The European Monetary Union is an economic entity and not a political one. As such, it is not one country, but rather is a group of 19 European countries, all members of the European Union, that have banded together to form a currency bloc for economic gain. The common currency — the euro — replaced the Deutschmark, French franc, Italian lira and others which were phased out of existence on January 1, 2002.

 

The original idea was developed shortly after the end of World War II as a political move (and it remains a political move even though the impact is economic). The goal was to link the European countries so closely that another war would be impossible. But political unity proved to be difficult with countries refusing to give up their national sovereignty. Political union would have meant a common government budget, foreign affairs and social policy. However, monetary union allows countries to have control over their national budgets. At the same time, the countries acknowledge that under monetary union it will be more difficult to solve long term internal problems such as unemployment under the European Economic and Monetary Union (EMU) constraints.

 

In a way, the euro's birth can be looked upon as a solution to the problem caused by the breakdown of the Bretton Woods system of fixed exchange rates in 1971-73. Because of the high level of trade between European countries, it was felt that freely floating exchange rates would be disruptive to commerce and economic growth. Countries attempted to peg their currencies to one another to limit fluctuations. However, because of the lack of economic convergence, periodic realignments were necessary and the countries drifted into two blocks — one with low inflation and low interest rates and another that required higher interest rates to maintain stable exchange. There were still disruptions.

 

The European Economic and Monetary Union had a major impact on the world economy, international trade relations and global financial markets. The Eurozone includes 19 European nations and will eventually rival the size of the U.S. economy as well as U.S. trade volumes. The nineteen countries are Germany, France, Belgium, Luxembourg, Estonia, Finland, Italy, Spain, Portugal, Ireland, Netherlands, Greece, Austria, Slovenia, Malta, Cyprus, Slovakia, Latvia and Lithuania. Three members of the Economic Union (EU) chose not to participate in EMU. Denmark, Sweden, and the United Kingdom did not join because of strong domestic and political opposition. But unlike Denmark, Sweden, and the UK, new members are obligated to join the EMU. EU membership now includes 27 countries.

 

In the absence of independent monetary and exchange rate policy, the only tool left to individual countries is fiscal policy. A Stability and Growth Pact, which puts tight limits on public borrowing, is part of the EMU plan. The logic behind the Pact was to prevent the use of fiscal policy to undermine monetary policy. But if the complicated Pact rules are followed, fiscal policy could become dangerously tight, especially in times of an economic slowdown. It should be noted that one of the criteria for entrance into the EMU was that the government deficit should be no more than three percent of GDP per year and the debt level be not more than 60 percent of GDP. It also should be noted that the three largest countries — Germany, Italy and France — have all breeched the 3 percent ceiling. Rather than being punished, they changed the Pact's rules. This did not sit well with smaller countries who have kept their deficits under control and under the Pact's limits.

 

In the last several years, the union has been challenged as never before by the ongoing sovereign debt crisis that hobbled Ireland, Spain, Italy, Greece and Cyprus.