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Benefits costs of Eurozone

Benefits costs of Eurozone - BENEFITS AND COSTS OF ENTERING...

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B ENEFITS AND C OSTS OF E NTERING THE E UROZONE George S. Tavlas Europe’s single-currency undertaking is perhaps the boldest at- tempt ever in which a large and diverse group of sovereign states has attempted to reap the efficiency gains of using a common currency. On January 1, 1999, 11 European Union countries initiated the Eu- ropean Monetary Union by adopting a common currency, the euro, and assigning the formulation of monetary policy to the Governing Council of the European Central Bank, based in Frankfurt. Two years later, Greece became the 12th member of the EMU. In May 2004, 10 additional countries joined the EU and eventually will become mem- bers of the EMU. 1 The EMU is the culmination of a process that began in the aftermath of World War II with a range of narrow economic-cooperation agreements, leading to the creation of a com- mon internal market, and, now, to a common central bank and a single currency. The decision whether to join the EMU is part of a broad economic and political calculus about the advantages and disadvantages of par- ticipation in a monetary union. What are the benefits and costs of entering the eurozone? This article addresses that question. Exchange Rate Regimes and Globalization In recent years, a large part of the economics profession appears to have become converted to “the hypothesis of the vanishing middle.” Cato Journal , Vol. 24, Nos. 1–2 (Spring/Summer 2004). Copyright © Cato Institute. All rights reserved. George S. Tavlas is Research Director at the Bank of Greece and Alternate to the Governor of the Bank of Greece on the European Central Bank’s Governing Council. He thanks Harris Dellas, Francesco Mongelli, and Michael Ulan for helpful comments. The views expressed are those of the author and should not be interpreted as those of the Bank of Greece. 1 The 10 accession countries are the Czech Republic, Cyprus, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia. Three countries, Denmark, Sweden, and the United Kingdom, are members of the EU, but have not adopted the euro. 89
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The underlying premise of this hypothesis is that increasing global- ization has undermined the viability of intermediate exchange rate regimes, such as adjustable pegs, crawling bands, and target zones (Eichengreen 2000: 316). 2 What has caused the retreat from the middle ground? First, an explosive increase in capital flows has had important im- plications for the ability to conduct an independent monetary policy. While the rise in capital flows has increased the potential for inter- temporal trade, portfolio diversification, and risk sharing, it has made the operation of soft pegs problematic. This circumstance gave rise to Cohen’s (1993) thesis of the Unholy Trinity: under a system of pegged exchange rates and free capital mobility, it is not possible to pursue an independent monetary policy on a sustained basis.
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