Introduction:

Both the advantages and disadvantages of a currency union have been rehearsed at length in the context of the adoption of the single (euro) currency in the Euro zone. Amongst the potential advantages are:

- Reduction in transaction costs;

- Increases in both the scale, competitiveness and liquidity of markets;

- Less external disturbance to the larger, more closed economy, andhence even greater price stability;

- Enhanced tendencies towards political and fiscal unity, with more internal risk sharing.

The experience of the Euro zone since its inception in January 1999 has been mixed. As a frequent traveller to many countries within the Euro zone, I can vouch for the reduction in transaction costs. The introduction of euro notes and coins at the start of 2002 was a technical triumph, though slightly marred by a public perception that it led to a blip in inflation, from the rounding-up of prices of some frequently purchased smallvalue items (e.g. in kiosks and in restaurants). Not all cross-border transactions costs, for example via bank payments, have, however, declined as much as had been expected or will eventually occur.

Again experience in the unification and cost reduction in markets has been mixed. Within financial markets, fixed interest markets, both the money market and the euro-bond market, have been effectively unified, and their scale and efficiency increased. Europe is in the throes of merger negotiations amongst many of the national stock-markets, but for the time being there has been little change in the efficiency, costs or (clearing and settlement) procedures of the various (national) stock markets. Although there are now clear signs of more cross-border mergers amongst large banks, retail financial markets in banking and insurance have remained separated, without much evidence of significant efficiency gains and cost reductions.

With the compression of twelve national currencies into a single Euro zone, a much larger share of trade of the individual enterprises has become internal within the Euro area. The Euro zone has become almost as much a closed economy as the USA or Japan; in 2003 the comparable data for foreign trade as a percentage of GDP are Japan 13.2 per cent, USA 14.4 per cent and the Euro area 16.7 per cent. This has the benefit of reducing the scale of shocks from external disturbances to the individual enterprise, or country, and this has been a significant boon. By the same token, however, the relatively closed nature of the Euro zone means that it will be less responsive to such exchange rate changes as do occur, and these may then have to be larger to have much aggregate effect.

Since its formation in 1999 the euro has certainly fluctuated considerably against the US$, and done so without any clear relationship with fundamentals.

But these fluctuations were not noticeably greater than that of the DM/$ exchange rate in the previous ten years. Moreover, the effective nominal (or real) exchange rate of the euro has fluctuated much less, because of the high weights of sterling and the Nordic currencies, plus the East-European, Mid-East and North-African countries, whose currencies are quite closely aligned with the euro,. Although the euro has not become as close a rival to the dollar for international financial purposes (reserve holding, invoicing, etc.) as some had hoped, its record on this front has been relatively successful.

There is, however, no doubt that the driving force for the adoption of greater European economic and monetary union (EMU) has consistently been political, with the over-riding aim of achieving rapprochement be tween France and Germany and maintaining peace in the European area, though over-taken in the latest decade by the concept of ‘return to Europe’ for countries east and south east of the Oder river, the previous boundary with communist Eastern Europe. Monetary union was perceived as an important step in this process, of achieving ever greater harmony and unification within Europe. Moreover, it was quite widely recognised that there could be difficulties in combining a federal, unified monetary system with national, decentralised fiscal systems; the centralised community budget is very small, just over 1 per cent of EU GDP (and still largely dedicated to agricultural subsides and economic development support for the lower income parts of the EU, previously the Mediterranean, but increasingly now the Eastern European, countries). It was hoped that such pressures could induce both politicians and voters to accept the necessity of moving quite rapidly towards greater coordination and then unification of both fiscal policies and political sovereignty. ...