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In order to enjoy the benefits of increased economic integration, 11 European countries formed the Economic and Monetary Union (EMU) and began using a common currency, the euro, on January 1, 1999. At the same time, each of the countries yielded its ability to conduct its own monetary policy to the European Central Bank (ECB), located in Frankfurt, Germany, which now conducts monetary policy for the EMU. The primary objective of the ECB is to "maintain price stability," and the Bank is instructed not to "seek or take instructions from . . . any government of a Member State or from any other body." The 11 countries in the EMU are Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. These countries have a combined population of about 300 million people—about 10 percent more than that of the United States—and a combined gross domestic product about one-third that of the United States. Greece joined the EMU as of January 1, 2001, while the citizens of Denmark voted in 2000 not to join. By agreement, the EMU countries' individual currencies will continue to circulate until 2002, but during this transition each currency has a fixed value in relation to the euro—and, consequently, in relation to the currency of each of the other EMU members, too. Thus, each participating nation has given up, in addition to its monetary policy power, its ability to influence the foreign exchange (FX) value of its country's currency. (The FX value of the euro may vary against other currencies, however.) Currently, the euro can be used only for non-cash transactions, although anyone can have a euro-denominated bank account. Euro notes and coins will be brought into circulation by January 1, 2002. The euro is divided into 100 cents, and there will be coins of one, two, five, 10, 20, and 50 cents, and one and two euros, and notes of five, 10, 20, 50, 100, 200, and 500 euros. As of July 1, 2002, the individual countries' notes and coins will no longer be legal tender. Background Benefits The common currency will promote trade among the EMU countries not only by reducing transaction costs, but also by eliminating both exchange-rate uncertainty within the EMU and the costs of protecting against foreign-exchange risk. Thus, the German wine importer will not have to worry about what might happen to the mark/franc exchange rate from when it places the order to when it has to pay for the wine, and neither will it have to go to the expense of a forward contract to protect against possible adverse changes in the exchange rate. The reduced costs of international trade will force firms to compete to a greater extent than previously against firms in other EMU countries. Moreover, because firms will be producing for larger market areas, they will be able to enjoy increased economies of scale. The increased competition and increased economies of scale, should, in turn, lower prices and raise the standard of living of the residents of EMU countries. The use of a single currency is generally regarded as a factor that has contributed to the success of the U.S. economy over the years, and Europeans hope that their use of a single currency will bring them similar benefits. Costs Labor mobility within the EMU is another factor. In a large single-currency area such as the United States, labor mobility plays a major role in solving the problem of high regional unemployment. If the economy is weak in one part of the country, while labor shortages exist elsewhere in the country, workers can move from the high-unemployment area to the regions where jobs are plentiful. However, because of differences in culture, language, etc., labor mobility has been much lower among EMU countries than it is between regions of the United States. With unemployment in the EMU running around 9%, and with the individual EMU countries having yielded much of their ability to conduct macroeconomic policy, the EMU faces the challenge of trying to increase international labor mobility. The advent of the euro also creates adjustment problems for the average citizen. Europeans must adjust to coins and notes with values different from those with which they have become familiar. Under the euro, for example, people in both France and Belgium will be using the same coins, but France currently has nine coin denominations, while Belgium has just five. Implications for the United States The Euro's First Two Years |