European Business

1. The Euro system asserts that, in its deliberations, it never pays attention to local (i.e. national) economic conditions. The reason is that there is a single monetary policy and that ‘one size fits all'. Discuss this approach and imagine alternative approaches.

Introduction

The official policy stance of the ECB (European Central Bank) is that monetary policy decisions are reflective of changing economic conditions of the euro area as a whole, and do not reflect any diversity among the national economies within the region (Duisenberg, 2002). While formation of the ECB is necessary for a complete monetary union between EU member states, its "one size fits all" monetary policy has faced criticisms on many fronts. This paper will discuss in detail about the euro system and its single monetary policy and provide alternative approaches that could possibly renew the disparities among the European union and its member countries.

The Single Monetary Policy and ‘Can one size fit all'?

The European Central Bank will face a complicated task setting monetary policy, partly because higher interest rates hit some economies harder than others. Since the euro system is governed by one central bank, all the decisions are collectively held by the heads of the central bank that are the governors of the national banks of the European economies (Begg et al. 2002).

The monetary policy of the European union is centralised and the fiscal policy is decentralised, therefore the main goal of the ECB is to protect the purchasing power of the currency. Which means avoiding rise or fall in prices that are inflation and deflation respectively. In the euro area this corresponds to the annual rise in prices of less than but close to 2%. Price stability effectively contributes to sustainable growth of economic activity and to job creation (De Grauwe, 2002).

Whenever the general price level fluctuates excessively, companies find it hard to plan their future and they tend to invest less, consumer confidence is shaken and demand for goods and services falls off and fewer jobs are created. It is by putting the monetary policy to practice the central bank endeavours to achieve price stability. The central bank does not have a direct influence on prices but rather on short-term interest rates, in order to meet public demand for bank notes the commercial banks have to borrow from the central bank (Schwartz, 2004).

By adjusting the interest rate applied to them the central bank induces the commercial bank to pass these conditions onto their customers, this in turn helps the commercial banks to set the proposed interest rates in the market (Schwartz, 2004).

The monetary policy decisions in the European union are taken by the governing body of the ECB consisting of the governors of the various national