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Relationship between the European Euro crisis in 2012 and the American economy.

Relationship between the European Euro crisis in 2012 and the American economy.

Evaluate the relationship between the European Euro crisis in 2012 and the American economy. Assess how this affects American businesses and decisions made by mangers related to sustainable profitability. Provide examples with your response. Aside from maximizing profits, assess the factors that managers must consider when making the decision to outsource or integrate forwards or backwards considering which factor would be most influential for decision-making.

The Euro experienced two main forerunners. The first one was the “currency snake” which was created in 1972/73 by the European Economic Community (EEC) as a new system of exchange rates. Within the currency snake currencies were pegged within a range of ± 2.25%. However, this system broke down. The second predecessor was the European Monetary System (EMS) which was founded in 1979 introducing an artificial currency, the so called European Currency Unit. The EMS consisted of 12 members but came under speculative attacks. In consequence, the UK and Italy left the EMS in 1992. At the same time Jacques Delors published his idea of a common currency in Europe. Finally, this plan was established by the Maastricht Treaty 1991/1992 which changed the European Community (EC) substantially. The treaty had three pillars.2 Most importantly, the treaty included the EC, which in turn consisted of four parts including the Economic and Monetary Union (EMU). This EMU was established in three stages. The first stage was the European Exchange Rate Mechanism (1990-1994). In the second stage (1994-1999), national central banks were granted (instrument) independence and the European Monetary Institute (EMI) was founded. The EMI was the predecessor of the European Central Bank (ECB), which started its work in 1999. The ECB is part of the European System of the Central Banks (ESCB) which is now in charge of monetary policy in the Eurozone. The Euro was introduced at the very beginning of 1999 as electronic currency only, while people used their domestic currencies from 1999 to 2002. From 2002 onwards the Euro is the sole legal tender in the Eurozone. Any country that wants to become member of the currency area is required to meet the Maastricht criteria. These are: first, inflation rates should not be more than 1.5 percentage points higher than the average of the top three countries. Second, exchange rates have to remain within the EMS bands for two years. Third, average nominal long-term interest rates should not surmount that of the three best performing countries by more than two percentage points. Fourth and most importantly, budget deficits must not be higher than 3% with respect to GDP and the debt-to-GDP ratio must not be higher than 60%. While the first three criteria were no hurdles for most countries, several countries struggled to meet the fourth criterion. However, budget deficits can relatively easily be reduced by privatizations and other measures. Thus, the focus was mainly on gross public debt. Eventually, most EC countries managed to meet this requirement. The exceptions were Italy, Belgium, and Greece. While Greece was not allowed to introduce the Euro in 1999, Italy and Belgium were, although they did not pass this test. Two years later Greece was allowed to join, despite the fact that Greece’s debt-to-GDP was still well above 60% and (as became known in 2004) its statistics were faked. This spotlights one of the root causes of the Euro crisis. The legal framework, which the founders of the Euro thought would force member countries to maintain fiscal rectitude turned out not to be “written in stone”. In fact, politicians can move the goalposts at will (and have done so). During the past 14 years several countries failed to fulfil the public deficit criterion, some repeatedly. However, the Maastricht deficit procedure, which mandates fines for sinner countries, was not always implemented. In 2002 and 2003 France and Germany ran deficits that were too high but strong-armed their partners in the Eurozone into forgoing punishment. This fatally weakened the legal framework of the Maastricht Treaty. Thus, the Maastricht criteria are merely recommendations, not requirements. The Treaty also included a no bail-out clause meaning that member countries shall not be liable for other countries’ debt. The idea that founders of the Euro had —namely that the criteria would be a benchmark that all members would endeavor to meet and that the no bail-out clause prevents the assumption of debt— turned out to be blue-sky thinking.

The most popular currency exchange was mainly a governmental undertaking, no financial 1. This fact explains the acceptance of countries whose public debt was too high as well as the establishment of the currency area as a whole. There is a broad literature that deals with the question whether countries should form a currency area. According to the impossible trinity model, each country has to select from capital mobility, autonomous monetary policy, and fixed exchange rates. One can only have two of the three. In the Euro zone countries have fixed exchange rates against the other member states and there is full capital mobility. Thus, EMU countries cannot conduct monetary policy autonomously. But why should a country voluntarily give up the right to an autonomous monetary policy? Theory might provide an answer. Robert Mundell (1961) was the first to talk about optimum currency areas. The question is always: How can economies deal with asymmetric shocks? Countries with flexible exchange rates can revalue their currencies. Such devaluations make the economy externally more competitive. In a currency area this mechanism is not available. Only the currency as a whole can devalue against other currencies. However, this mechanism can be offset by capital and labour mobility. If one member country is hurt by a negative demand shock (e.g., Spain) and another is confronted with a positive demand shock (e.g., Germany), yields and wages decrease in Spain and increase in Germany. These imbalances can be eliminated if workers and capital move from Spain to Germany. This would eventually lead to increasing prices and wages in Spain and decreasing prices and wages in Germany. However, this depends on the condition that workers and capital freely move and that investors and employees are willing to do so. In theory, the first condition is satisfied in the EMU, which mandates free capital and labour mobility. Capital is in fact mobile, but this does not apply to labour for several reasons.

Firstly, moving internationally is costly compared to relocating capital between monetary centres. Even so, the largest barrier is language. From the 18 Euro countries around the world there are actually 16 various languages. English is not the doing work language everywhere and particularly not in the production sector. Moreover, skilled credentials will not be an easy task to transfer from state to state. While nurses have to review at college in Italy, they are only needed to complete a course of training in Germany. And most importantly, so many people are not happy to move from a region to a different one while they will have to abandon their households and friends powering. Nonetheless, as outlined by McKinnon (1963), a currency exchange region might still be useful for nations, considering that the most important component is openness, not component mobility. The more open up an economic system is, the a lot less charges are dependant upon domestic source and demand. For the very available economy, revaluation might resulted in a even worse scenario as transfer costs raise and result in brought in rising prices. If import goods are an essential insight for exports, export prices might must also climb. Additionally, domestic income might increase as staff members request a pay tag-up as a result of greater household inflation. Both situations would minimize value competition. Therefore, whether or not a currency region is sensible is dependent upon the interconnectedness of domestic financial systems. These dinner table features some facts in regards to the position of intra-national buy and sell of chosen regions.

One third idea coping with money locations comes from Kenen (1969). According to him, asymmetric shocks are not that problematic if countries are highly specialized in producing several goods. A more diversified economy has also a more diversified export sector. This means that an asymmetric shock affects only part of the economy. Eventually, shocks should balance themselves out. This means that fixed exchange rates are useful for countries that produce a variety of goods. There are only some studies that discuss whether this applies to Euro countries. According to Baldwin and Wyplosz (2004), product diversification is reasonably high in Europe. However, there are large differences between countries.