Success Or Failure Of The Euro Currency Economics Essay

Success Or Failure Of The Euro Currency Economics EssayChapter 1IntroductionWhen the European Union was founded in 1957 their initial endeavor was to establish a roughhewn grocery store. nonetheless they found this idea not winning shape as their pecuniary objectives didnt seem to prosper due(p) to lack of a plebeian c. In 1992, the Maast adequatet Treaty paved the way for a single c for the EU.Its been a decade since euro had been floated into the internationalist markets. With its introduction in the rush for globalization saw m some(prenominal) gains for euro in terms of increase in cross-b club corking, trade, and outsourcing, securities and unlike diversify markets turnoer as well as in cross-border summation holdings. The decade as yet saw a huge mounting up of unlike reserves due to growing current handbill imbalances. With euro taking the grapheme of an international c, there had been drastic changes in the international markets with portfolios creation mo difyed from dollar-denominated to euro-denominated which had led to depreciation in dollar. Moreover Bank of Chinas opinion to incarnate gruellinger currencies had added to the dollar depreciation.Research aimThe main aim of the research is to realize the sustainability of euro based on financial, economical and semi policy-making planetors. With the euro combining various markets into a single European market, consumer welf ar has improved. This had led to convergence of money and enceinte markets through change magnitude competition, market liquidity and transp arncy in performance with economies of scale and scope. Euro has gained the potential of risk diversification and more efficient some(prenominal)ocation of capital resources. Elimination of telephone exchange govern risk has increased outlay transp atomic number 18ncy, thereby reducing transaction be and boosting competition in international markets.Research objectiveThe primary intention is to analyze if the future of euro is wretched towards success or failure given the social, economic and political factors. sequence the euro c as well as its policy framework has attributed to perceptual constancy and prosperity in euro argona, the global crisis identified the necessity to strengthen European economic plaque as a remedy against future ch eitherenges. Euro has gained magnificence in global markets by al milding global public and private investors to turn their as cook allocation and borrowers to find other sources of funding. Proper and timely actions by the European fiscal constancy Facility had dish uped a great achievement in safeguarding euro so far. With the European Stability Mechanism being pioneer till June 2013, financial perceptual constancy of the euro area is expected to be in full transparency so as to revive in clock of financial distress.Research questionsWill the size of the frugality divine service in sustaining the euro stability?Will focus on inte rnational trade help in stabilizing?Based on the size, depth, liquidity and openness of the internal financial markets, charge the euro be stabilized?Is the euro st able-bodied enough to warrant easy convertibility of its c?Can macroeconomics play a vital role in preserving euro stability?Signifi firece of the pick outThe study aims to implicate the chaseNeed for further economic amalgamation so as to accept problems in clock of crisis.Need for a banking married couple thereby fully gr have control to European Central Bank (ECB) to oversee all euro-zone banks in one step process.Government efforts are needed in order to devise economic and fiscal outline which are essential to the euro c.Efforts are besides needed from financial market participants and supervisors, given that the maintenance of the financial market stability plays a crucial role for monetary and macroeconomic stability.Research objectivesThe main objective of this report is to assess the success or failur e of implementing a co-ordinated c, being the Euro c. Examining this topic yields a pay heed into the viability of having a uniform c across a region with comparable economic and political attributes.When the idea of a single c was initiatory suggested, doubts raised as to the credibility of the gradeance as each instalment states had different political heads. With the single c, however all these political heads would be combined as one governing body to govern all division states. However in a region with similar economic and political attributes, the idea seemed successful with the formation of EU which consisted of European Council to character course of actions and to suggest new laws the European parliament to discuss on and endorse laws suggested by the council finally the European Commission with personnel to hand the laws. The EU helped a great deal in providing effective governance in the Euro-zone which helped European economy overtake US economy in 2009 with a trade of $14.5 trillion against US trade of $14.3 trillion, thereby invoice to 40% of the publics economic power.Further, researching the different factors and aspects of what makes a c succeed or fail in meeting its set objectives shall provide insight into arrest the dynamics of the relationship among members of the EU.The vital factors that help judge the energy of a c are the size of the economy, political stability, and role in international trade, transparency and openness in domestic markets, easy convertibility to hard cash and impact of macroeconomics in preserving euro.Relationship between EU members had been strengthened aft(prenominal)ward the launch of euro. Thats beca routine al most(prenominal) 17 of the 27 member states devour force outonical euro. It has alike paved the way for a single monetary council to govern the functioning of euro throughout the euro-zone. Moreover cross border trade had increased which was mainly due to creation of single c whic h cuts transaction be. hydrofoil had also been maintained with the euro in domestic markets without legal injury fluctuations. Tourism had also increased with the launching of euro, as tourists didnt have to keep changing their currencies when traveling around the euro-zone. This way Euro ensured easy convertibility of cash. Finally member countries which were financially rich in EU were used to arseup poorer economies in EU, thereby ensuring financial stability whenever any of the macroeconomic components triggered a threat to EU. It was this backup which helped euro from weakness to a greater extent when the 2008 crisis broke out.The report also provides object for analyzing the values of poorer EU member states aggrandizeing the Euro c. This provide check the economic drive that can occur from having a monetary union between countries with changeing economic statures.The emoluments of poorer economies joining the euro can be said to be both an advantage as well as a d isadvantage. Its an advantage as crimson if they fail to repay bills owing to crisis, with the help of EMU they would get help from the richer economies in EU to repay the bills. Disadvantage can be attributed to the fact that salaries may be lesser in less wareive areas when compared to salaries of employees in lavishlyer(prenominal) production areas. This advantage is due to the fact that all of these employees are promptly paid in Euros. So indirectly it can mystify a threat as the standard of living may vary from place to place, but the salaries remain the like, thereby generating problems in getting even basic daily household things. For pillow slip, we may consider the following example between Greece and Germany.Item20002010GreekGermanGreekGerman issue forth of cups made an hour551020Employee absorb per hour5 drachma5 euro10 euro12 euro appeal of fashioning a cup1 drachma1 euro1 euro0.60 euroThe above example gives an insight as to more production at lower price ther eby encouraging more contract gaining big. However Greece seems to be losing the race.The report also will touch on the import of failures in the Euro, if any, and the remedial measures that can be adopted in lesson of much(prenominal) failures. This also gives indication to other regions that may want to adopt the strategies used by the Euro while avoiding the discon upstandinging aspects of the Euro example. on that point is a wisdom in euro that it is working only in favour of France and Germany, but the tangible fact is these countries have achieved little in terms of bargaining success. line of reasoning-still if they had been doing well, ii happens that in times of debt by other EU countries, much(prenominal) rich countries will have to take the burden of clearing unpaid bills, thereby making it impossible for such countries to decide on their foundation plans. Moreover in the aftermath of 2008 crisis, TARGET 2 set for the subprogram of clearing euro combined al l imbalances between banks in the euro-zone. However this failed to meet its objective right from 2007 till 2011, there was an increase in the capital from weaker countries. When the entire euro-zone was lowgoing crisis, Germany was doing sex actly well, thereby showing diversification in thoughts in terms of social and political issues.In order to prevent failing of euro, policies have to be effectively modified in such a way that there is a win-win situation between both the financially rich and poorer countries, thereby ensuring equal competition. In times of crisis, EU member states can increase inflation rates for a while thereby ensuring their economic growth steady enough to get away from raise debts. However these two can be achieved only with political consolidation by all EU member states.Having a monetary union and examining its performance is an example set by the Euro. In case of a failure of the c, the report will try to highlight the possibility of discontinuing the circulation of the unified c and reverting to each uncouths earlier adopted c.This success can be attributed to ECB cutting down the interest rates 3 times in 2012, thereby lowering borrowing costs creating confidence among investors in euro market that a euro- breakup would not be imminent. In short to say, fail of the euro is not bound to happen soon, however the stability of euro is unclear in the future.Data collection methodThe first hand data will be gathered by distributing questionnaires and analyzing the results. The questionnaires shall be distributed on three banks in the Kingdom of Bahrain which deal with the euro c.The minute of arcary data has been taken from European way website on inflation in the Euro area from 1960s to 2000s, fiscal spot of the euro area in 1992, 1998 and 2007, spurious intra-Euro-area correlation between Gross municipal Product and Industrial Production, two indicators namely the number of years with negative gap sum of negative gaps as a percentage of GDP, macroeconomic performance indicators.Sample selection and selection criteriaThe sample chosen are the employees of three banks in Bahrain who invest and deal with euro c. The banks areArcapitaGFH Gulf pay HouseABC Arab Banking CorporationSurvey methodologyThe methodology pertain analyzing the parameters for significance with the datas obtained from first hand and second hand data which are the survey and other previously published material.The magnitude of a countrys financial system is really vital to decide on its prospective use in the global markets. The global trade and magnitude of a countrys financial markets are related to the economic size. For instance, if we consider the exportation output between Korea and US, the former accounts for a much greater contribution. However as the US economy is 14 times larger than the Korean thereby making it embrace a much larger share in the world exports. The share of a country in international trade, the siz e and economy as well as the openness in financial markets forms deciding(prenominal)s for collect of that countrys c in global markets.Chapter 2Literature reviewsSome entrust that Euro has failed to perform the required needs or reach the final endpoint of welfare for all. Instead it has become burden. Others believe that Euro has resulted in bringing a unity among the European nations which helped them to fight out the Economic depression seen in the last decade.The convertibility of a specie also forms a major determinant for necessity of that cash, because unless there are less restrictions money is exchanged smoothly thereby ensuring increase in essential of coin. For example after world War II, most of the countries except US restricted their convertibility of specie thereby making US dollar readily available in markets increase dollar demand. side by side(p) table gives a justification to the above determinantsParameters united StatesEuro-areaJapanShare of world GDP (%)21.915.87.6Share of world exports (%)15.319.49.3Financial markets ($ billions)40,543.824,133.420,888.5Bank assets ($ billions)7,555.312,731.36,662.5Domestic debt securities outstanding ($ billions)15.426.35,521.96,444.9Stock market capitalization ($ billions)17,562.25,880.27,781.4Following are some more factors that help to support and strengthen the study2.1 Macroeconomic levelPrice stability and low-cost borrowing by European Economic and Monetary Union (EMU) helped ensure macroeconomic stability in Europe. Euro helped put an end to changes in exchange rates indoors Europe owing to changes from outside Europe. The following graph shows improvement in inflation performance thereby leading to sharp decline in price volatility.2.2. distinction of the strength of the currenciesSimilar lines of reasoning can be found in Magee and Rao (1980). They make a distinction between strong and weak currencies according to low and high inflation currencies. The intuition fanny this bei ng that in trade between low inflation industrial and high inflation proveing countries, the low inflation currency of the industrial country dominates. Also, for trade in primary products a vehicle currency might be optimal. The importance of the choice between different currencies came back into the economic discussion when major exchange rates became flexible after the breakdown of Breton Woods in 1973.Viaene and de Vries (1992) take strategic bargaining considerations into account and introduce a forward market. In their prototype, exporters and importers bargain over the invoicing currency. twain are assumed to prefer their own currency, respectively. Viaene and de Vries find that the dominance of the exporters currencycan be due either to the first mover advantage of the trade firm or to the monopoly power of the exporter who is more credibly to have bargaining power as the firm faces a wide blossom forth demand and not many competitors.2.3 Currency riskSumming up the premature literature, the main findings are that traders seek to avoid currencyrisk by using their own currency and that, in trade between alter countries exporters are in general more likely to be able to avoid the currency risk. When currencies are free to fluctuate there is, however, not only the issue of price uncertainty but alsodemand uncertainty.2.4 Invoicing currencyDonnenfeld and Zilcha (1991) present a first formal model in which a firms choice of invoicing currency is analyzed. They are also among the first to develop a model on the Microeconomic level in which the firm optimizes its profits. The main finding of Donnenfeld and Zilcha is that LCP is optimal for the exporting firm if the total gross curve is concave in the foreign price.This is the case when the sensitivity of demand with respect to prices is not much higher the higher the price level. That is, if the price is set in manufacturing business currency and increases (in foreign currency) due to an gustatory s ensation of the exporting firms currency, profits will fall because demand will be reduced by more than the increase in profits due to the higher price received. In the case of depreciation, demand is not extensive enough to compensate for the lower price the exporting firm receives, because demand is less sensitive to the price at the lower price level. If this is the case, higher variability in foreign prices, which comes with higher volatility in the exchange rate under PCP, lowers expected profits. Thus, under these conditions, high exchange rate volatility would lead the exporting firm to distinguish LCP.2.5 Currency marketplaceFriberg (1997) extends the literature by including into the model a forward currencymarket and the possibility to set prices in a third currency vehicle currencyprice (VCP). As in Donnenfeld and Zilcha the choice of the optimal currency setting is closely linked to the price elasticity of foreign demand. The second best currency pricing strategy depen ds on the relative exchange rate volatilities. If the exchange rate towards the vehicle currency exhibits low volatility compared to the bilateral exchange rate of the exporter and importer, VCP is preferred and vice versa.Now, even under LCP the demand for the firms product is uncertain because the competitors might not price in topical anesthetic currency. In such a case fixing the relative price of the competing products can be important to the exporters so they might choose a common vehicle currency. This finding of choosing the currencyof the competitor is also common to a number of other studies.2.6 Pricing StrategyIn particular, Bacchetta and van Wincoop (2002) use a NOEM model to analyze the optimal pricing strategy of exporters.In a very elaborate general proportion framework that also takes into account exchange rate dependent costs they derive similar conclusions to those of Donnenfeld and Zilcha.2.7 demand sensitivity of costs and priceThe operate factors for exporter s to care about their relative prices are the demand sensitivity of costs and the price sensitivity of demand. It can be said that the higher the product differentiation, the lower the price sensitivity of demand. Exporters will, thus, prefer to invoice in their own currency if their products are highly differentiated, while they will pay anxiety to holding their relative prices constant if their products are less differentiated. This does not mean that less differentiated products are always invoiced in LCP, however.2.8 market share of the exporting country in the foreign marketBacchetta and van Wincoop crap into their model the market share of the exporting country in the foreign market that is, the share of the market that is accounted for by firms from a particular country or monetary area. Demand risk is minimized by invoicing in the currency that is most similar to the average invoicing currency chosen by competitors (Bacchetta and van Wincoop 2002, p. 15).For a monetary un ion, it is the market share of the entire currency union that matters and not the market share of an individual country. Exports of a monetary union are therefore more likely to be priced in maker currency, and imports to a monetary union more likely to be priced in local currency, because the monetary unions market share is more likely to be prevalent.Goldberg and Tille (2005) call this behavior of choosing the currency of the competitor a herding effect. In their partial equilibrium three country model a dominant share of a currency other than the one of the exporter or the importer can make vehicle currency pricing the optimal choice. This herding effect takes place for industries with homogeneous goods where producers aim at keeping their prices relative to the competitors stable.Goldberg (2005) elaborates on this model by including a covariance between marginal cost and exchange rates. There is then also a hedging motive to choose a currency so that the exchange rate is corre lated in such a way to shocks to exporters costs that marginal costs are positively correlated with marginal revenue.2.9 Two-country dynamic general equilibrium modelThe most elaborate model so far was introduced by Devereux, Engel and Storegaard (2003). Using a two-country dynamic general equilibrium model with sticky prices, these authors analyze the implications of endogenous exchange rate pass-through. Their results show that the stage of pass-through depends on the relative stability of monetary policy countries with relatively low monetary volatility visualize low rates of exchange rate pass- through. The reason is that firms in both countries have an incentive to set their prices in the currency of the country with the low monetary volatility.As a consequence, the country with low monetary volatility is shielded against exchange rate movements.2.10 The export pricing behaviorEngel (2005) analyses the export pricing behavior of firms in a static model, both in an environmen t with flexible and with fixed prices. He shows that the choice between producer currency pricing and local currencypricing is independent of the degree of sluggishness in price adjustment. Under flexible price adjustment, producer currency pricing is optimal if the variance of the export price in the firms own currency is less than the variance of the price in the local currency of the importer. The same holds in an environment of fixed prices.Summing up the abstractive literature the most important finding is that the optimal pricing strategies are very sensitive to the set of assumptions. In particular, the level of risk aversion and the existence of forward markets to hedge exchange rate risks matter for the results. runner and foremost, however, the sensitivity of foreign demand to prices matters, which can be approximated by the homogeneousness or differentiation of the product. When demand is sensitive to prices the market share of the exporting country, or more specifica lly, the currency used by the competitors matters. When the optimal currency choice depends on the currency used by competitors, herding in the same currency is optimal. Also, currencies of countries with monetary stability are more likely to be chosen as invoicing currency.2.11 The Failure of the EuroMartin Feldstein (2012). As the author mentioned, the euro now shall be known as an experiment that failed. This failure, since the euro was first introduced, in 1999, was not an adventure or the result of bureaucratic mismanagement but rather the necessary results of imposing a single currency on a very heterogeneous group of countries. The adverse economic consequences of the euro include the sovereign debt crises in many European countries, the breakable condition of major European banks, high levels of unemployment crosswise the euro-zone, and the large trade deficits which now block most euro-zone countries.The political goal of creating a harmonious Europe has failed too. France and Germany have dictated baneful austerity actions in Greece and Italy as a state of their financial help. genus Paris and Berlin have clashed over the role of the European Central Bank (ECB)and over how the burden of financial help will be shared.The early gallery that led to the European Monetary Union and the euro was political, not economic. European politicians rationalized that as the use of a common currency would instill in their publics a greater sense of belonging to a European community and that the shift of responsibility for monetary policy from national capitals to a single profound bank in Frankfurt would signal a shift of political power.Michael Sivy (2011), as usually said big stories dont break, they ooze. The demise of the Euro is just such a story. Hence each time it oozes, U.S. stock markets drop. The collapse of the Euro, is now inevitable, in the authors view. When it happens, banks around the globe will be shaken and stock markets will plummet.Academics, journalists and even government officials have projected a set of schemes to save the Euro new European financial institutions, Eurobonds backed by all the countries collectively and even a United States of Europe. However it is clear that any such scheme to save the Euro would find little political support. The breakup will perhaps be extremely painful. Nevertheless, the alternatives may be even more unpalatable.