The Euro is a currency union where multiple countries adopted a single currency— the euro. Though a currency union makes trade easier, it also disables individual countries from conducting monetary policy. Monetary policy in the member countries has to be conducted by the European Central Bank (ECB) since only one currency supply exists for all the countries in the Euro Zone.[1] The Euro started in 2002 and now consists of seventeen countries. However, the debt of several countries using the Euro — Portugal, Greece, Ireland— has sharply increased. Few economists believe that the Euro Zone will dissolve, but what would be the effect on the global economy if the Euro did dissolve?[2]
If the Euro Zone were to collapse, countries whose economies are performing strongly, such as Germany, could implement their own contractionary monetary policies and thus lower inflation. For example, England, which did not join the Euro Zone, is now able to use monetary policy to recover from the recession. In contrast, countries in a recession, such as Greece, could conduct expansionary monetary policies in order to increase aggregate demand and production. If Greece adopts the drachma (its currency before the euro), the government could use expansionary monetary policy to increase the supply of drachmas and thus depreciate (decrease in value) the drachma. As a result, Greek goods will become cheaper to foreigners, and Greece will produce and export more. This will stimulate Greece’s economy, increase the GDP and help the country climb out of its current recession. The collapse of the Euro Zone will also be helpful for Germany. As Germany converts back to the Deutsche mark, the demand for the Deutsche mark would increase and the demand for the other currencies would decrease. As a result the Deutsche mark would appreciate, and German imports would increase, and as a result, aggregate demand would decrease, therefore lowering inflation, which is currently high in Germany.[3]
The main negative consequences that would follow the break up of the Euro Zone are the effects of the new currencies and their exchange rates. First of all, having different currencies would hinder trade within Europe. Different currencies would have to be converted in order for countries to trade. Second, abandoning the Euro as a currency would affect consumer confidence and encourage households to “rein in their spending.”[4] A number of other countries are likely to enter into a “very serious recessions.[5] The United Bank of Switzerland predicts that the stronger countries might experience 20-25 percent contraction in GDP, while the weaker countries might suffer 50 percent contraction.[6]
Created in 1998, the Euro Zone united most of the EU members and adopted a single currency in order to encourage trade. Without different currencies, countries could not devalue their currencies and thus increase their exports. The financial crisis in 2008 brought turmoil in the Euro Zone and countries like Greece, Ireland and Portugal have experienced huge budget deficits. The ECB should implement any possible policies to keep the Euro Zone strong and to sustain healthy economies of the countries, because, if the Euro Zone collapses, countries can enter a recession “on a scale beyond modern experience in a Western democracy.”[7] However, countries such as Greece, Ireland and Portugal should withdraw from the Euro Zone in order to take control over their economies and stimulate economic growth.
Sources
“ECB: The European Central Bank”, n.d. http://www.ecb.int/ecb/html/index.en.html.
“Euro News - The New York Times.” New York Times, September 13, 2011.
http://topics.nytimes.com/top/reference/timestopics/subjects/c/currency/euro
index.html.
Ewing, Jack, and James Kanter. “In Euro Zone, Some See Risk of Currency Breakup.” The New York Times, November 17, 2010, sec. Business Day / Global Business.
http://www.nytimes.com/2010/11/18/business/global/18zone.html.
“Treasury fears effects of a euro break-up - FT.com”, n.d.
http://www.ft.com/intl/cms/s/0/eb62a6d4-eb77-11e0-a576
00144feab49a.html#axzz1aWwKUmza.
“Why collapse of the euro equals collapse of the EU – Telegraph Blogs”, n.d.
http://blogs.telegraph.co.uk/finance/andrewlilico/100011966/why
collapse-of-the-euro-equals-collapse-of-the-eu/.
[1] “ECB: The European Central Bank”, n.d., http://www.ecb.int/ecb/html/index.en.html.
[2] Jack Ewing and James Kanter, “In Euro Zone, Some See Risk of Currency Breakup,” The New York Times, November 17, 2010, sec. Business Day / Global Business, http://www.nytimes.com/2010/11/18/business/global/18zone.html.
[3] Ibid.
[4] “Treasury fears effects of a euro break-up - FT.com”, n.d., http://www.ft.com/intl/cms/s/0/eb62a6d4-eb77-11e0-a576-00144feab49a.html#axzz1aWwKUmza.
[5] Ibid.
[6] “Why collapse of the euro equals collapse of the EU – Telegraph Blogs”, n.d., http://blogs.telegraph.co.uk/finance/andrewlilico/100011966/why-collapse-of-the-euro-equals-collapse-of-the-eu/.
[7] Ibid.
1 comment:
Do you think a collapse of the Eurozone is likely? I think that given the disastrous consequences of such a breakup (like those your post mentions), that this is pretty unlikely. I think it is more likely that the Eurozone would move toward fiscal union or that maybe Germany might exit the Euro which would force the devaluation of the Euro and make it easier for countries like Greece to handle their debt. What do you think?
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