Global Balance of Payments of the European Union - Essay Example

? ‘One of the aims of EMU was that only the global balance of payments of the European Union with the rest of the world be of importance and not those between members’ Introduction The major states of the European provinces are controlled together in terms of certain policies that are framed and structured by the European Monetary Union. 17 states of the Euro zone and the 11 non-euro states are members of the EMU (Sadeh, 2006). There are mainly three subdivisions of the EMU but all the members have to be a part of the ‘third EMU stage’. Each of the member states that are part of the third stage is only eligible to use the Euro currency. In the recent economic epoch it is analyzed that the economic structure of different nations in the euro zone is actually separate. The monetary inflexibility of the policies in the EMU is becoming difficult when followed under the current economic operations of different nations. There is a widespread financial crisis in the European states (Kenen, 2000). The rigid policies of EMU prevent the monetary authorities in different countries to undergo the process of deficit financing that would help the nations to pay out its creditors. The EMU aims at evaluating the currencies of its European states and thus improving their Balance of Trade. It facilitates the nations to collect higher tax revenues and achieve a successful growth in their GDP (Visser, 2004). The essay tries to show how the EMU aims at improving the Balance of Payment (BOP) situation of Euro zone states with the rest of the world. The essay will try to analyze the optimal policy that can be adopted by the European Union to improve its balance of payments disequilibria with the rest of the world. Balance of Payment and its Significance The Balance of Payment helps to take an account of the monetary transactions carried out by a nation with the rest of the world (McCombie and Thirlwall, 1994). It involves the financial imports and exports that a country gets involved into by comprising the trade with goods and services, economic resources and monetary transfers. If the Balance of Payment account becomes 0 in a nation it simply means that the country is neither having any surplus nor any deficit. The essay mainly emphasizes on the two main components of Balance of Payment (BoP) account that is current account and capital account. The current account looks into the trading affairs mainly of tangible goods and services; on the other hand the capital account looks into the inflow and outflow of financial assets in an economy. A nation can have either a fixed or a floating exchange rate. If a country has a fixed exchange rate then the central bank of the nation accepts foreign fund inflow exactly at par with the level of fund that the nation has out-flowed. By doing so the state makes the exchange rate of the economy rigid. The BoP surplus or deficit can only be analyzed in that situation by the reserves of foreign exchange with the central bank. On one other hand if the exchange rate of a country is more flexible than the central bank does not intervene in the matters of goods and service trading. In such situation, the country’s currency evaluates if its exports are more than its imports and the currency devaluates if the imports are more than the exports. The essay will throw a light on the BoP situations of the almost all the states as a whole who are included in the Euro Zone. BoP Situations of Euro Zone The countries in the European Union are undergoing severe financial crisis since the latter half of 2009. The nations are not only facing a sovereign debt crisis but also a crisis in their banking affairs. The Euro Zone nations are lagging behind other nations both in terms of competitiveness and growth. In some of the countries the crisis was so severe that to refinance their state debts they had taken assistance from the third parties. The commercial banks in the Euro zone are undercapitalized (Baimbridge and Whyman, 2008). The configuration of the nations of the Euro zone countries as a monetary union but not as an economic union added to the problem. Along with the government debts the level of private debts was also increasing. As a result the economy of the Euro zone was not just suitable for new investments and implicit bailouts were also not allowed by the commercial banks. The European Momentary Union is experiencing a severe Balance of Payment crisis. In order to eradicate the problem many of the countries have responded to public rescue funds. Many nations to negotiate the deficit in their BOP have taken loans from the European Central Bank (ECB); most of these funds granted by the ECB is actually comes from German Bundesbank (Thirlwall and Gibson, 1992). Among the member states the economic situation of Greece, Ireland, Portugal and Spain are worst. The acronym GIPS is used to address there laid back economies in the Euro zone. By the mid of 2011 the BoP deficit of these nations has reached to a level of almost 327 billion Euros (Sinn, 2012). On the other hand Germany claimed a surplus in its BoP account of about 337 billion Euros. This fact explains that since 2009 the economic status of the European Union has been generally unequal. In general it can be concluded that the European Monetary Union must allow flexible policies for the purpose of improving the Balance of Payment deficits in most of the nation. (Source: Kentwillard, 2012) Dynamics Approach in BoP to get sustained growth The essay will now try to analyze the best policy that EMU can adopt to improve the Balance of Payment situations of the European Union. A sustained growth in balance of Payment can be achieved by the Keynesian approach according to Thirwall in 1979. This approach will concentrate on the growth of BoP by considering the real exchange rate to be constant. It is accounted that since 2007 the countries in Europe had poor balance of payment situation, especially in the current account. The full employment level of output in Keynesian theory is the output produced when all the resources of the economy are utilized fully and efficiently. There can be different types of policies that the European Monetary Union can adopt to improve the BoP conditions of certain countries in the Euro zone. One policy that the EMU can adopt is to increase the level of expenditure in the economy; this is the expenditure changing policy (ECP). It is assumed here that the actual level of output is less than the potential or full employment level. The target is to improve the BoP account. Then with this policy EMU can either adopt expansionary fiscal or monetary policies for the countries in the Euro zone. By doing so the income levels of the nations severely running under crisis can be improved (King, 2003). The EMU must consider the most desirable regions while framing its policies. The EMU can also have direct controls in the economies. For this rule the organization should try to focus on the price level. So EMU can control over the tariff and non tariff barriers in the economy or keep controls in the exchange rates. Thus the policy will result in changes of both imports and exports of the country (Flanders, 1989). This policy is in reality not accepted by the policy makers as it goes against the theories of free trade and opposes the rules of WTO. Optimal Policy The best and optimal policy that the EMU can adopt is the structural investment policy. These policies are analyzed to improve the downtrodden state of European economies over the years. They can be in the form of European Social Fund (ESF), European Regional Development Fund (ERDF), European Maritime and Fisheries Fund (EMFF) and European Agricultural Fund for Rural Development (EAFRD). The concept of such policies actually came up during the 1980’s when the International Monetary Fund and the World Bank used to offer loans to the poor economies of certain developing nations like India. In return to the loans offered, the countries had to make certain economic reforms instructed by the lending organizations. These reforms resulted in unfavorable outcomes in such economies. It caused high inequality of income distribution in their economies. Thus such policies, as the structural investment policies may not be best for the poor Euro economies. It is most desirable that EMU should try to adopt expenditure changing policies that will help to boost up the exports and reduce the imports of the nations. The institution should encourage in export promotion and import substitution policies. The nation should try to increase its capacity to expand its world market for exports. The state should adopt expansionary fiscal policies. These policies involve in increasing the level of government spending in the economy. The state should try to reduce its taxes. It should increase the level of its transfers and unilateral payments. The government in such policies can also adopt expansionary monetary policies. Unlike the fiscal policies the monetary policies involve in the changes of money related affairs of the economy (Verdun, 2002). The state should try encouraging the financial institutions and make them offer greater loans to the business firms in the country. If the level of investments increases in the economy, then it would help in increasing the production level of various goods and services. A rise in production level will offer a greater level of employment opportunities for not only labors but for all other resources. In the theories of John Maynard Keynes efficient and appropriate allocation of resources would help the economy reach its full employment level (Machlup, 2003). The country can then widen its exports and sustain itself by reducing the level of its imports. Thus the essay analyses that it would be best for EMU to encourage expansionary fiscal policies in the economy. Conclusion ‘One size does not fit all’; different member states in the European economy have different determinants for its crisis so it is not feasible that the same monetary policies will be applicable for all the Euro zone economies. This is because certain countries are now no longer in crisis like Germany. If the European Monetary Union adopts same policies for all the countries then it would inappropriately give higher attention to the wealthy economies at the cost of the weak once. Thus optimally to improve the BoP situation of the nations the ECB should realize the core areas of concern in its territories. However the ECP can be a good policy for the poor Euro economies. Reference List Baimbridge, M. and Whyman, P., 2008. Britain, the Euro and Beyond. Aldershot: Ashgate. Flanders, J., 1989. International Monetary Economics, 1870-1960: Between the Classical and the New Classical Cambridge: Cambridge University Press. Kenen, P., 2000. The International Economy. Cambridge: Cambridge University Press. Kentwillard, 2012. Balance of Payment as a % of GDP. [online] Available at: [Accessed 02 August 2013]. King, J. E., 2003. A History of Post Keynesian Economics since 1936 Cheltenham: Edward Elgar Publishing. Machlup, F., 2003. International Monetary Economics. London: Routledge. McCombie, J. S. L. and Thirlwall, A. P., 1994. Economic Growth and the Balance-of-Payments Constraint. London: Macmillan. Sadeh, T., 2006 Sustaining European Monetary Union: Confronting the Cost Of Diversity. Colorado: L. Rienner Publishers. Sinn, H. W., 2012. The European Balance Of Payments Crisis. [online] Available at: [Accessed 02 August 2013]. Thirlwall, A. P. and Gibson, H. D., 1992. Balance of Payments Theory and the United Kingdom Experience. London: Macmillan. Verdun, A., 2002. The Euro: European Integration Theory and Economic and Monetary Union. Maryland: Amy Rowman & Littlefield. Visser, H., 2004. A Guide to International Monetary Economics: Exchange Rate Theories, Systems and Policies. Cheltenham: Edward Elgar Publishing. Read More