I.

Pszczółka, Advantages and Disadvantages of Introducing the Euro 215

IRENEUSZ PSZCZÓŁKA*

ADVANTAGES AND DISADVANTAGES

OF INTRODUCING THE EURO
„L’Europe sera monètaire ou ne sera pas” – Jean Monnet1

Abstract
Introduction of the common currency in Europe was one of the most spec−
tacular events in the world monetary history. It took almost half of the twentieth
century to reach this goal and see the euro circling in European economy. There
are still some European Union countries left that are potential members of the
European Monetary Union. Therefore it is very important for them to estimate
properly all costs and benefits of this decision, thought only some of them have
right not to join the EMU.
There are two main benefits to be considered. One is the elimination of trans−
action cost and the other is the elimination of exchange rate risk. There are also
two most important costs: one is a cost of institutions and individuals adjustment
to a new currency and the other is a lack of national monetary policy as an adjust−
ment tool when a member state experiences an economic asymmetric shock.

JEL classification: F3, F36, F41.

Key words: euro, convergence criteria, common currency, common financial market, economic
shocks.

Introduction
On 1st January 1999 we witnessed the introduction of a new European com−
mon currency. At that time 11 countries, members of the European Union (UE),
decided to replace their own legal tender with a brand new one, euro. Since that
the euro has been the official currency of Austria, Belgium, Finland, France, Ger−
many, Ireland, Italy, Luxemburg, the Netherlands, Portugal, and Spain. These elev−
en countries, before joining the European Monetary Union (EMU) had to fulfil the
following convergence criteria:
1) price stability – country must have a rate of inflation no more than 1,5 pp above
the average of the three countries in the EU with the lowest inflation,
2) long−term interest rate – country must have a nominal interest rate on long−term
(usually 10−years) government bonds no more than 2 pp above the average of
the three countries in the EU with the lowest inflation rate,
3) government budget deficits – no more than 3 % of Gross Domestic Product
(GDP),
4) total government debt – no more than 60% of GDP,

* Adjunct Professor, Higher Finance & Banking School in Radom, K. Pulaski Technical University
of Radom, Poland.
1
There will be a monetary union in Europe or there will be no Europe, [in:] E. Apel, European Mon−
etary Integration 1958−2002. Routledge, New York 1998, Preface.
216 The Dilemmas of Regional Economic Integration

5) exchange rate stability – national currency of potential participant has to join

Exchange Rate Mechanism (ERM) for two years period, the exchange rate has
to fluctuate between ±15% band and short term high changes of the exchange
rate are not acceptable,
6) central bank independence – national government cannot influence central
bank’s decisions2.
At the time of launching euro in Europe, four other members of the UE stayed
out of EMU due to various reasons. Greece wanted to join the EMU but didn’t
satisfied above mentioned criteria, Sweden didn’t want to do so and deliberately
decided not to satisfy these criteria while Great Britain along with Denmark stayed
out, taking advantage of the “opt−out right” which gives them such a possibility3.
So far only Greece has changed its position, fulfilling the criteria in the year 2000
and launching euro from the beginning of year 2001.
Nowadays there are still 13 members of the UE which stay out of the EMU4.
From their point of view some very important questions arise: is it worth speeding
up the entire process of joining euro zone and what are the pros and cons of intro−
ducing the euro.

1. Road to the euro

Plans for the introduction of a common currency in Europe were named be−
fore the 2nd World War. During the European Congress of the Pan−European Move−
ment, which was held in Basle in 1932, the chairman of the German bank Berliner
Handelgesellschaft Hans Fürstenberg presented the idea of introduction of a Euro−
pean currency as well as setting up a European central bank. His view was wildly
accepted but the plan itself ended up with no farther activities5.
After the 2nd World War European politicians breathed new life into the idea of
European integration. The key date of this integration is 9th May 1950 with the dec−
laration of the French foreign affairs minister Robert Schuman and Jean Monnet pro−
posing to place the coal and steel resources of France and Germany under a common
authority, which was to be opened to any other European country. As a result of that
the European Coal and Steel Community (ECSC) was established6. The next impor−
tant event in the entire process of economic integration in Europe was the Treaty of
Rome, signed by Belgium, France, Italy, Luxemburg, the Netherlands and West Ger−
many, in 1957. At that time the monetary integration was the least important issue
but as a result the European Economic Community7 (EEC) was formed8.
2
See more S. F. Overturf, Money and European Union.St. Martin’s Press, New York 1997, p. 109−113
and N. Barkin, A. Cox, EMU explained. The impact of the euro. Kogan Page, London 1998, p. 15.
3
See more Ch. N. Chabot, Understanding the euro. McGraw−Hill, New York 1999, p. 23−25.
4
It is due to the UE enlargement process. On the 1st May 2004, ten new members (Cyprus, Czech
Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia) joined UE with
no right to stay out of EMU, so this is only a matter of time when these countries introduce euro.
5
W. F. V. Vanthoor, European monetary union since 1848. A political and historical analysis. Ed−
ward Elgar, Cheltenham 2002, p. 59.
6
E. Apel, European Monetary …, op. cit., p. 4−5.
7
Denmark and the United Kingdom joined in 1973, Greece joined in 1981, Spain and Portugal in 1986,
Austria, Finland and Sweden joined in 1995.
8
See more S. F. Overturf, Money …, op. cit., p. 2−8.
I. Pszczółka, Advantages and Disadvantages of Introducing the Euro 217

The year 1969 was a turning point in the whole process of monetary integra−
tion. In December 1969, on the initiative of the French Head of State Georges
Pompidou, The Hague Summit was held. Six Government Leaders strong−willed to
give European integration a fresh impulse. It was decided that the final objective
of the European Community is to create the EMU which should be completed in
1980. All details concerning entire process of monetary integration in Europe was
published in The Werner Report in 1970. Unfortunately the Community didn’t suc−
ceed in achieving this ultimate goal9.
Meanwhile, the Bretton Woods10 system collapsed so the Community author−
ities decided to widen fluctuating margins of members’ currencies against the dol−
lar by introducing the European currency ‘snake in the tunnel’ in 1972. This was
named so, because the margin for fluctuation between European Community (EC)
currencies was narrower than against the dollar11. The snake was not a success and
after a few years shrank so much that was not capable of operating any more12.
The next important step on the road to the full monetary integration in Eu−
rope was the creation of the European Monetary System (EMS) in 1979. The core
of this system are the Exchange Rate Mechanism (ERM) and the European Cur−
rency Unit (ECU) used as a unit of account in the intervention and credit mecha−
nism and as a mutual means of settlement. For every members’ currency, a central
rate against the ECU was calculated and these rates were used to find out a grid of
bilateral central rates. The fluctuation bands were set at 2.25% on either side of the
central rate for most currencies but there was also another option for weaker cur−
rencies with margin of 6%13. Due to the EMS hassles, especially 1992−1993 ERM
crises, Finance ministers of European Community decided to widen the currency
bands for all currencies except the Deutsche Mark (DM) and Dutch Guilder (DG)
to 15%. The DM and DG margin remained at 2.25% on either side of the central
rate14.
The Delors Report, the most important document regarding European union
on the monetary front since establishing the EMS, was published in 198915. There
are several similarities between this Report and The Werner Report, mainly in struc−
ture and ideas, therefore one can call it “a new Werner Report”. According to The
Delores Report, the crucial issue was to centralise monetary authority by establish−
ing a whole new institution – the European System of Central Banks (ESCB). That
Report is treated as a prologue to the first Stage of launching the new European
currency16.

9
W.F.V. Vanthoor, European monetary union …, op. cit., p. 75−77.
10
See more about the Bretton Woods system S.K. Cooper, D.R. Fraser, G.C. Uselton, Money, the fi−
nancial system, and economic policy. Addison−Wesley Publishing Company, 1985.
11
See more H. Carter, I. Partington, Applied economics in banking and finance, Oxford University
Press, 1984, p. 339.
12
N. Barkin, A. Cox, EMU explained …, op. cit., p. 5.
13
W. F. V. Vanthoor, European monetary union …, op. cit., p. 87−94
14
About the ERM crises see more A. Buckley, The essence of international money, Prentice Hall,
London 1996, p. 140−147
15
The Delors Report was one of the effects of the Single European Act (SEA) signed in 1986 and
finally approved in 1987. See more about the SEA S. F. Overturf, Money …, op. cit., p. 59−71.
16
Ibidem, p. 73−103.
218 The Dilemmas of Regional Economic Integration

The milestone of European monetary integration was Maastricht Treaty signed

in 1992. The EMU section of that Treaty appeared mainly in Title II, Articles 102A
to 109M, and eleven Protocols and six Declarations17. According to the Treaty the
entire process was divided into three stages.

Stage I – July 1990 to December 1993

During the summit held in Madrid in June 1989, the Council managed to de−
cide that the first stage of EMU would start on 1 July 199018. That was a time when
a huge progress had been made with regard to the liberalisation of capital move−
ment. Participating Member States decided that the European System of Central
Banks would be composed of the European Central Bank and national central banks
of the EU members and would conduct the common monetary policy which would
be aimed at price stability. At the end of that stage the Single Market was virtually
completed what means that all required law was stated, especially concerning free
movement of goods, services and capital19.

Stage II – January 1994 to December 1998

The mid−stage of the new common currency introducing process start off with
establishing the European Monetary Institute (EMI) as the precursor to the ECB.
The EMI was to prepare and publish operational framework for the single mone−
tary policy. During the special European Union summit in Brussels held in May
1998, the eleven participants of the EMU were announced20. The EMI was trans−
formed into the EBC so the first production of euro notes and coins could start and
permanent bilateral exchange rates between national currencies were announced21.
That was also a time for final adjustment for national legal systems to accommo−
date a new currency.

Stage III – January 1999 to July 2002

The period from the beginning of 1999 till the final money exchange moment
was divided into two phases. The first phase lasted for 3 years from January 1999
to December 2002. This phase began with the introduction of the euro as a legal
tender in eleven mentioned countries, but no coins and notes were distributed at
that time and no one could have been forced to use new currency22. Exchange rates
between the new European currency and all national currencies were irrevocably
locked. European Central Bank (ECB)23 took over responsibility for common mon
17
E. Apel, European Monetary Integration …, op. cit., 1998, p. 100−101
18
This is the date of the entry into force of the directive on the general liberalisation of capital flow in
Europe.
19
W. F. V. Vanthoor, European monetary union …, op. cit., p. 96−107
20
These countries which satisfied convergence criteria and did not take advantage of the „opt−out right”.
The reference period was between mid 1996 and beginning of 1998. All economic indicators of EU
members required by the Maastricht Treaty convergence criteria were published in Convergence
Report prepared by the ECB in 1998.
21
E. Apel, European Monetary Integration …, op. cit., p. 114−130.
22
This rule was called „no compulsion, prohibition”.
23
More about the EBC structure and authorities see The European Central Bank – History, role and
functions. ECB, October 2004.
I. Pszczółka, Advantages and Disadvantages of Introducing the Euro 219

etary policy and all new government bonds in participating countries stared to be
issued in euros. The second phase was planned to last for 6 months but finally it
ceased four months earlier. In January 2002 euro notes and coins appeared for the
first time and national currencies were withdrawn24. During this phase Greece, af−
ter fulfilling convergence criteria, joined the EMU.

2. Advantages of common currency in Europe

Introducing the common currency leads to gains in economic efficiency. These
gains can be divided into two groups. One is the elimination of transaction cost
and the other is the elimination of risk which comes from uncertain fluctuation of
the exchange rates25.
Transaction cost appears in different ways, as a fixed commission or the
spread between the buying and the selling prices of any given currencies. The cur−
rency conversion costs disappear in EMU and it is important either for individuals
or for companies dealing with their foreign partners. One common currency also
creates a simple platform for price comparison, makes price differences more no−
ticeable and helps to equalise it across borders. Disappearance of transaction costs
and price transparency certainly makes the common financial market in Europe
deeper and more integrated. Since the beginning of January 1999 the main finan−
cial instruments are being issued and listed in euros what makes prospective inves−
tors more confident to invest on different EU member’s financial markets26. Finan−
cial market integration provides different channels of risk sharing in EMU.
If we assume that the French and German bond and equity markets are fully
integrated, it will facilitate the adjustment to asymmetric shocks (see Figure 1).

Fig 1. Aggregate demand and supply with asymmetric shocks

Source: P. De Grauwe, Economics of Monetary …, op. cit., p. 219.

24
See more S. F. Overturf, Money and …, op. cit., p. 105−115, Ch. N. Chabot, Understanding the
euro …, op. cit., p. 6−9
25
P. De Grauwe, Economics of Monetary Union. Oxford University Press, 2000, p. 59.
26
For more opportunities for financial markets after the introduction of euro see M. Artis, E. Hennessy,
A. Weber, The euro. A challenge and opportunity for financial markets. Routledge, London 2000,
p. 3−10 and R. Smith, I. Walter, High finance in the euro zone. Pearson Education, London 2000.
220 The Dilemmas of Regional Economic Integration

When France is hit by a negative shock, companies there make losses and that
drives down stock prices of these companies. We assume that both mentioned
markets are fully integrated so stocks of French companies are held by German
investors. At the same time there is an economic boom in Germany and stocks of
German companies go up what gives profits also to French investors holding Ger−
man shares. In this case the risk of a negative shock in one country is shared by all
EMU members. A very similar mechanism also works through the fully integrated
bond market27.
The most important argument justifying the introduction of common curren−
cy is that exchange rate uncertainty is inherently damaging to the volume of real
flows of trade and investment. It means that entrepreneurs facing investment or
trade opportunity are likely to be more enthusiastic when the decision does not
involve the risk of currency fluctuations28.
The elimination of exchange rate risk affects positively international business
environment. The more unpredictable are exchange rates, the more risky are for−
eign investments (both, portfolio and direct) and it is the least expected that com−
panies are willing to purse growth in foreign markets29. This risk is bothersome to
all who make economic decision today and expect payoff in a future time. The euro
completely eliminates exchange rate risk between all the EMU members30.

3. Disadvantages of common currency in Europe

Although the euro brings substantial advantages, it also has many disadvan−
tages31. There are two most important costs: one is a cost of institutions and indi−
viduals adjustment to a new currency and the other is a lack of national monetary
policy as a important tool for a member state to adjust to the economic equilibrium
when it experiences an economic shock32.
While introducing a new currency, public and private institutions of the new
EMU member state have to spend enormous amount of money to adjust invoices,
price lists, office forms, payrolls, bank accounts, databases, software, parking and
postage meters, to name only a few. It is also important to calculate the cost of
notes and coins33. But this disadvantage seems to be less important than the other
one.
Economic shocks are unexpected changes in the macroeconomic environment
of a EMU member state that results in imbalance of production, consumption, in−
vestment, government spending and trade. The worst one for the EMU is that which
affects members unequally and it is called an asymmetric shock. The important
feature of this type of shock is that economic growth in a country affected by it
goes down while in others it does not. If a country does not change its currency

27
P. De Grauwe, Economics of Monetary …, op. cit., p. 219−220.
28
L. S. Copeland, Exchange rates and international finance, Pearson Education, London 2000, p. 264−266.
29
See more P. De Grauwe, Economics of Monetary …, op. cit., p. 61−64.
30
Ch. N. Chabot, Understanding the euro…, op. cit., p. 39−42.
31
See more P. De Grauwe, Economics of Monetary …, op. cit., p. 5−22.
32
L. S. Copeland, Exchange rates …, op. cit., p. 269−270.
33
Ch. N. Chabot, Understanding the euro …, op. cit., p. 50.
I. Pszczółka, Advantages and Disadvantages of Introducing the Euro 221

into the euro it can handle asymmetric shock using monetary34 and fiscal policies,
but when it decides to enter a monetary union it does not have right to conduct
national monetary policy any more and has to search for different tools to deal with
this kind of shocks. The remaining tools are fiscal adjustment, labour mobility,
capital mobility and, as it was mentioned above, fully integrated common financial
market in the EMU, just to mention a few35.

Conclusions
The introduction of the euro was one of the most important events in the
world’s monetary history. It started with eleven countries, then also Greece joined
in, and there is still a long queue of the EU members willing to be a member of the
EMU. This big number of countries doing their best to fulfil convergence criteria
confirms, that there are more advantages than disadvantages of changing their na−
tional legal tenders into the common European currency. Apart from all mentioned
negative effects, lower transaction costs, elimination of exchange rate risk along
with price transparency and single legal tender, have increased the effective size of
products markets across the EMU. Therefore, it should facilitate achieving econo−
mies of scale.
On the other hand at the time of birth of the euro many politicians claimed
that the common currency would lead Europe to a golden age of higher economic
growth. That has not happened so far and the same politicians state that it is due to
introducing the euro. In fact, they use common European currency as an excuse of
their internal economics ineffectiveness.
Some economists also say that introducing euro is not just about cost−benefit
analysis. The main driving force of entire European integration process was the pure
political goal36. Even the EU member countries differ in estimating the advantages
and disadvantages of new European currency. The three countries of a „old core of
the EU”, Denmark, Sweden and the Great Britain decided to stay out of the EMU
but almost all new members of the EU are very excited about joining the monetary
union. Some of them have already decided to enter the European Rate Mechanism
II (ERM II).

References
1. Apel E., European Monetary Integration 1958−2002. Routledge, New York 1998.
2. Artis M., Hennessy E., Weber A., The euro. A challenge and opportunity for finan−
cial markets, Routledge. London 2000.
3. Barkin N., Cox A., EMU explained. The impact of the euro. Kogan Page, London
1998.
34
For example by interest rate adjustment or exchange rate intervention. National central bank of a non−
member state can response to economic slow dawn by lowering this country’s interest rates. As far
as a member state is concern, the ECB is responsible for interest rates in the EMU and has to take
care of all economics.
35
Ch. N. Chabot, Understanding the euro …, op. cit., p. 51−53.
36
Ibidem, p. 59.
222 The Dilemmas of Regional Economic Integration

4. Buckley A., The essence of international money. Prentice Hall, London 1996.
5. Carter H., Partington I., Applied economics in banking and finance, Oxford Uni−
versity Press, 1984.
6. Chabot Ch. N., Understanding the euro. McGraw−Hill, New York 1999.
7. Cooper S.K., Fraser D.R., Uselton G.C., Money, the financial system, and econo−
mic policy. Addison−Wesley Publishing Company, 1985.
8. Copeland L.S., Exchange rates and international finance. Pearson Education, Lon−
don 2000.
9. De Grauwe P., Economics of Monetary Union. Oxford University Press, 2000.
10. Overturf S.F., Money and European Union. St. Martin’s Press, New York 1997.
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14. Vanthoor W.F.V., European monetary union since 1848. A political and historical
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