria had been enforced in the first place and the sanctions had been different, the EMU would not be where it is now. The penalty for breaching them should have been EU economic oversight and signoff on national budgets. Instead there was supposed to be a massive fine on the country involved, which was stupid because fining a country facing recession makes no sense. When the red lines were actually crossed they were first broken by Germany and France, and no fine was applied, so the Maastrict criteria were downgraded from firm rules to mere guidelines. This was when the Euro was broken. It could have been fixed at this stage. Enforced economic oversight might have been sufficient sanction – especially if national accounts had to be signed off by Eurostat which would have prevented the Greek debacle. But at this time, France and Germany were pushing for the EU constitution, and they eventually got their way via the Lisbon Treaty. Nothing in the Lisbon treaty was designed to fix the Euro.

    Without a real central bank like the Fed or the Bank of England, the Euro is doomed.

  13. b.aiy
    November 15, 2011 at 3:18 am

    If they (mainly Germany and France) decide that its worth it to keep Greece in the Eurozone, then they have to take one for the team and commit to save Greece. That means not just bailing out Greece, but injecting it with large amounts of capital to reverse this downturn. From what I know of Keynesian economics (intro classes @ Delta, yay!), you shouldn’t be punishing and enacting austerity measures on a country going through a recession. You do just the opposite. Of course, this money will have to be invested in diversifying the Greek economy which relies too heavily on Tourism and Shipping (rebirth of the Athenian Empire!!!!… no? Okay). These industries are also too heavily affected by the world economy. They need industries that are somewhat averse to global fluctuations in the world market. And unlike the failed regulation authorities the US failed to put into place after the recent recession due to US politics, the EU must form an independent regulation authority to see that financial and political institutions are doing what they’re suppose to be doing. In addition, Greek fiscal policies need to change, but only after the economy starts recovering.

    Then again… what do I know? I’m probably just making all of this stuff up.

  14. Christopher McHenry
    December 1, 2011 at 8:44 am

    The SNL clip made it clear of whats going on. Europe needs to get a grip on their economy. Europe economy is doing worse than the U.S. economy. Terrible

  15. Brishonn
    December 4, 2011 at 2:02 pm

    i love the title

  1. November 7, 2011 at 8:59 am

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